Charlie Munger: A Lesson on Elementary Worldly Wisdom

Talk 2 of the eleven in Chapter Four of Poor Charlie’s Almanack. See The Eleven Talks of Poor Charlie’s Almanack for the full collection.

Key Takeaways

You should understand the environment in which you operate. Incentives, motivations, people you work with, everything. They all impact you for better or worse.

Highlights & Notes

Kyle’s reading layer from Poor Charlie’s Almanack, preserved verbatim. Munger’s text and pulled-in source quotes appear as bullets; Kyle’s own annotations appear as Kyle: callouts.

• After all, the theory of modern education is that you need a general education before you specialize. And I think, to some extent, before you’re going to be a great stock picker, you need some general education. #Education
• “There is no royal road to learning; no short cut to the acquirement of any art.” Anthony Trollope
• However, double-entry bookkeeping was a hell of an invention. And it’s not that hard to understand. But you have to know enough about it to understand its limitations because although accounting is the starting place, it’s only a crude approximation.
• He had another rule, from psychology, which, if you’re interested in wisdom, ought to be part of your repertoire-like the elementary mathematics of permutations and combinations.
• You might ask why is that so important? Well, again, that’s a rule of Psychology. Just as you think better if you array knowledge on a bunch of models that are basically answers to the question, why, why, why, if you always tell people why, they’ll understand it better, they’ll consider it more important, and they’ll be more likely to comply. Even if they don’t understand your reason, they’ll be more likely to comply.
• Now you get into the cognitive function as distinguished from the perceptual function. And there, you are equally-more than equally in fact-likely to be misled. Again, your brain has a shortage of circuitry and so forth-and it’s taking all kinds of little automatic shortcuts. So when circumstances combine in certain ways-or more commonly, your fellow man starts acting like the magician and manipulates you on purpose by causing you cognitive dysfunction-you’re a patsy.
  • Q: If humans have no free will, why do you even bother to write books? What do you expect people to do with this insight? YNH: Let’s leave abstract philosophy aside and look at this question from a very practical perspective. For most people, the question of free will is really one about making choices in life. How do you choose what to eat for breakfast? How do you choose where to go on vacation? Where to work? Whom to marry? Whom to vote for? People imagine that they make these choices “freely.” Ideologies such as liberalism and capitalism encourage people to think that way. This makes people very incurious about themselves. As long as I think that my choices reflect my free will, I have no incentive to investigate what made me choose this or that — I simply did it of my own free will. Therefore I completely identify with whatever choices I make, and I remain ignorant about the biological, social, and cultural forces that have really shaped my decisions. This is how belief in free will becomes a big barrier to self-exploration and self-understanding. In the twenty-first century the price we pay for ignorance about ourselves will increase dramatically, because governments and corporations are now gaining unprecedented abilities to hack and manipulate human choice. And the easiest people to manipulate are those who believe in free will — because they refuse to acknowledge that they can be manipulated. So forget the philosophy and be very practical about it. Even if you believe in the theoretical possibility of free will, at least acknowledge that this possibility is not realized in each and every choice you make. Freedom isn’t something you automatically have; it is something you must struggle for. In 99 percent of cases, your choices aren’t made freely but are shaped by various biological, social, and cultural forces. I would be happy to concede that there is such a thing as “free will” and that 1 percent of our decisions are made completely freely if in exchange people investigate more seriously what shapes the other 99 percent. #free will #Compromise #Behavioral Economics
• Personally, I’ve gotten so that I now use a kind of two track analysis. First, what are the factors that really govern the interests involved, rationally considered? And second, what are the subconscious influences where the brain at a subconscious level is automatically doing these things-which, by and large, are useful but which often misfunction?
• Just as in an ecosystem, people who narrowly specialize can get terribly good at occupying some little niche. Just as animals flourish in niches, similarly, people who specialize in the business world-and get very good because they specialize-frequently find good economics that they wouldn’t get any other way. #Hedgehog vs. Fox #Jack of all trades, master of none
• “Change, as in the case of the Internet, can be the friend of society. But it is the absence of change that is often the friend of the investor. While the Internet will change many things, it will not likely change the brand gum people chew. Charlie and I like stable businesses like chewing of gum and try to leave life’s more unpredictable things to someone else.” Warren Buffett #Circle of Competence
• “From 1981 to 1995, we said we were going to be “the most competitive enterprise in the world” by being No. 1 or No. 2 in every market-fixing, selling, or closing every underperforming business that couldn’t get there. There was no doubt what this mission meant or entailed.” Jack Welch
• “Before you are a leader, success is all about growing yourself. When you become a leader, success is all about growing others.” Jack Welch #Leadership
• “Give a project visibility. Put great people on it and give them plenty of money. This continues to be the best formula for success.” Jack Welch
• “Finding great people happens in all kinds of ways, and I’ve always believed, ‘Everyone you meet is another interview.” Jack Welch #Networking
• “It was a real blessing for me to be so green and ignorant, because it was from that experience that I learned a lesson which has stuck with me through all the years: you can learn from everybody. I didn’t just learn from reading every retail publication I could get my сan hands on, on, I probably learned the most from studying what [my competitor] was doing across the street.” Sam Walton #Spirit of Humility
• If people tell you what you really don’t want to hear-what’s unpleasant-there’s an almost automatic reaction of antipathy. You have to train yourself out of it. It isn’t foredestined that you have to be this way. But you will tend to be this way if you don’t think about it. #Spirit of Humility
• Walton, being as shrewd as he was, basically broke other small town merchants in the early days. With his more efficient system, he might not have been able to tackle some titan head-on at the time. But with his better system, he could sure as hell destroy those small town merchants. And he went around doing it time after time after time. Then, as he got bigger, he started destroying the big boys.
• You can say, “Is this a nice way to behave?” Well, capitalism is a pretty brutal place. But I personally think that the world is better for having Wal-Mart. I mean, you can idealize small town life. But l’ve spent a fair amount of time in small towns. And let me tell you-you shouldn’t get too idealistic about all those businesses he destroyed. Plus, a lot of people who work at Wal-Mart are very high-grade, bouncy people who are raising nice children. I have no feeling that an inferior culture destroyed a superior culture. I think that is nothing more than nostalgia and delusion. But, at any rate, it’s an interesting model of how the scale of things and fanaticism combine to be very powerful. #Small Towns

  Kyle: Scale brings cost cutting. Then that culture erodes.

  • “Cost synergies represent people, not just numbers.” - Mitt Romney
• The great lesson in microeconomics is to discriminate between when technology is going to help you and when it’s going to kill you. And most people do not get this straight in their heads. But a fellow like Buffett does.
• That’s such an obvious concept-that there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you. All of the advantages from great improvements are going to flow through to the customers. #Competition #Commoditization

  Kyle: Competition in commodity markets drives down the ROI of innovation.

• If you want to be the best tennis player in the world, you may start out trying and soon find out that it’s hopeless-that other people blow right by you. However, if you want to become the best plumbing contractor in Bemidji, that is probably doable by two-thirds of you, It takes a will, It takes the intelligence. But after a while, you’d gradually know all about the plumbing business in Bemidji and master the art. That is an attainable objective, given enough discipline. And people who could never win a chess tournament or stand in center court in a respectable tennis tournament can rise quite high in life by slowly developing a circle of competence-which results partly from what they were born with and partly from what they slowly develop through work. #Whatever you are, be a good one
• And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.
• The way to win is to work, work, work, work, and hope to have a few insights.
• I think the reason why we got into such idiocy in investment management is best illustrated by a story that I tell about the guy who sold fishing tackle. I asked him, “My God, they’re purple and green. Do fish really take these lures?” And he said, “Mister, I don’t sell to fish.” #Oil man in Heaven
  • Warren Buffett retells the story of the dead oil prospector who gets stopped at the pearly gates and is told by St Peter that Heaven’s allocation of miners is full up. The speculator leans through the gates and yells “Hey, boys! Oil discovered in Hell.” A stampede of men with picks and shovels duly streams out of Heaven and an impressed St Peter waves the speculator through. “No thanks,” says the sage. “I’m going to check out that Hell rumour. Maybe there is some truth in it after all.”
• So what makes sense for the investor is different from what makes sense for the manager. And, as usual in human affairs, what determines the behavior are incentives for the decision maker.
• From all business, my favorite case on incentives is Federal Express. The heart and soul of its system which creates the integrity of the product-is having all its airplanes come to one place in the middle of the night and shift all the packages from plane to plane. If there are delays, the whole operation can’t deliver a product full of integrity to Federal Express customers. And it was always screwed up. They could never get it done on time. They tried everything-moral suasion, threats, you name it. And nothing worked. Finally, somebody got the idea to pay all these people not so much an hour, but so much a shift-and when it’s all done, they can all go home. Well, their problems cleared up overnight. #Incentives
• In investment management today, everybody wants not only to win, but to have the path never diverge very much from a standard path except on the upside. Well, that is a very artificial, crazy construct. That’s the equivalent in investment management to the custom of binding the feet of the Chinese women. It’s the equivalent of what Nietzsche meant when he criticized the man who had a lame leg and was proud of it. That is really hobbling yourself. Now, investment managers would say, “We have to be that way. That’s how we’re measured.” And they may right in terms of the way the business is now constructed. But from the viewpoint of a rational consumer, the whole system’s “bonkers” and draws a lot of talented people into socially useless activity. #Incentives #Money Management
  • “When performance is measured, performance improves. When performance is measured and reported, the rate of improvement accelerates” Thomas S. Monson
• And it makes sense to load up on the very few good insights you have instead of pretending to know everything about everything at all times.
• Over the long term,** it’s hard for a stock to earn a much better return than the business which underlies it earns.** If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return-even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.

  Kyle: Price doesn’t matter much if the business is gold or if its crap. Kyle: Be a business analyst, not a market, macroeconomic, or security analyst

• How do you get into these great companies? One method is what I’d call the method of finding them small-get ‘em when they’re little. For example, buy WalMart when Sam Walton first goes public and so forth. And a lot of people try to do just that. And it’s a very beguiling idea. If I were a young man, I might actually go into it.
• However, averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager. But, very rarely, you find a manager who’s so good that you’re wise to follow him into what looks like a mediocre business. #Management
• You will get a few opportunities to profit from finding underpricing. There are actually people out there who don’t price everything as high as the market will easily stand. And once you figure that out, it’s like finding money in the street-if you have the courage of your convictions. #Pricing
• I’ve had many friends in the sick-business fix game over a long lifetime. And they practically all use the following formula-I call it the cancer surgery formula: They look at this mess. And they figure out if there’s anything sound left that can live on its own if they cut away everything else. And if they find anything sound, they just cut away everything else. Of course, if that doesn’t work, they liquidate the business. But it frequently does work. #turnarounds
• Finally, I’d like to once again talk about investment management. That is a funny business-because on a net basis, the whole investment management business together gives no value added to all buyers combined. That’s the way it has to work. #Money Management
• Of course, that isn’t true of plumbing, and it isn’t true of medicine. If you’re going to make your careers in the investment management business, you face a very peculiar situation. And most investment managers handle it with psychological denial-just like a chiropractor. That is the standard method of handling the limitations of the investment management process. But if you want to live the best sort of life, I would urge each of you not to use the psychological denial mode. #Investment Returns
• Harvard and Yale selected or directly employed investment managers who were way above average in ability, providing additional evidence that investment markets are not perfectly efficient and that some good investment results come from abnormal skill or other abnormal advantage. As one example, Harvard and Yale, by reason of their own prestige, were able to get into some of the most profitable high-tech venture-capital funds, not available to all other investors. These funds, using momentum provided by their own past success, had an opportunity advantage over less well established venture capital operations, in that the best entrepreneurs, quite logically, made early presentations to the best regarded funds. #Investment Returns
• My pain comes from (1) foreseeing a lot of future adversity for other worthy institutions, driven by envy and salesmen into enthusiastic imitation of Harvard and Yale and (2) disapproval of the conduct of many of the salesmen likely to succeed in pushing the imitation. Something similar to what I fear happened near the end of the high-tech bubble. At that time envy of successful early-stage, hightech venture-capital investors like Stanford, plus dubious sales methods of many venture capitalists, caused about $90 billion to rush into low quality, imitative earlystage ventures that by now may have created as much as $45 billion in net losses for late-coming investors.

  Kyle: Compare to Innovator’s University; not everyone should be Harvard, and not everyone should be Sequoia.

• It is quite counter-intuitive to decrease that part of one’s activity that has recently worked best. But this is often a good idea. #The Innovator’s Dilemma
• What should a young person look for in a career? #Career Advice #Lilly pads of your career
  • “I have three basic rules. Meeting all three is nearly impossible, but you should try anyway:
    • Don’t sell anything you wouldn’t buy yourself.
    • Don’t work for anyone you don’t respect and admire.
    • Work only with people you enjoy.
  • I have been incredibly fortunate in my life: with Warren I had all three.”
• “You don’t have to be brilliant, only a little bit wiser than the other guys, on average, for a long, long time.” Charlie Munger