Charlie’s Approach and Tools
Multiple Mental Models – borrow from and stick together the analytical tools, methods, and formulas from such traditional disciplines as history, psychology, physiology, math, engineerings, biology, physics, chemistry, statistics, and economics. Only need to reach freshman in college level of proficiency in each field to get there.
Key Mental Models
Redundancy / Backup system – Engineering
Compound Interest – Math
Breakpoint / Tipping Point / Autocatalysis – Physics and Chemistry
Modern Darwinian Synthesis Model – Biology
Cognitive Misjudgment – Psychology
Fundamental Guiding Principles – Preparation, Patience, Discipline, and Objectivity.
Sit On Your Ass Investing – limit decisions, do your homework, and when you see an opportunity bet very big. Avoid at all cost mediocre opportunities.
Inversion – focus on the result you don’t want to have happen and identify the steps that would take you to this undesirable outcome. These are the steps that must be avoided as a primary priority. Identifying the stumbling blocks first should simplify the decision making process by cutting some of the options.
General skepticism of financial reports and accounting as the sole basis for making an investment. Too much opportunity for funny business.
Moats – We consider a moat and the ability to keep its width and impossibility of being crossed as the primary criterion of a great business. And we’ll tell our managers that we want the moat widened every year.
Checklists – popularized in aviation. Should be created and referenced formally when making important decisions.
Proper Allocation of Capital – The investor’s #1 job. The highest and best use is always measured by the next best use (opportunity cost).
Morals – There should be a huge area between everything you should do and everything you can do without getting into legal trouble. I don’t think you should come anywhere near that line.
Managing Portfolio Companies – Decentralized power to a point just short of total abdication. Passion in founders is the trait to look for, much more important than brain power. Low overhead, and no quarterly goals and budgets.
Mistakes of omission – can be invisible since they don’t appear on a financial statement, but they cannot / should not be ignored if you are really trying to improve decision making. Must evaluate all choices through the lens of opportunity cost. Measure everything against the alternatives available.
The this of not fooling yourself – It is ridiculous that people cling to failed ideas. “It is not bringing in new ideas that’s so hard. Its getting rid of the old ones.” Keynes
To have a “good life” – Avoid being envious, spend each day trying to be a little wiser than you were when you woke up, reduce the need for superfluous material goods, read, give back, avoid debt.
Inversion – Algebra concept from Jacobi. “Invert, always invert.” Hard problems are best solved only when they are addressed backwards.
Extreme Objectivity – Pay close attention to those ideas which disprove your own most cherished beliefs. Practiced by Charles Darwin amongst others.
Mental Model Breakdowns
Math – Decision trees, permutations and combinations, basic algebra.
Accounting – double entry bookkeeping, and the limitations, opportunities for manipulation.
Asking and communicating ‘why’ – will help you understand things better, will force you to think things through fully, and will be useful for the people you are instructing as well.
Biology / Physiology – understand that all things are programmed by our genetic makeup to be much the same.
Psychology / cognitive function – again understand the limitations of your brain circuitry and be aware of it’s ability to be manipulated and / or make errors on it’s own.
Economics – Understanding the advantages of scale (volume leads to efficiency)
Career Advice – 1. Don’t sell anything you wouldn’t buy yourself. 2. Don’t work for anyone you don’t respect and admire. 3. Work with only people you enjoy.
Life Advice – 1. Have low expectations 2. Have a sense of humor 3. Surround yourself with the love of friends and family. Above all, live with change and adapt to it.
Ideology – one of the most extreme distorters of human cognition. Avoid developing strong opinions in any direction that can become locked in stone.
Mistakes – no way that you can live an adequate life without making many mistakes. Goal is to learn how to make fewer mistakes, and how to fix your mistakes faster in and when you do
Highly complex systems – can never be very confidant that what you’re doing is going to to do more good than harm since everything interacts with everything else. Unintended consequences.
Simplfy – decide on the “no brainer” questions first to help figure out complex problems.
Use Math – from Galileo, scientific reality is often revealed only by math as if it is the language of god.
Terms & Definitions To Investigate Further
Paramutuel System – A system of betting on races in which the winners divide the total amount bet, after deducting management expenses, in proportion to the sums they have wafered individually.
Competitive Destruction – why certain entities are able to adapt, survive, and even dominate over time.
Rembrandt Effect – seen in equity markets today. Instead of buying assets based on roughly accurate projections of producing future cash, investors buy because the values of the assets have gone up so far. This is not tied to any true valuation.
Wealth Effects – the excess purchasing power of investors pushing up asset prices beyond any rational value. Goes hand in hand with the Rembrandt effect.
Grandma’s Rule – you have to eat the carrots before you get the dessert.
Two Track Analysis – Track One – Look at the factors that really govern the interests involved, rationally considered. Track Two – What are the subconscious influences where the brain is automatically doing these things, sometimes causing misfunction?
Social Proof – the influence of the approval of others on our decision making. Leads to herd mentality when unchecked.
Bureaucracy – natural effect of getting larger / scale. Leads to territoriality at the management level which is another force grounded in human nature. Slows down decision making / operations in addition to adding lots of unnecessary costs and paperwork.
Capitalism – it is a pretty brutal place, but overall the gains for society as a whole outweigh the negative impact it can have on individuals.
Pavlovian Association – If people tell you what you really don’t want to hear, there’s an automatic reaction of antipathy. You have to train yourself out of it, otherwise, others not wanting to hurt you will filter their information sharing telling you only what you want to hear.
Incentives – what determines behavior ultimately. Incentive caused bias will allow people to rationalize that bad behavior is ok. Be extremely careful when setting incentive structures.
New Displays of unconventional wisdom – always will be required if you want to keep growing. Force yourself to decrease the part of one’s activity that has recently worked the best.
People’s natural inclination to cheat – Better to let life be hard than to create systems that people can easily cheat for the good of society / civilization. Very hard to stop moral failure once it starts.
Operant Conditioning – people’s natural tendency to repeat what has worked for them in the past. BF Skinner popularized it.
Lollapalooza Effects – really big effects come from the combination of factors.
Habitual Objectivity – be like Darwin, and thoroughly challenge your most sacred beliefs.
Take What You Wish Model – approach used in hard sciences (Biology, Chemistry, Physics, etc) where it’s expected to build upon others work / findings versus trying to reinvent the wheel. Applications in soft sciences starting (behavioral economics is psychology and econ) but still a long way to go.
Leveraged and Unleveraged Investments / Funds – need to research.
Ethical issue with the nation’s best and brightest moving into money management since the earning potential is so large as opposed to focusing their efforts on something that provides more value to others.
Wealth Effects – when a person spends more than their usual rate based on an increase in the value of their assets on paper.
Overweighting the importance of what can be counted -flaw in current economics.
Extreme success – Caused by some combination of the following factors: 1. Extreme maximization or minimization of one or two variables. 2. Adding success factors so that a bigger combination drives success, often in a non-linear fashion. 3. Extreme good performance over many factors. 4. Catching and riding some type of big wave.
Second and higher-order effects- common cause of economic forecasts for complex issues being inaccurate. They are overly simplistic and do not consider effects of effects. Also can be a big problem with government / legislation, where they often come up with well-intentioned systems that are too easily gamed / abused.
Filial Piety – Concept popularized by Confucius in Ancient China. Love and respect for one’s parents and ancestors. This belief should translate into better ability to function in society and government according to Confucius.
Acquisition of Knowledge – moral duty. Must be hooked on lifelong learning. You’re not going to get very far in life based on what you already know.
Iron Prescription – Do not express your opinion unless you can state the arguments against your position better than the people who are in opposition.
Planck Knowledge – Be able to differentiate between those who have a real knowledge gained via aptitude and paying dues versus those with a superficial knowledge and ability to “talk the talk”.
Categorical Imperative – Created by Emmanuel Kant, requires humans to follow a behavior pattern that if followed by others, benefits everyone. Similar to the golden rule.
Benjamin Franklin – Original Poor Richard’s Almanak
Adam Smith – Wealth of Nations
Cicero – Roman writer, orator, lawyer, and statesman. Encouraged the celebration of old age. Helped create modern US Democratic government system – distrust of human nature requires checks and balances. Duty of the citizen to serve the state and promote it’s values vigorously. Self improvement proponent.
Ben Graham – Author of The Intelligent Investor. Warren Buffet’s first mentor.
Andrew Carnegie – Steel titan. Became heavily involved in philanthropy.
Ptolemy – 14 AD. Challenged the church belief that the world was flat, not round.
Plato – 427 BC – 327 BC – credited for creating the academic system.
Sir Issac Newton – 1642-1727. Math, algebra, geometry, calculus, optics, and celestial mechanics scholar. Biggest contribution was discovering the concept of gravity.
Epictetus – 55-135. Humans are free to control their own lives and live in harmony with nature. Promoted a daily regime of rigorous self-examination.
Pierre de Fermet & Blaise Pascal -foundations of probability theory (France Mid 17th century). Decision tree theory.
Sir William Osler – “the father of modern medicine”. Advocated pluralism like Charlie. The first step towards success in any field is to become interested in it.”
Stanley Milgram – Famous for the Milgram Experiment, where subjects were instructed to give a strong electrical (potentially fatal) shock to other people at the instruction of several authority figures. Surprising number of normal people did it, making it a comparison for normal people joining he Nazis and working in concentration camps during WWII.
BF Skinner – operant conditioning pioneer. Ran experiments with rodents, often influencing their current and future behavior with food.
Max Planck – German physicist, know for his work on thermodynamics and radiation.
Galileo Galilei – creator of the first telescope. Contributed to physics, mathematics, education, and many other subjects. 1564-1642.
Ivan Pavlov – discovered the concept of conditional reflexes through experimentation with dogs. Powerful effects come from mere association. Associate one thing with another, ex a dinner bell signifies food.
Sophocles – famous ancient Greek playwright who focused on tragedies.
“Acquire wisdom and adjust your behavior accordingly. If your new behavior gives you a little temporary unpopularity with your peer group, then to hell with them.” Charlie Munger
“Life’s tragedy is that we get old too soon and wise too late. When you’re finished changing, you’re finished.” Benjamin Franklin
“Faced with the choice between changing one’s mind and proving there is no need to do so, almost everyone get’s busy on the proof.” John Kenneth Galbraith
“A scientific theory should be as simple as possible, but no simpler.” Albert Einstein
“A great business at a fair price is superior to a fair business at a great price.” Charlie Munger
“Price is what you pay, value is what you get.” Charlie Munger
“Compound Interest is the eighth wonder of the world.” Albert Einstein
“Ability will get you to the top, but it takes character to keep you there.” Abraham Lincoln
“It’s remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” Charlie Munger
“Opportunity comes to the prepared mind.” Charlie Munger
On Tycoons – “When they’re talking they’re lying, and when they’re quiet, they’re stealing.” Charlie Munger
“Capitalism without failure is like religion without hell.” Charlie Munger
“How many legs does a dog have if you call a tail a leg? Four. Calling a tail a leg doesn’t make it a leg.” Abraham Lincoln
“Whose bread I eat, his song I sing.” Charlie Munger in commenting on accounting ethics.
“To the man with a hammer, the world looks like a nail.” Charlie Munger
“Curiosity, concentration, perseverance, and self criticism.” Einstein on where his most successful theories came from.
“The mind of a man at one and the same time both the glory and the shame of the universe.” Blaise Pascal
“The consistent lesson I’ve learned over the years is that I have been in many cases too cautious. Almost everything should have been done faster.” Jack Welch
“What you measure is what you get. What you reward is what you get.” Jack Welch
“Mankind invented a system to cope with the fact that we are so intrinsically lousy at manipulating numbers. It’s called the graph.” Charlie Munger
“Appealing to interests more likely to work better as a matter of human persuasion than almost anything else.” Charlie Munger
“A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because it’s opponents eventually die, and a new generation grows up that is familiar with it.” Max Planck
“The man who doesn’t read good books has no advantage over the man who can’t read them.” Mark Twain
“If I have ever made any valuable discoveries, it has been due more to patient attention, than to any other talent.” Sir Issace Newton.
“If I have seen farther than others, it is only because I was standing on the shoulders of giants.” Sir Issace Newton.
“Not ignorance, but ignorance of ignorance is the death of knowledge.” Alfred North Whitehead
“Truth is hard to assimilate in the mind when opposed by interest.” Samuel Johnson
“What a man wishes, he will believe.” Demosthenes
“There is no limit to what a man can do or where he can go if he doesn’t mind who gets the credit.” Bob Woodruff.
“An organization foolish in one way of dealing with a complex system is all too likely to be foolish in another.” Charlie Munger
“The man who needs a new machine tool and hasn’t bought it yet is already paying for it.” Warner & Swasey (advertisement)
“In any respectable organization, it is far safer to be wrong with the majority than to be right alone.” John Kenneth Galbraith
“People of privilege will always risk their complete destruction rather than surrender any material part of their advantage.” John Kenneth Galbraith
“Better roughly right than precisely wrong.” John Maynard Keynes
“The safes way to get what you want is to deserve what you want” Charlie Munger
“It is dangerous to be right in matters where established men are wrong.” Voltaire
“Make the best use of what is in your power and take the rest as it happens” Epictetus
“Wealth consists not in having great possessions, but in having few wants.”
“An ounce of prevention is worth a pound of cure.” Benjamin Franklin
“It is not greed that drives the world but envy.” Warren Buffett
“Never underestimate the man who overestimates himself.” Unknown.
Failings of Human Psychology
A summary of standard human thinking errors. Our behavior is driven by the algorithms coded into our gentics, which have evolved over thousands of years. Although they are useful and work for most situations, they are prone to oversimplify things when addressing complex problems.
- Reward and Punishment Superresponse Tendency – The power of incentives in driving behavior. Can be good and useful to a certain extent, but can quickly lead to incentive caused bias if left unchecked. This is the tendency for incentives to drive people to immoral behavior to get what they want. Natural tendency for humans to look for ways to “game” systems to swing results in their favor. If these tendencies are overlooked in creating systems (business or government) more blame goes to the system architects than the criminal parties.
- Liking / Loving Tendency – The tendency for humans to strive, lifelong, for the affection and approval of many people not related to them. Causes people to overlook obvious flaws and favor the people, products, and actions associated with the target of their affection.
- Dislike / Hating Tendency – tendency of humans to splinter into groups and war.
- Doubt Avoidance Tendency – The tendency of humans to quickly remove doubt when reaching some type of decision.
- Inconsistency – Avoidance Tendency – The tendency to be reluctant to change. Shown by the difficult we have in breaking bad habits, changing previous conclusions, human loyalties, repetitional identity, etc. Toxic when combined with our quick, doubt-adverse decision making tendency from above. Can otherwise be known as “status quo bias”.
- Curiosity Bias – stronger tendency in humans than in other mammals.
- Kantian Fairness Tendency – The natural tendency we have for being fair, and expecting the same from others.
- Envy / Jealousy Tendency – Can easily trigger hatred and injury.
- Reciprocation Tendency – tendency to reciprocate both favors and disfavors. Facilitates group cooperation for the benefit of the group’s members. On the negative side, can sometimes leads to overreactive hostility. Can lead to guilt. But on balance, the positives outweigh the negatives and help contribute to functioning society.
- Influence-from-Mere- Association Tendency – conditioned reflex wherein mere association triggers a response. Example – people believe the item with the highest price will have the highest quality. Also exploited in advertising – happy, smiling faces on Coke ads, etc. Most dangerous application causes people to make miscalculations, assuming incorrect influences on past success or failures. Hatred can also become a problem since it can cause you to underestimate the positive attributes of those hated. Blaming the messenger who brings negative news, one more ex. Stereotypes – assuming all people who look a certain way will act a certain way.
- Simple, Pain-Avoiding Psychological Denial – reality is too hard to bear, so one distorts facts until they become believable.
- Excessive Self Regard Tendency – usually we misappraisal ourselves on the high side. Causes you to prefer people who are just like you. Correct by under-valuing face-to-face impressions and overweigh actual credentials when hiring. Evidenced by the “endowment effect” where you immediately your possessions take on more value to you than if you were offered them for sale when you didn’t already own them.
- Overoptimism Tendency – combat with simple probability math from Pascal and Fermat.
- Deprival-Superreaction Tendency – The quantity of pleasure from a $10 gain does not exactly match the quantity of displeasure from a $10 loss. Losses hurt much more than gains. Causes people to irrationally throw good money after bad. And causes people to become very stuck-in on issues when their strong belief maintenance systems are challenged by others.
- Social Proof Tendency – Thinking and doing what you seeing others around you thinking and doing. Especially prevalent in young people, where respect from their pier group trumps that of parents or adults. Made even more powerful when combined with stress.
- Contrast-Misreaction Tendency – as perception goes, so goes cognition. Example of misuse – real estate agent shows you really bad properties first, to condition you to pick a better option over your original budget.
- Stress-Influence Tendency – can prompt faster and more extreme reactions and decisions.
- Availability-Misweighing Tendency – overestimating what can quickly and easily be brought to mind. An idea or fact should not be worth more just because it’s easily available to you.
- Use-it-or-lose it Tendency – Essential to assemble skills into a checklist that he /she routinely uses. Skills of a very high order can be maintained only with daily practice. But once you become fluent in a skill, it will be lost more slowly and it will come back faster.
- Drug-Misinfluence Tendency – Don’t do drugs.
- Senesence- Misinfluence Tendency – Prevent the effects of old-age related cognitive declines by continuously thinking and learning.
- Authority-Misinfluence Tendency – Natural tendency to follow leaders in dominance hierarchies.
- Twaddle Tendency – Man’s tendency to sometimes produce gibberish when in an uncertain situation. Have to have the ability to cut through it. (?)
- Reason-Respecting Tendency – Wise to think through the reasons for doing something, and to provide these reasons to the recipients versus just telling someone what to do. Will lead to much better compliance.
- Lollapolooza Tendency – extreme consequences when many of the factors listed above combine.
Should you abuse your understanding of how the human mind can be manipulated to get what you want? No, because intelligent people who are targeted for manipulation will likely figure it out at some point and deeply resent you / your actions. Better to understand as a way to protect yourself from others and yourself.