A book that has had a large impact on how I think and approach problems. Formatted after Ben Franklin’s yearly publication of advice, Munger lays out all sorts of things, from clear investing principles, to an introduction to mental models and how more people should be thinking with interdisciplinary tools.
Particularly relevant for those interested in business and finance, but as he makes clear in many of his speeches (transcripts included in the book), it should be relevant for all, from lawyers to economists. Highly recommend.
Focs on what to avoid - that is, what NOT to do - before considering affirmative steps to take.
Avoid “physics envy” - the tendency to want to reduce enormously complex systems into one-size-fits-all Newtonian formulas.
“A scientific theory should be as simple as possible, but no simpler.” - Albert Einstein
Quickly eliminate the big universe of what not to do, follow up with a fluent, multidisciplinary attack on what remains, then act decisively when, and only when, the right circumstances appear.
There should be a huge area between everything you should do and everything you can do without getting into legal trouble.
There are two kinds of businesses: the first earns 12%, and you can take the profits out at the end of the year. The second earns 12%, but all the excess cash must be reinvested - there’s never any cash. We hate that kind of business.
You should pay attention to mistakes of omission.
The keys t becoming an investor are discipline, hard work, and practice. It’s like playing golf - you have to work on it.
Pay attention to the micro to get the macro.
Mutual fund and money management in general is disgusting; the incentives are perverse and no one notices because they’re still making money. An index fund would be better.
EBITDA = “bullshit earnings"
The theory that stock options have no cost is stupid. A stock option is both an expense and dilution.
Derivatives are dumb, and the accounting for them is worse.
“I’d remove 3/4 of the faculty - everything but the hard sciences."
Departments need more interconnectedness and understanding of other departments.
A lot of success in life and business comes from knowing what you want to avoid: early death, a bad marriage, etc.
Beware of envy - if someone else is getting richer faster than you, who cares??
"Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts…Slug it out one inch at a time, day by day. At the end of the day - if you live long enough - most people get what they deserve."
“In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time - none, zero."
Once you get into debt, it’s hell to get out.
Carson: Avoid ingesting chemicals in an effort to alter mood or perception, avoid envy, and avoid resentment.
Munger: avoid being unreliable, learn as much as you can from the good and bad experience of others & become as educated as you possibly can, get up from your first, second, or third severe reverse in the battle of life, invert, always invert (or in other words, be objective, and avoid the negative).
Where can you find the money in the business? Where is the free cash being generated?
What can you “surf”?
The way to win is to work, work, work, work, and hope to have a few insights.
Beware gaming of systems and stop any abuse early.
Ex: worker’s compensation systems.
On Berkshire investing in USAir - it was a preferred stock with a mandatory redemption - ie. basically a loan, with a good fixed dividend and mandatory redemption. The only guess was that they would be able to pay it back.
“I’m all for fixing social problems. I’m all for being generous to the less fortunate. And I’m all for doing things where, based on a slight preponderance of the evidence, you guess that it’s likely to do more good than harm. What I’m against is being very confident and feeling that you know, for sure, that your particular intervention will do more good than harm, given that you’re dealing with highly complex systems wherein everything is interacting with everything else."
On education in elite soft science:
Many more courses should be mandatory (including psychology and accounting for legal)
Much more problem-solving practice that crosses several disciplines, including practice that mimics the aircraft simulator to prevent loss of skills through disuse.
Increase use of the best business periodicals (Wall Street Journal, Forbes, Fortune, etc.)
Professors of super-strong ideology (either right or left) should usually be avoided. Also for students.
Should more intensely imitate the fundamental organizing ethos of hard science (math/physics/chemistry/engineering).
Rational organization of multi-disciplinary knowledge is forced by making mandatory 1) full attribution for cross-disciplinary takings and 2) mandatory preference for the most fundamental explanation.
An old two part rule works wonders in business, science and elsewhere: 1) take a simple, basic idea and 2) take it very seriously.
Extreme success is likely causes by some combination of the following factors:
Extreme maximization or minimization of one or two variables. Ex: Costco or our furniture store.
Adding success factors so that a bigger combination drives success, often in non-linear fashion, as one is reminded by the concept of breakpoint and the concept of critical mass in physics. The “lollapalooza” result.
An extreme of good performance over many factors. Ex: Toyota or Les Schwab.
Catching and riding some sort of big wave. Ex: Oracle.
One must consider second-order and higher-order effects.
Inspired by Keynes: Better roughly right than precisely wrong.
“You want to deliver to the world what you would buy if you were on the other end."
The acquisition of knowledge is a moral duty. You must be a lifelong learner.
Once you have the ideas, you must continuously practice their use.
Beware, as you can cause enormous offence by being right in a way that causes somebody else to lose face in his own discipline or hierarchy.
Generally speaking, envy, resentment, revenge and self-pity are disastrous modes of thought.
Embrace non-egality - done the right way, and it will allow you to reach the highest levels of achievement. (ie. provide lots of playing time for your best players).
What to Look for in a Partner (Warren Buffett):
Someone smarter and wiser than you.
Someone who will never second-guess you nor sulk when you make expensive mistakes.
A generous soul who will put up his own money and work for peanuts.
Someone who will constantly add to the run as you travel a long road together.
Praising Old Age (inspired by Cicero’s Discourse of Old Age):
Performing well for a long time gives you great comfort in old age as you can look back at a job well done.
Self-improvement should continue as long as you are alive.
The study of philosophy is an ideal activity for old age.
The only life worth living is dedicated in substantial part to good outcomes one cannot possibly survive to see.
Early retirement is virtually unthinkable.
Do not complain about personal misfortune or the physical decline with aging.
Good wine in moderation and stays at a country retreat can improve life.
“The best Armour of Old Age is a well spent life preceding it;” - Cicero, de Senectute (?)
From his children:
Do the job right the first time.
Admit your mistakes.
Endless practice and determination will allow you to succeed.
Going along with normal social customs allows harmonization.
Durability is a first-rate virtue.
The Two-Track Analysis (Pages 63, 64):
What are the factors that really govern the interests involved, rationally considered? (For example, macro and micro-level economic factors).
What are the subconscious influences, where the brain at a subconscious level is automatically forming conclusions? (Influences from instincts, emotions, cravings, and so on).
Investing and Decision Making Checklist (Pages 73-76):
An Investing Principles Checklist:
Risk - All investment evaluations should begin by measuring risk, especially reputational
Incorporate an appropriate margin of safety
Avoid dealing with people of questionable character
Insist upon proper compensation for risk assumed
Always beware of inflation and interest rate exposures
Avoid big mistakes; shun permanent capital loss
Independence - “Only in fairy tales are emperors told they are naked"
Objectivity and rationality require independence of thought
Remember that just because other people agree or disagree with you doesn’t make you right or wrong - the only thing that matters is the correctness of your analysis and judgment
Mimicking the herd invites regression to the mean (merely average performance)
Preparation - “The only way to win is to work, work, work, work, and hope to have a few insights"
Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day
More important than the will to win is the will to prepare
Develop fluency in mental models from the major academic disciplines
If you want to get smart, the question you have to keep asking is “why, why, why?"
Intellectual humility - Acknowledging what you don’t know is the dawning of wisdom
Stay within a well-defined circle of competence
Identify and reconcile disconfirming evidence
Resist the craving for false precision, false certainties, etc.
Above all, never fool yourself, and remember that you are the easiest person to fool
Analytic rigor - Use of the scientific method and effective checklists minimizes errors and omissions
Determine value apart from price; progress apart from activity; wealth apart from size
It is better to remember the obvious than to grasp the esoteric
Be a business analyst, not a market, macroeconomic, or security analyst
Consider totality of risk and effect; look always at potential second order and higher level impacts
Think forwards and backwards - Invert, always invert
Allocation - Proper allocation of capital is an investor’s number one job
Remember that highest and best use is always measured by the next best use (opportunity cost)
Good ideas are rare - when the odds are greatly in your favour, bet (allocate) heavily
Don’t “fall in love” with an investment - be situation-dependent and opportunity-driven
Patience - Resist the natural human bias to act
“Compound interest is the eighth wonder of the world” (Einstein); never interrupt it unnecessarily
Avoid unnecessary transactional taxes and frictional costs; never take action for its own sake
Be alert for the arrival of luck
Enjoy the process along with the proceeds, because the process is where you live
Decisiveness - When proper circumstances present themselves, act with decisiveness and conviction
Be fearful when others are greedy, and greedy when others are fearful
Opportunity doesn’t come often, so seize it when it does
Opportunity meeting the prepared mind: that’s the game
Change - Live with change and accept unremovable complexity
Recognize and adapt to the true nature of the world around you; don’t expect it to adapt to you
Continually challenge and willingly amend your “best-loved ideas"
Recognize reality even when you don’t like it - especially when you don’t like it
Focus - Keep things simple and remember what you set out to do
Remember that reputation and integrity are your most valuable assets - and can be lost in a heartbeat
Guard against the effects of hubris and boredom
Don’t overlook the obvious by drowning in the minutiae
Be careful to exclude unneeded information or slop: “A small leak can sink a great ship"
Face your big troubles; don’t sweep them under the rug
Other investing notes:
Trade infrequently - if you could only make 20 trades in your lifetime, how would that change what you do?
Find your ‘fat pitch’ and swing hard - look for opportunities where you have a big advantage, and swing hard at these ones. Most investors swing too often.
To do this, you must be prepared and have capital available.
We have three investment buckets: yes, no and too hard to understand.
difficult to understand: Pharma, tech, etc.
Heavily promoted: IPOs, “deals”, etc.
Financial reports and accounting examined with skepticism
Additional factors examined is extensive, includes: current and prospective regulatory climate, state of labor, supplier and customer relations, potential impact of changes in technology, competitive strengths and vulnerabilities, pricing power, scalability, environmental issues, presence of hidden exposures;
Recast financial statement figures to fit own view of reality, including actual free or “owners” cash being produced, inventory and other working capital assets, fixed assets, and intangible assets (usually overstated, like goodwill)
Assessment of true impact, current and future, of cost of stock options, pension plans, and retiree medical benefits.
Assesses a company’s management well beyond conventional number crunching, including the degree to which they are “able, trustworthy, and owner-oriented”. Ex: do they deploy cash? Do they allocate it intelligently on behalf of the owners, or do they overcompensate themselves? Or pursue ego-oriented growth for growth’s sake?
Above all: understand competitive advantage in every respect - products, markets, trademarks, employees, distribution channels, societal trends, and so on - and the durability of that advantage.
What competitive destruction forces may deteriorate this?
Then: calculate the intrinsic value of the whole business and, with allowance for potential dilution, etc., to determine an approximate value per share to compare to market prices.
“A great business at a fair price is superior to a fair business at a great price."
Ex: Washington Post, GEICO, Coca-Cola, Gillette, etc.
Finally: “prior to pulling the trigger” checklist
Includes what are the current price, volume and trading considerations? What disclosure timing or other sensitivities exist? Are better uses of capital currently or potentially available? Is sufficient liquid capital currently on hand or must it be borrowed? What is the opportunity cost of that capital?
Then: make a large and decisive bet. No initial positions or small speculative investments.
Ben Graham: if you could calculate the value of a whole enterprise (what it would sell for if available), and then take the stock price and multiply it by the number of shares, and get something that was one-third or less of sellout value, then you’ve got a lot of edge going for you (big margin of safety) - but this was in a different time, it doesn’t exist like this anymore.
Often maximization or minimization of a single factor (notable specialization) can make that single factor disproportionately important.
What “moat” does the business have? Can we widen this every year?
Overall: far more time is committed to learning and thinking than doing.
Score yourself on how you played the hand, not whether you won it.
For the smaller investor, find smaller companies.
Anytime someone offers you a tax shelter in life, don’t buy it.
Anytime someone offers you anything with a big commission and a 200-page prospectus, don’t buy it.
"On a net basis, the whole investment management business together gives no value added to all buyers combined."
Answer to reaching financial security:
“Spend less than you make; always be saving something. Put it into a tax-deferred account. Over time, it will begin to amount to something. THIS IS SUCH A NO-BRAINER."
What should a young person look for in a 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."
On life advice:
“Have low expectations.
Have a sense of humour.
Surround yourself with the love of friends and family.
Above all, live with change and adapt to it."
Ultra-Simple, General Problem-Solving Notions (Pages 279-281):
Decide the big “no-brainer” questions first.
Apply numerical fluency.
Invert (think the problem through in reverse).
Apply elementary multidisciplinary wisdom, never relying entirely upon others.
Watch for combinations of factors - the Lollapalooza effect.
25 Psychology-Based Tendencies (Pages 440-498):
Reward and Punishment Superresponse Tendency
Incentives have huge power
“If you would persuade, appeal to interest and not to reason.” - Benjamin Franklin
Especially fear professional advice when it is especially good for the advisor;
Learn and use the basic elements of your advisor’s trade as you deal with your advisor;
Double check, disbelieve, or replace much of what you’re told, to the degree that seems appropriate after objective thought.
The power of incentives can cause poor behaviour if checks are not in place.
Man tends to “game” all human systems; anti-gaming features are a huge and necessary part of system design.
“Granny’s Rule”: you must first do the unpleasant thing (eat your carrots) before getting your reward (dessert).
Man likes being liked and loved.
Man will ignore faults of, and comply with witness of, the object of his affection
He will favour people, products, and actions merely associated with the object of his affection
He will distort other facts to facilitate love
This also works in reverse; admiration also causes or intensifies liking or love
A man who loves admirable persons and ideas has a huge advantage in life
There are social policy implications; ex: it’s obviously desirable to attract a lot of lovable, admirable people into teaching
The opposite of liking/loving:
Disliker/hater will ignore virtues in the object of dislike
Dislike people, products and actions merely associated with the object of his dislike
Distort other facts to facilitate hatred
Man is programmed to quickly remove doubt by reaching some decision
What usually triggers doubt-avoidance tendency is some combo of:
(Both of these factors naturally occur facing religious issues); thus, the natural state of most men is in some form of religion.
The brain of man is reluctant to change
Ex: few people can list bad habits they have eliminated, but instead give excuses or state it is “fate"
The rare life wisely lived has in it many good habits maintained, and many bad habits avoided or cured
We will tend to ignore or discount evidence to maintain our previously-held beliefs, rather than change those beliefs (confirmation bias)
Charles Darwin provides a counter-example: he trained himself to intensively consider any counter-evidence he encountered
Can be manipulated by getting someone to do you a favour; this works in reverse (manipulate someone to hurt someone and they will dislike/hate them)
Also, to achieve something, or a particular state - pretend to have done it already, or to be it already (smiling makes you happier just as being happier makes you smile)
Benefit in education when a pupil has to teach a topic; have to beware this doesn’t turn students into zealots
There is an innate curiosity in humans
This often helps temper some other psychological habits
Kantian Fairness Tendency
Humans often follow behaviour patterns that, if followed by all others, make the human system better for everyone
Ex: lining up at coffee shops, being courteous on the road, etc.
We have a strong tendency to compare ourselves to others
“It is not greed that drives the world, but envy.” - Warren Buffett
Humans tend to reciprocate favours and disfavours
Antidote: train yourself to delay reaction
This drives trade, marriage, and joins inconsistency-avoidance tendency to help make humans fulfill promises, behave ethically, etc.
Can be used in sales when someone does you a favour; to counter, don’t let buyers accept any favours
Can also be used when making a big ask, you do a favour by asking something smaller - the other person is likely to acquiesce
A thing will be associated with the rewards previously bestowed
Ex: advertisements of products with pretty girls (Graham: believe this is more like/love tendency)
Ex: a man gambles in a casino once and wins, and then continues to gamble to his detriment
Carefully examine past success, looking for accidental, non-causative factors associated that will tend to mislead
Look for dangerous aspects of a new venture that were not present when past success occurred
Hating and disliking also cause miscalculations triggered by mere association
Ex: we dislike those who bring us bad news
Antidote: develop a habit of welcoming bad news
Another bad result here is the common use of classification stereotypes
The average dimension in some group will not reliably guide you to the dimension of a specific item.
Simple, Pain-Avoiding Psychological Denial
The reality is too painful to bear, so facts will be distorted to become bearable.
Ex: a tragic death; drug addiction
Excessive Self-Regard Tendency
We tend to regard ourselves more highly than others would; the same applies to our spouses, children, etc.
We tend to prefer those who are like ourselves; select those like ourselves; etc.
We tend to overestimate our talents in comparison to others
We tend to overweight the interview portion of a hiring process because we tend to overweight our own intuitions
Man should face two facts:
Fixable but unfixed bad performance is bad character that tends to create more of itself, causing more damage to the excuse giver with each tolerated instance
In institutions, fair, meritocratic, demanding culture plus personnel handling methods that build up morale and removal of the worst offenders
Force yourself to be more objective when you are thinking about yourself, your family and friends, your property, and the value of your past and future activity.
Excess of self-regard can sometimes cause success from overconfidence.
“Pride” - in a job well done, a life well lived, etc. - is a good force; perhaps the best is a pride in being trustworthy
Even people doing well will display an excess of optimism
Antidote: trained, habitual use of the simple probability math of Fermat and Pascal
Loss-avoidance: we tend to overvalue losses compared to gains
We tend to frame problems incorrectly when dealing with loss
This plus inconsistency-avoidance tendency causes us to hate/dislike non-believers of our own causes
Causes many people to continue when they should cut their losses
Man automatically thinks and does what he observes to be thought and done around him (or not done)
Triggering most often occurs in the presence of puzzlement or stress, particularly when both exist
Stop bad behaviour before it spreads
Foster and display all good behaviour
Antidote: learn how to ignore the examples from others when they are wrong.
Also known as anchoring, we tend to judge things in relation to things immediately available
Ex: buying an over-priced option on a car because we evaluate the price compared to the overall car cost
Also leads to drift, when a small step in the wrong direction is unrecognizable because it is so small in contrast to the overall picture; however, a large number of these small steps can lead to ruin
Small amounts of stress can increase performance
Heavy stress can destructively change behaviour and lead to depression
Some late research by Pavlov suggested that reversing a breakdown only happened when stress was re-imposed
The mind overweighs the factors easily available to it
Antidote: use checklists
Behave like Darwin - emphasize factors that don’t produce reams of easily available numbers
Hire skeptical, articulate people to act as advocates for notions opposite to the incumbent
Consequence: extra-vivid evidence should be under-weighed, while less vivid evidence should be over-weighed.
Can constructively use this: in persuading someone else to reach a correct conclusion; as a device for improving ones own memory by attaching vivid images
“An idea or a fact is not worth more merely because it is easily available to you."
All skills attenuate with disuse.
Antidote: make use of the functional equivalent of the aircraft simulator used by pilots.
Engage in practice of all useful, rarely used skills, many outside his discipline, as a sort of duty to his better self.
Assemble skills into a checklist that is routinely used.
Skills of a very high order can only be maintained with daily practice.
The tendency is less present when skills are slowly raised to fluency rather than crammed.
Don’t use drugs, kids.
Continuous thinking and learning, done with joy, can help delay the inevitable cognitive decline.
We tend to over-weight the instructions or example set by people of authority.
Man tends to fill time with “busy work” or communication that is not useful.
Beware distraction from serious work.
Man possesses a natural love of accurate cognition and joy in its exercise.
It makes man especially prone to learn well when he has a good reason for it.
To use: communicate the reason behind learning or doing something when you desire someone to do it.
Tell Who What do to, When, Where and Why.
Used backwards: people will be more likely to respond even when the reasons given are dubious.
Lollapalooza Tendency - The Tendency to Get Extreme Consequences from Confluences of Psychological Tendencies Acting in Favour of a Particular Outcome
Self-explanatory: when combining several of these tendencies, one is likely to get an extreme outcome (or, worded differently, to get an extreme outcome, combine many of these tendencies).
Other Mental Models:
~100 in number
“To the man with a hammer, the world looks like a nail."
Redundancy/backup system model (engineering)
Compound interest (math)
Darwinian synthesis (biology)
Cognitive misjudgments (psychology)
Permutations and combinations (math); Fermat/Pascal system
Accounting (double-entry bookkeeping)
Advantages of scale (microeconomics)
Surfing (finding a wave and staying there for a long time)
Tragedy of the commons (economics)
Invisible hand (economics)
Invisible foot (biology/economics)
Comparative advantage in trade (economics)
Pin factory (economics)
Bernie Cornfeld (negative example)
Henry E. Singleton
Sir Isaac Newton
W. Edwards Deming
James Clerk Maxwell
John Kenneth Galbraith
N. Gregory Mankiw
John Maynard Keynes
A Matter of Degrees: What Temperature Reveals About the Past and Future of Our Species, Planet, and Universe - Gino Segre
Andrew Carnegie - Joseph Frazier Wall
Deep Simplicity: Bringing Order to Chaos and Complexity - John Gribbin
F.I.A.S.C.O.: The Inside Story of a Wall Street Trader - Frank Partnoy
Genome: The Autobiography of a Species in 23 Chapters - Matt Ridley
Getting to Yes: Negotiating Agreement Without Giving In - Roger Fisher, William Try, and Bruce Patton
Guns, Germs and Steel: The Fates of Human Societies - Jared Diamond
How the Scots Invented the Modern World: The True Story of How Western Europe’s Poorest Nation Created Our World & Everything in It - Arthur Herman
Ice Age - John & Mary Gribbin
Influence: The Psychology of Persuasion - Robert Cialidini
Living Within Limits: Ecology, Economics, and Population Taboos
Models of My Life - Herbert Simon
Only the Paranoid Survive - Andy Grove
The Autobiography of Benjamin Franklin - Benjamin Franklin
The Third Chimpanzee: The Evolution and Future of the Human Animal - Jared Diamond
The Selfish Gene - Richard Dawkins
The Warren Buffett Portfolio: Mastering the Power of the Focus Investment Strategy - Robert Hagstrom
The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor - David S. Landes
Three Scientists and Their Gods: Looking for Meaning in an Age of Information - Robert Wright
Titan: The Life of John D. Rockefeller, Sr. - Ron Chernow
From the Editor:
Les Schwab: Pride in Performance - Les Schwab
Men and Rubber: The Story of Business - Harvey Firestone
Men to Match My Mountains: The Opening of the Far West, 1840 - 1900 - Irving Stone
Other Books Mentioned:
B.F. Skinner: A Life - Daniel W. Bjork
Be Quick - But Don’t Hurry! - Andrew Hill with John Wooden
Cicero, On a Life Well Spent
Collapse - Jared Diamond
Common Stocks and Uncommon Profits - Philip Fisher
Darwin’s Blind Spot
Godel, Escher, Bach - Douglas Hofstadter
Objective Accounting - Carl F. Braun
Principles of Microeconomics - N. Gregory Mankiw
Process and Reality - Alfred North Whitehead
Shaping the Managerial Mind - Peter Drucker
Shoot the Piano Player - David Goodis
Surely You’re Joking, Mr Feynman - Richard Feynman
The Affluent Society - John Kenneth Galbraith
The Moral Consequences of Economic Growth - Benjamin M. Friedman
The Wealth of Nations - Adam Smith
The Language Instinct - Steven Pinker
Winning - Jack Welch