Charlie Munger: Seven Sage Lessons on Investing and Life

I launched this newsletter in September with a quote from legendary investor Charlie Munger, who was not only the most prominent advocate but also the best role model for the benefits of compound learning. He passed away on Nov 28, just 34 days before his 100th birthday, which would have been today. ?

To commemorate this day and celebrate this icon, I want to highlight some of my favourite lessons from a man who loved to give advice, lived by what he preached, and never stopped looking for ways to improve.

But first, some friends gave me feedback on a previous edition of this newsletter and advised that it could have been shorter. I’ve tried limiting myself to seven lessons here, but if you find this edition still too long – I couldn’t resist expanding on the fantastic source materials. For those readers who find this edition not long enough, I strongly recommend reading further and studying Munger’s corpus of advice in Peter Kauffman’s Poor Charlie’s Almanack (get the expanded third edition) and Peter Bevelin’s Seeking Wisdom: From Darwin to Munger. Both can be found here, with proceeds going to The Munger Research Center in the Huntington Library in San Marino, CA.

Now, to the lessons. Munger has consistently advised investors and managers to learn, develop, and in his 1994 USC speech entitled “A lesson on element worldly wisdom” he elaborated on how to apply a Latticework of Mental Models that will allow them to approach problems through various lenses. “What is elementary, worldly wisdom? Well, the first rule is that you can’t really know anything if you just remember isolated facts and try and bang them back”. In short, you need a theory.

?

1.?Avoid stupidity and misery with inversion.

One of Munger’s favourite mental models was inversion. The core idea is to invert the traditional, forward-thinking problem-solving perspective and look back at the desired outcome to identify and avoid potential missteps. In various ways, Munger’s advice was more about preventing misbehaviours and misjudgments than pursuing prescriptions for success.

For example, in his 1986 Graduation Ceremony speech at the Los Angles-based Harvard School to his youngest son’s graduating classmates, Munger provided a set of prescriptions guaranteed to deliver misery. At the top of the list was being unreliable. He advised that this one lousy habit “will more than counterbalance all your virtues, however great. If you like being distrusted and excluded from the best human contribution and company, this prescription is for you. Master this one [bad] habit, and you will always play the role of the hare in the fable, except instead of being outrun by one fine turtle, you will be outrun by hordes and hordes of mediocre turtles and even some mediocre turtles on crutches.”

Twenty years later, Munger said about this speech, “I now believe even more strongly that (1) reliability is essential for progress in life and (2) while quantum mechanics is unlearnable for a vast majority, reliability can be learned to a great advantage by almost anyone.”

If there is just one thing you take from this post, make it this one.

Munger included other prescriptions to guarantee misery, including not learning from others’ mistakes or successes and not persevering. Misery is assured if you “...stay down when you get the first, second, or third severe reverse in the battle of life. Because there is so much adversity out there, even for the lucky and wise, this will guarantee that, in due course, you will be permanently mired in misery.”

His final prescription for “a life of fuzzy thinking in infelicity” was to ignore the wisdom of inversion. He recalled hearing about a rustic who said, “I wish I knew where I was going to die, and then I’d never go there.” He added, “Most people smile at the rustic’s ignorance and ignore his basic wisdom. If my experience is any guide, the rustic’s approach is to be avoided at all costs by someone bent on misery”.

Munger’s curiosity and tenacity to identify sources of human stupidity have exceeded all but very few, as the example of his remarkable talk mentioned next.

2.?The superpower of incentives.

In 1995, Munger gave a talk at Harvard University about 25 cognitive biases. He was already 71 years old, but when he looked back at this speech ten years later, in a fashion that embodies his unique capacity for self-improvement and his passion for sharing his wisdom, he rewrote and extended the address to a 50-page document. The reward and punishment Super Response Tendency is his list's number one cognitive bias. Munger counsels, quoting Benjamin Franklin, “If you would persuade, appeal to interest and not to reason.” He continues, "This maxim is a wise guide to a great and simple precaution in life: Never, ever, think about something else when you should be thinking about the power of incentives.” Also, don’t expect things to happen without incentives. He refers to an old joke about a soviet employee describing that system: “They pretend to pay us, and we pretend to work.”?

In powerful ways, incentives encourage both desirable and undesirable behaviours. So Munger had another precaution: “Dread and avoid as much you can, rewarding people for what can be easily faked." He argued that every system could be gamed, so anti-gaming features were essential. He foresaw that when motivated by incentives, self-serving or even organization-serving behaviours could gradually drift into immoral actions.

While we tend to think first about financial incentives, in every system there are plenty of non-financial ones and that includes systems we create for our own self-improvement. As such, Munger offered the Granny’s rule that children should eat their carrots before they get dessert. Applied to business, get in the habit of doing unpleasant tasks before pleasant ones.

3.??The circle of competence.

Munger made sure that he continuously operated within an ever-expanding circle of competence. Thomas Watson Sr, the founder of IBM, succinctly summarised the circle of competence when he said, “I’m no genius. I’m smart in spots, and I stay around these spots”. Munger added, “If you have competence, you pretty much know its boundaries already. To ask whether you are past the boundary is to answer it”.

Munger applied the circle of competence to investing. He had three investment categories– yes, no, and too tough to understand. He only invested in businesses that he understood, that led their peers, and that sustained and thrived in any external environment.

Of course, the value of the circle of competence is not limited to investing. Munger believed it was necessary to combine intellectual humility with lifelong learning. He tried to learn something about everything but didn't consider any such knowledge to qualify as competence,.

Some topics are simply elementary to better handle specialty domain. For example he highlighted the importance of mastering the concepts of compound interest and probability, because otherwise our default mode is to ignore them (as our brain seeks computational shortcuts). He explained this more colourfully than I ever could: “If you don’t get this mildly unnatural mathematics of elementary probability into your repertoire, then you go through life like a one-legged man in an ass-kicking contest.” ?

4.?Wait to identify the best opportunities, then pounce.

Munger approached investing with a hit mentality. He and his Berkshire Hathaway partner Warren Buffett looked for the big wins. They referred to their strategy as sit-on-your-ass investing: “If you took our top 15 decisions out, we would have a pretty average record. It wasn’t hyperactivity but a hell of a lot of patience. You stuck to your principles, and when opportunities came along, you pounced on them with vigour.” In my strategy work at McKinsey, we practice a similar approach and look for opportunities to pour resources into the best candidates for striking it big. Of course, this approach requires boldness, and Munger knew that waiting was only worthwhile if bold, timely actions followed. He observed, “Patience is a virtue, but you will never ever get anywhere if you don't do something.” Munger believed you must work hard to sift the world for a mispriced asset while being mindful that you will only seldom find one: “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.”

Warren Buffett has a favourite thought exercise, which others have called the “20 Slot” rule. Munger described it: “When Warren lectures at business schools, he says, “I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches—representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all. Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about, so you’d do so much better.”

Connected to this, as an investor, Munger proudly focused all his energy on what to buy and gave comparatively little thought to when to sell, explaining that “We're partial to putting out large amounts of money where we won't have to make another decision. If you buy something because it's undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That’s hard. But if you buy a few great companies, then you can sit on your ass. That’s a good thing”.

5.?Blinkered ideology can seriously hurt you.

Munger acknowledged our tendency to drift towards comforting and familiar ideologies and advised against it. He explained how to avoid this drift: “I have what I call an “iron prescription” that helps me keep sane when I naturally drift toward preferring one ideology over another. And that is I say, “I’m not entitled to have an opinion on this subject unless I can state the arguments?against?my position better than the people do who are supporting it. I think only when I reach that stage am I qualified to speak.”

Very few people are good at this, but developing the habit of pausing and collecting the arguments against our position before speaking is valuable and can save us from ourselves. Unfortunately, Munger observed, “most people early achieve and later intensify the tendency to process new and disconfirming information so that any original conclusion remains intact.”

Munger agreed with Keynes who said: “It’s not bringing in the new ideas that’s so hard, it’s getting rid of the old ones.”

?

6. The importance of character

Munger placed a huge value on character. He remarked that, “To get what you want, you have to deserve what you want. The world is not yet a crazy enough place to reward a whole bunch of undeserving people.” I hope that’s still true. He referenced Lincoln when he said that “ability gets you the top, but it takes character to keep you there” and, “I think track record records are very important. If you?start early trying to have a perfect one in a some simple thing like honesty, you're well on your way to success in this world.” Indeed, Munger believed honesty created loyalty among Berkshire Hathaway shareholders and employees. He took pride in the company’s clean record over many decades and the legal line was never the standard for him. He said that, “We believe there should be a huge area between everything you should do and what you can do without significant risk of suffering criminal penalty or causing losses. I don't think we get a lot of credit for that, because we understood early that we’d make more money that way. I'd like to believe that we'd behave well even if it didn't work so well financially. And every once in a while we get an opportunity to behave that way. But more often, we've made extra money out of morality. Ben Franklin was right for us. He didn’t say honesty was the best morals; he said it was the best policy.”

?

7.?Self-improvement so long as breath lasts

To finish where we began, above all the many brilliant and witty Mungrisms, his passion for lifelong learning is the most inspiring to me.

Others inspired Munger to learn throughout his life. Ben Franklin, for one, but also one of Franklin’s heroes, the Roman statesman, writer, and orator Marcus Tullius Cicero (106 to 43 BC). ?When Cicero was 60 (old for his time) he wrote a book titled, “On a Life Well Spent”. Munger summarized: “Cicero, learned man that he was, believed in self-improvement so long as breath lasts.” And Cicero twice quotes with relish what was often said of Solon, the great man of early Athens: “Daily learning something, he grew old”. For Cicero, it is unworthy that an old man would work to improve only what he would live to enjoy. For him, the only life worth living is dedicated in substantial part to good outcomes one cannot possibly survive to see.”

And it was in this way that Charlie Munger lived and learned for the best part of 100 years.

Vale Charlie Munger.

?

?