Charlie Munger: Investing Success From Mental Models Amp; Checklists

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As many will know, Charlie Munger is Warren Buffett’s confidant, partner and the Vice-Chairman of Berkshire Hathaway. Buffett credits him with much of the success of his investing approach: quot;Charlie shoved me in the direction of not just buying bargains, as Ben Graham had taught me. This was the real impact Charlie had on me. It took a powerful force to move me on from Graham’s limiting views. It was the power of Charlie’s mind. He expanded my horizons.

Although less well-known than Buffett, Munger was also a first class investor in his own right before his years with Berkshire. He was lauded in Buffett’s 1984 essay, quot;The Superinvestors of Graham-and-Doddsvillequot;. Although Charlie started out as a lawyer, he also ran an investment partnership of his own from 1962 to 1975 and generated compound annual returns of 19.8% during the 1962–75 period (vs. a 5.0% annual return for the Dow).

A very interesting distillation of Munger’s approach can be found in quot;Poor Charlie’s Almanackquot; (first published in 2004). Compiled by Peter Kaufman, the book is a collection of Munger’s speeches over the years and a summary of his ideas. Munger is an admirer of Benjamin Franklin, and the book’s title is apparently a tribute to Franklin’s Poor Richard’s Almanack.

Latticework of Mental Models

Munger is best known for  emphasising the power amp; importance of multi-disciplinary learning (or he calls it, quot;worldly wisdomquot;) to become successful at stock-picking as well as life generally. He argues that investors should not just focus on a few narrow topics but expand their horizons to understand many different subjects. This allows savvy investors to avoid myopia – quot;If you have a hammer everything will start to look like a nailquot; – and profit from others’ shortsightedness. 

The best example of this thinking was a speech he gave in 1994 to the University of Southern California Business School entitled quot;A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management amp; Businessquot;. Rather than discussing the stock market specifically, he challenged the students to see the market, of finance, and of economics as part of a larger body of knowledge, that also incorporates psychology, engineering, mathematics, physics, and the humanities. To drive his point home, Charlie used a memorable metaphor to describe this interlocking structure of ideas: 

quot;You’ve got to have models in your head and you’ve got to array your experience – both vicarious and direct – on this latticework of models…. The first rule is that you’ve got to have multiple models because if you just have one or two that you’re using, the nature of human psychology is such that you’ll torture reality so that it fits your models, or at least you’ll think it does…  And the models have to come from multiple disciplines because all the wisdom of the world is not to be found in one little academic departmentquot;

While this may seem intimidating and beyond the capacity of mere mortals, Munger suggest about that 80 or 90 important models will do 90% of the work and, of those, only a mere handful are the most important. Unfortunately, he doesn’t specify exactly which models he’s referring to, but others have speculated on the list and it seems clear from his writings that he’s refering to concepts like auto-catalysis, decision-trees, operant conditioning social proof, and natural selection.

The Power of Checklists

Munger is also an advocate of employing a checklist approach in order to try to marshall acquired knowledge effectively. As he noted in a speech to the University of Southern California Law School

quot;Checklist routines avoid a lot of errors. You should have all this elementary [worldly] wisdom and then you should go through a mental checklist in order to use it. There is no other procedure in the world that will work as well.quot; 

He also noted in another speech:

quot;The antidote to man with a hammer is a tool kit full of tools, not just a hammer. And use the tools checklist style because you’ll miss a lot if you hope the right tool just pops up unaided whenever you need it. But if you’ve got a full list of tools and you go through them in your mind checklist-style, you will find a lot of the answers you won’t find any other way.”

An Investing Principles Checklist

On that note, Charlie’s Almanack contains a fascinating 10 point investing principles checklist, along with some interesting comments/observations in support of each point. It is emphasised that this isn’t used by Charlie in a one-by-one procedural fashion, nor are the principles prioritized in terms of importance. Nevertheless, the idea is that each of these elements should be considered as part of the investment analysis process…

  1. Measure risk: All investment evaluations should begin by measuring risk, especially reputational.  This is said to involve incorporating an appropriate margin of safety, avoiding permanent loss of capital and insisting on proper compensation for risk assumed. 
  2. Be independent: Only in fairy tales are emperors told they’re naked.  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.
  3. Prepare ahead: The only way to win is to work, work, work, and hope to have a few insights. If you want to get smart, the question you have to keep asking is “why, why, why?”
  4. Have intellectual humility: Acknowledging what you don’t know is the dawning of wisdom.  Stay within a well-defined circle of competence amp; identify and reconcile disconfirming evidence.
  5. Analyze rigorously: Use effective checklists to minimize errors and omissions. Determine value apart from price; progress apart from activity; wealth apart from size. Think forwards and backwards – Invert, always invert
  6. Allocate assets wisely: Proper allocation of capital is an investor’s No. 1 job. You should remember that good ideas are rare – when the odds are greatly in your favor, bet heavily. At the same time, don’t “fall in love” with an investment.
  7. Have patience: Resist the natural human bias to act. “Compound interest is the eighth wonder of the world” (Einstein); never interrupt it unnecessarily and avoid unnecessary transactional taxes and frictional costs.
  8. Be decisive: 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 comes.
  9. Be ready for change: Accept unremovable complexity. Continually challenge and willingly amend your “best-loved ideas” and recognize reality even when you don’t like it – especially when you don’t like it
  10. Stay focused: Keep it 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. Face your big troubles; don’t sweep them under the rug.

The Lollapolooza Effect

Another idea that Munger introduces is the  quot;Lollapalooza Effectquot;. This describes multiple biases, tendencies or mental models acting at the same time in the same direction. With the Lollapalooza effect, the result is often extreme, due to the confluence of the mental models, biases or tendencies acting together. During a talk at Harvard in 1995, Munger mentions Tupperware parties and open outcry auctions as good examples:

the open-outcry auction is just made to turn the brain into mush: you’ve got social proof, the other guy is bidding, you get reciprocation tendency, you get deprival super-reaction syndrome, the thing is going away… I mean it just absolutely is designed to manipulate people into idiotic behavior.

From the Source

In addition to the quot;Poor Charlie’s Almanackquot; compilation (available on Amazon or direct from the website itself), there are a number of interesting speeches by Munger available online:

It’s also worth checking out the excellent Munger resource page at Value Walk

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