Now I've read a lot of books from a lot of authors and today I’m going to talk about one of the most important books in my library, "Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger" which is the closest thing to a life manual as I have found so far.
Charlie Munger is Warren Buffett’s long-time partner at Berkshire Hathaway. Content to being the lesser known of the two, Munger is no less impressive. Bill Gates says that Charlie Munger “is truly the broadest thinker I have ever encountered,” and Buffett calls him the ideal partner who is “both smarter and wiser.”
Poor Charlie’s Almanack is a collection of Charlie Munger’s best advice given over 30 years, in the form of 11 speeches given as commencement addresses and roundtable talks. He covers a wide range of topics, including rationality and decision making, investing, and how to live a good life.
I'm going to break this video down by the key concepts and learning points that the book collects together. I'm splitting the article into five sections similar to the key themes in the book: 1. Rationality and Decision-Making, 2. Understanding and Avoiding Psychological Biases, 3. Building Mental Models, 4. Understanding Investing and Business and 5. Character and Living a Good Life. Each of these sections I'm going to break down into individual points so let's get into the first rationality and decision making.
1. Rationality and Decision Making
When asked to describe himself in one word, Charlie Munger chose “rational.” He knows he’s subject to the same biases affecting all other humans, and he’s trained himself to recognize when the biases are active and how to limit their damage.
Objectivity and Changing One’s Mind
If you want to make better decisions, you need to seek truth—what is really happening in the world, not what you want to believe is happening. Recognizing the truth is often painful—it may go against your prior beliefs or desires, but recognizing reality is better than deluding yourself.
- First, recognize that it’s very easy to delude yourself.
- Second, you should readily entertain other opinions. You should deliberately consider arguments of the other side. In fact, try to state the other side’s opinions better than they can themselves.
Third, after considering other viewpoints, you should readily change your mind. Be willing to destroy your favorite ideas. Munger says that any year he doesn’t destroy one of his beloved ideas is a wasted year. Charlie also highlights the importance of avoiding extreme ideologies and following ideas blindly without understanding the pros and cons and being able to make an informed decision appreciating both sides of an idea or situation.
Practice Divergent and Contrary Thinking
Social proof bias is the tendency to believe what others believe, to improve social cohesion. This causes humans to think like sheep, even if the ideas they believe are wrong. Practicing contrary thinking invites new ideas that might be more correct than what everyone else thinks.
Munger and Buffett practice this regularly in their financial management. If you adopt the same investment practices as everyone else, you can by definition only get average returns. To achieve outstanding returns, you need to think differently from the crowd.
Invert, Always Invert
One way to practice divergent thinking is to invert your view on a situation, to look at it from the opposite perspective. This can reveal new insights. “Many hard problems are best solved only when they are addressed backwards.”
Here are a few examples of inverting thinking:
- Instead of thinking about how something can succeed, think about how it can fail. “What can go wrong that I haven’t seen?”
- When physicists were trying to revise Maxwell’s electromagnetic laws to be consistent with Newton’s mechanical laws, Einstein inverted the situation—he revised Newton’s laws to fit Maxwell’s, and so discovered special relativity.
Know Your Circle of Competence
To make good decisions, you need to know what you’re good at and what you’re bad at. Munger calls this the “circle of competence”—know where your boundary is, and don’t step outside of the circle.
Here are elaborations of this idea:
- “Knowing what you don’t know is more useful than being brilliant.”
- “People are trying to be smart—all I am trying to do is not to be idiotic, but it’s harder than most people think.”
- “You have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don't, you are going to lose.”
- “It’s great to have a manager with a 160 IQ—unless he thinks it’s 180.”
In investments, Charlie Munger and Warren Buffett know what they’re good at and what they’re bad at. They hesitate to stray outside their circle of competence. For example, they have three baskets for investing: yes, no, and too tough to understand.
- First, Munger looks for an easy to understand, dominant business franchise that can sustain itself and thrive in all market environments. Most businesses don’t make this cut.
- Certain businesses, like pharmaceuticals and technology, go into the “too tough to understand” bucket. Munger finds that the dynamics of software and computer chips are simply outside their area of expertise, so they reject them completely. Munger and Buffett don’t try to grasp the esoteric—they simply try to remember the obvious.
- “Hot” deals and IPOs get rejected as no’s (Munger considers these as overhyped and overpriced).
Learn Vicariously from Others’ Mistakes
Munger and Buffett both read and learn constantly, and one of the reasons is to learn from other people’s mistakes. You can learn vicariously from other people’s terrible experiences and save yourself from the same fate.
Charlie strives to reduce complex situations to their most basic, unemotional fundamentals. Yet, within this pursuit of rationality and simplicity, he is careful to avoid what he calls “physics envy”, the common human craving to reduce enormously complex systems (such as those in economics) to one-size-fits-all Newtonian formulas. Instead he faithfully honors Albert Einstein’s admonition, “A scientific theory should be as simple as possible, but no simpler.” Or in his own words, “What I’m against is being very confident and feeling that you know, for sure, that your particular action will do more good than harm. You’re dealing with highly complex systems wherein everything is interacting with everything else.”
2. Understanding and Avoiding Psychological Biases
A student of human psychology, Munger compiled a list of 25 psychological biases that distort how you see the world and impair decision making. This is such an important topic that I'm going to break this down into it's own blog and video but here are a few notable ones:
- Incentive bias: Self-interest drives human behavior. If someone receives rewards for doing a behavior, they will do that behavior again and again.
- Doubt-avoidance tendency: Doubt is painful, causing puzzlement and stress. When you feel doubt, you reach a decision more quickly than a fully considered decision would take.
- Inconsistency-avoidance tendency: People are reluctant to change. This applies to personal behavior, beliefs, relationships, and commitments. Once someone believes something, it’s typically hard for them to change their mind.
- Influence from mere association: When two items are placed close together, the qualities of one item transfer to the other. If you like something, you’ll like other things that it’s paired with. The inverse is also true.
- Deprival super-reaction: We hate having things taken away from us. Being deprived of things ignites a strong counterreaction.
- Social proof: You think you’re in independent control of your actions, but in reality you do what you observe from other people. You think their thoughts and you mirror their actions.
- Authority mis-influence: Man was born mostly to follow leaders, with only a few people doing the leading. People tend to follow instructions from authority, even blindly.
- Lollapaloozas: this is a kind of “super-tendency”—it involves the confluence of multiple tendencies that reinforce each other and lead to extreme consequences. Examples include people who join extreme cults and the Milgram shock experiment.
The best way to guard against biases is to learn what they are and how they affect cognition, then construct a checklist to go through each one and think about whether it’s affecting your current judgment.
3. Build a Latticework of Mental Models
Charlie Munger has learned a lot about the world, and he calls the main ideas from the major fields “mental models.” He stresses the importance of multidisciplinary learning and connecting the major ideas together in a latticework, where the ideas can interact with each other. This is similar to interleaving of concepts in learning.
The inferior way to learn is to learn isolated facts that exist entirely in separate silos. You can recite the facts, but you don’t know the ideas underlying them, and you can’t apply those ideas to solve problems in real life. This is a failure of rote learning, which is common in many national education systems.
Munger argues that the superior way to learn is to learn lots of mental models, then assemble them into a connected latticework or a network.
What are Mental Models?
You can think of “mental models” as important ideas in a field that have broad relevance outside the field itself.
For example, the idea of “critical mass” comes from physics. Within the field of physics, the idea of critical mass relates specifically to the mass needed to sustain a nuclear chain reaction—if you have less than the critical mass, a chain reaction won’t perpetuate itself. But this concept applies generally outside of physics—metaphorically, it can apply to the minimal mass needed to start any virtuous cycle, like the minimum number of users needed to get a social networking app off the ground.
Other examples of mental models include “margin of safety” from engineering, “compound interest” from math, and “feedback loops” from biology.
Learn Models from Different Fields
The best ideas in the world exist in each of the major fields. No single academic department has all the answers to all the problems. To become the most versatile problem solver, you need to collect mental models from every major field of study.
Modern academia tends to silo fields of study into isolated departments. Ideas stay narrowly defined, and experts within the field stay largely within their lane. Munger argues this is why a literature professor can be esteemed in her field but be considered unwise in other aspects of life.
When you have models from different fields working together, this can yield surprising results that other people don’t see.
A Latticework of Mental Models
As you collect more of these ideas, you will start relating them together. For example, you might see how stock market swings are a combination of psychological biases (loss aversion, social proof), feedback loops from biology, critical mass from physics, and random walks from math. These connected ideas form a latticework of mental models.
4. Understanding Investing and Business Strategy
In Poor Charlie’s Almanack, Munger doesn’t talk directly about Berkshire Hathaway’s decisions much, but he does share the general investment philosophies and practices that have made them successful over decades.
Be Patient But Decisive
Warren Buffett and Charlie Munger make successful investments because they’re able to wait patiently for great deals. Unlike many investors, they don’t mind staying inactive, even for years at a time, when they don’t see great opportunities. However, when they do see great opportunities, they bet big.
When Warren Buffett lectures at business schools, he’s known for saying that everyone would make better investments if they were given a punch card with twenty slots in it and were restricted to only twenty investments throughout their entire lifetime. Once they punched all twenty holes, they would be able to make zero additional investments. Under these conditions, investors would be much more discerning about which investments to pursue, and they’d bet big on the few investments they found.
Find High-Quality Businesses
Beyond just looking for cheap deals, Munger looks for high-quality businesses. In sum, these are profitable businesses that have a sustainable competitive advantage and good growth prospects.
The quality of a company may even override cheapness—”a great business at a fair price is superior to a fair business at a great price.” A company that returns 18% on capital over twenty years can get amazing results, even if you pay a price that looks expensive at first.
Moats and Competitive Advantage
Munger and Buffett consider the primary factor of a great business to be an enduring competitive advantage—what they call a “moat.” Like a moat protecting a castle, the competitive advantage allows a business to resist being made obsolete by competitors or changing markets. Examples of moats include loyal branding (such as See’s Candies) or a massive distribution system that is hard to rival (such as Coca-Cola).
Berkshire Hathaway thus counsels its companies to widen their moats every year. This doesn’t necessarily mean earning more profits each year, but rather growing a company’s strategic position to weather the long term.
The father of value investing Ben Graham never accounted for management quality in his value investing principles, partially because he was writing to a mass audience who wouldn’t have the opportunity to talk to and assess management, and partially because he had an intrinsic distrust of management.
But Munger and Buffett believe management can make a big difference. For example, famed CEO Jack Welch made a big difference for General Electric, in ways that the manager of Westinghouse didn’t. Munger looks for management that is 1) unusually skilled and 2) trustworthy.
Of course, to earn great returns, it’s important not just to find great businesses, but also great businesses at great prices. Even a fantastic business can be a terrible investment if the price is too high.
Consider betting on a horse race. The best horse is often obvious, based on its track record, weight, health, and so on, and it’s clearly better than a sickly horse with a bad record. But the odds already reflect that—the best horse might have odds of 2 to 1, while the bad horse has odds of 50 to 1. Which is the better deal? It’s not immediately clear.
5. Character and Living a Good Life
In all, Charlie Munger is said to be a man of solid character—hard-working, humble, and always learning. In his speeches, he talks often about the traits leading to a happy and productive life.
How to Live Happily
- Have low expectations.
- Have a sense of humor
- Surround yourself with the love of friends and family.
- Figure out the lifestyle that you want most. You might indeed work eighty hours a week for fifteen years to make partner at a law firm, just to get the right to do more of the same. But if you don’t, this might not be the right life for you.
- To get what you want, try to deserve what you want.
- Avoid self-pity. It’s counterproductive and doesn’t change your situation. If you don’t feel self-pity, you’ll have an advantage over many people, since it’s a common response. Munger had a friend who carried a stack of business cards, and when he heard a self-pitying comment, he’d give the person a card; the card read, “Your story has touched my heart. Never have I heard of anyone with as many misfortunes as you.”
- Be around people you admire. Don’t work under someone you don’t want to be like.
- Work hard. Munger likes the word “assiduity” because it informally means, “Sit down on your ass until you do it.”
- Anticipate trouble. You’ll better know how to avoid it.
Moral Character and Honesty
Munger cares a lot about reputation—the reputation of Berkshire Hathaway, of its owned companies, and of himself. He desires integrity from people he works with and managers of companies he wants to acquire. Companies that have a trusted brand name have a competitive advantage that can persist over time. Trust takes a long time to build, and an instant to vanish.
- “When you borrow a man’s car, you always return it with a full tank of gas.” People notice these little things.
- Track records are important, and if you develop one in an integral trait like honesty, you’ll have a big advantage in the world.
Munger and Buffett are both famous for their curiosity and their voracious reading.
- “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. You’d be amazed at how much Warren reads — and at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”
- “You need to have a passionate interest in why things are happening. That cast of mind, kept over long periods, gradually improves your ability to focus on reality. If you don’t have that cast of mind, you’re destined for failure even if you have a high I.Q.”
- Spend each day trying to be a little smarter than when you woke up.
Success doesn’t come without hard work.
- Munger thinks that passion is more important than natural talent or brain power. Berkshire has many companies with people who are fanatics about their business.
- Munger and Buffett are both famous for reading a lot. But reading isn’t enough—you need to have the courage to choose the right ideas and do good things with them.
Choosing a Career
What should a young person look for in a career? According to Charlie you should try to follow 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 working with.
According to Cicero, a passage in the “de Sertare”:
“The best armour of old age is a well spent life preceding it. A life employed in the pursuit of useful knowledge, in honorable actions and the practice of virtue; in which he who labors to improve himself from his youth, will in age reap the happiest fruits of them; not only because these never leave a man, nor even in the extremist(ic) old age; but because a conscience bearing witness that our life was well-spent, together with the remembrance of past good actions, yields an unspeakable comfort to the soul."
Here’s Charlie's full commencement address video if you would like to watch it: