“No wise pilot, no matter how great his talent and experience, fails to use his checklist.“
o Incorporate and appropriate margin of safety
o Avoid dealing with people of questionable character
o Insist upon proper compensations for risk assumed
o Always beware of inflation and interest rate exposure
o Avoid big mistakes; shun permanent capital loss
o Objectivity and rationally require independence of thought
o 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 you analysis and judgement
o Mimicking the herd invites regression to the mean (merely average performance)
o Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day
o More important than the will to win is the will to prepare
o Develop fluency in mental models from the major academic disciplines
o If you want to get smart, the question you have to keep is asking is “why, why, why?”
o Stay within a well-defined circle of competence
o Identify and reconcile disconfirming evidence
o Resist the craving for false precision, false certainty, etc.
o Above all, never fool yourself, and remember that you are the easier person to fool
o Determine value apart from price; progress apart from activity; wealth apart from size
o It is better to remember the obvious than to grasp the esoteric
o Be a business analyst, not a market, macroeconomics or security analyst
o Consider totality of risk and effect; look always at potential second order and higher level effects
o Think forward and backwards – Invert, always invert
o Remember that highest and best use is always measured by the next best use (opportunity costs)
o Good ideas are rare –when the odds are greatly in your favour, bet (allocate) heavily
o Don’t fall in love with an investment – be situation-dependent and opportunity driven
o “Compound interest is the eighth wonder of the world “ (Einstein); never interrupt it unnecessarily
o Avoid unnecessary transactional taxes and frictional costs; never take action for its own sake
o Be alert for the arrival of luck
o Enjoy the process along with proceeds, because the process is where you life
o Be fearful when others are greedy, and greedy when others are fearful
o Opportunity does not come often, so seize it when it does
o Opportunity meeting the prepared mind: that’s the game
o Recognize and adapt to the true nature of the world around you; don’t expect it to adapt to you
o Continually challenge and willingly amend your “best-loved-ideas”
o Recognize reality even when you don’t like it – especially when you don’t like
o Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat
o Guard against the effects of hubris and boredom
o Don’t overlook the obvious by downing in minutiae
o Be careful to exclude unneeded information or slop: “A small leak can sink a great ship”
o Face your big troubles don’t sweep them under the rig
In the end it comes down to Charlie’s most basic guiding principles, his fundamental philosophy of life: Preparation. Discipline. Patience. Decisiveness. Each attribute is in turn lost without the other, but together they form the dynamic critical mass for a cascading positive effects for which Munger is famous (the “lollapalooza”).
Summary of Charles T. Munger’s psychology checklist taken from “Poor Charlie’s Almanack”. We should develop mental checklists for investing or at least go through them before important decisions. This one is highly relevant to life in general.
1) Reward and Punishment - Get the incentives right (Management consulting report this problem needs more management consulting). First action should always be to write down the incentives of everybody involved. If the equation does not workout change it. Incentives are despite being taught in each business school, often underestimated in real life.
2) Like Loving Tendency - like and love being liked, positive feedback bias towards the loved ones. Ignore faults of and comply with wishes of, the object of affection, to favour people, products and actions merely associated with the object of affection, to distorts other facts to facilitated love.
3) Dislike Hating Tendency - Often used in politics to “channel” the hatreds and disliking of individuals and groups into nonlethal patterns including elections. Politics is the art of marshalling hatreds. Often relevant on family level (property law).
4) Doubt-Avoidance Tendency - The brain of man is programmed with a tendency to quickly remove doubt by reaching a decision. Which is often supported by puzzlement and stress (used as well in religion).
5) Inconsistent Avoiding Tendency - Easy to prevent habits than to avoid them. It’s difficult for us to change something which we already programmed into our brain. “An ounce of prevention is worth a pound of cure”. Developing good habits and avoid the bad ones from the beginning.
6) Curiosity Tendency- Curiosity can be strong motivation and lead to better performance, education needs to embrace this.
7) Kantian Fairness Tendency – Human have a natural understanding for fairness, sort of “golden rule” everybody is aware of according to Kant.
8) Envy/Jealousy Tendency – Natural tendency in humans, to compare. “It’s not greed that drives the world but envy.”
9) Reciprocation Tendency - Small courtesy, car sales man cup of coffee for $500 extra dollars, ask for a small favor to gain relationship advantage.
10)Influence –from-Mere-Association Tendency- Associate highest price with highest quality. Even trivial associations work, Coke ads of happy life, military bands play impressive music etc. Some of the most important miscalculations come from what is accidentally associated with one’s past success, or one’s liking and loving, or one’s disliking and hating, which includes a natural hatred for bad news.
11)Simple, Pain-Avoiding Psychological Denial - If something is painful to admit, an easy way is just too simply deny it. E.g. drug addicted often trick themselves. Stay away from any conduct at all like do drift into chemical dependency.
12)Excessive Self-Regard Tendency - We all commonly observe the excessive self-regard of man. He mostly misappraisals himself on the high side, like ninety percent of Swedish drives that judge themselves to be above average. Also once you own something you value it more also called “endowment effect”. Example is also the overinfluence by face-to-face impression for a job candidate who is a marvelous “presenter” often causes great danger under modern executive-search practice.
13)Overoptimism Tendency - “What a man wishes, that also will he believe”. Excess of optimism is standard approach for us even when we are already doing well. One antidote to foolish optimism is trained, habitual use of simple probability math of Fermat and Pascal. The mental rules of thumb that evolution gives us to deal with risk are not adequate.
14)Deprival-Superreaction Tendency - Man values overvalues not losing to gaining. Or if man almost get something he greatly wants and has it jerked away from him in the last moment, he will react much as if he had long owned the reward and had it jerked away. Man also often compare to what is near instead of what really matters. For instance a man with $10m in his brokerage account will often be extremely irritated by the accidental loss of $100 out of the $300 in his wallet. Am man ordinarily reacts with irrational intensity to even a small loss, or threated loss, of property, love friendship, dominated territory, opportunity, status, or any valued thing. As a natural result, bureaucratic infighting over the threatened loss of dominated territory often causes immense damage to an institution as a whole. This factor, among others accounts for much of the wisdom of Jack Welch’s long fight against bureaucratic ills at General Electric.
15)Social-Proof Tendency - Compliance behaviour and management errors result out of social proof tendencies, most easily triggered under puzzlement or stress, and particularly when both exist. Because both bad and good behaviour are made contagious by Social-Proof Tendency, it is highly important that human societies 1) stop any bad behaviour before it spreads and 2) Forster and display all good behaviour. If only one lesson is to be chosen this would be learn how to ignore the examples from others when they are wrong, because few things are more worth having.
16)Contrast Misreaction Tendency - The eyes contrast in what is seen registered. Moreover, as perception goes, so goes cognition. Few psychological tendencies do more damage. Small scale damages involve buying an overpriced $1000 leather dashboard merely because the price is so low compared to his concurrent purchase of a $65000 car. Large-scale damages often ruin lives, as when a wonderful woman having terrible parents marries a man who would be judged satisfactory only in comparison to her parents. Salesman deliberately shows the customer three awful houses at ridiculously high prices. Then he shows him a merely bad house at a price only moderately too high. And, boom the broker makes an easy sale. Other example, to make an ordinary price seem low, the vendor will advertise an ordinary price as reduction. Even when people know this sort of manipulation, it will often work to trigger buying. It also demonstrated that being aware of psychological ploys is not a perfect defense.
17)Stress Influence Tendency - More social confirmatory decision under stress. People might turn complete personality after break down (Palov experiments), every person can be broken. A break down can change a personality completely.
18)Availability- Misweighting Tendency - Theories and stories that can be easy remembered have a higher weight for us, and therefore are more likely to be seen as true. Good example for this in finance is the CAPM.
19)Use-It-Or-Lose-It-Tendency - Over time educations narrows down to the field in which knowledge is applied. One needs systematic checklist of skills and constant training of important theoretical frameworks to keep a general toolbox for solving problems, and don’t become the man with the hammer who treats every problem with the same solution.
20)Drug-Misinfluence Tendency - Avoid problem from the beginning, can result in “Simple, Pain-Avoiding Psychological Denial.”
21)Senescene-Misinfluence Tendency - Continues learning and practice will slow down aging of mental abilities.
22)Authority-Misinfluence Tendency - Higher authority can result in blind following of orders, reason for many catastrophes. Warren Buffet is always quite like a mouse around his pilots.
23)Twaddle Tendency – Tendency to focus on unimportant stuff.
24)Reason-Respecting Tendency - Why is the most important question for any task. Reason can lead to strong motivation but is often also misused to manipulate people. “Why?” is a sort of Rosetta stone opening up the major potentially of mental life.
25)Lollapalooza Tendency - Bringing pressure to bear form various psychological tendencies at the same time. Extreme consequences from confluences of psychological tendencies acting in favor of a particular outcome. One of the key reasons for the success of the Milgram experiment often not considered in psychological textbooks.
This is best piece on investment I have been reading for a long time.
“Indeed, the average result has to be the average result. By definition, everybody can’t beat the market. As I always say, the iron rule of life is that only 20% of people can be in the top fifth. That’s just the way it is. So the answer is that it’s partly efficient and partly inefficient.
And, by the way, I have a name for people who went to extreme efficient market theory – which is “bonkers”. It was an intellectually consistent theory that enabled them to do pretty mathematics. So I understand its seductiveness to people with large mathematical gifts. I just had a difficulty in that the fundamental assumption did not tie properly to reality.
Again, to the man with the hammer, every problem looks like a nail. If you’re good at manipulating higher mathematics in a consistent way, why not make an assumption which enables you to use your tool?
The model I like–to sort of simplify the notion of what goes on in a market for common stocks – is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what’s bet. That’s what happens in the stock market.
It’s not a bit easy of course, 50% will end up in the bottom half and 70% will end up in the bottom 70%. But some people will have an advantage. And its fairly low transaction cost operation, they will get better than average results in stock picking.
It’s not given to human beings to have such a talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it – who look and sift the world for mispriced be – that they occasionally find one.
And 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.
That is a very simple concept. And to me it’s obviously right –based on experience not only from the pari-mutuel system, but everywhere else.”
Below the link to his full document: