10 Uncanny Investment Principles by Charlie Munger
“You need a different checklist and different mental models for different companies. I can never make it eary by saying, ‘Here are three things.’ You have to derive it yourself to ingrain it in your head for the rest of your life.” —Munger
Today I finished reading the great book Poor Charlie’s Almanack – The Wit and Wisdom of Charles T. Munger.
I have read all of the talks included in the book earlier, but re-reading them is a true pleasure.
Listening to what Schopenhauer had to say about good books, I think I might pick it up again once or twice.
“Any book, which is at all important, should be reread immediately.” —Arthur Schopenhauer
In the book, Charlie talks about the importance of having different checklists and using them properly when making decisions in different situations.
This to avoid making foolish judgmental mistakes.
An Investing Principles Checklist
“No wise pilot, no matter how great his talent and experience, fails to use his checklist.”
In keeping with our intent to observe “how he seems to do it,” we will recap his approach by using the “checklist” methodology he advocates. (For Charlie’s own words of wisdom on the value and importance of checklists, see Talk Five and page 320.)
The following principles are not employed by Charlie on a one-by-one or one-time fashion as the checklist format might seem.
They can’t be easily prioritized by apparent or relative importance. Rather, each must be considered as part of the complex whole or gestalt of the investment analysis process, in much the same way that an individual tile is integral to the larger mosaic in which it appears.
Charlie Munger’s Investment Principles
1. 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
2. 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)
3. 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?”
4. 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
5. 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
6. 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 favor, bet (allocate) heavily
- Don’t “fall in love” with an investment—be situation-dependent and opportunity-driven
7. 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
8. 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
9. Change—Live with change and accept un-removable 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
10. 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 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
The Constant Search for Better Methods of Thought
Charlie’s superior performance doesn’t come from a magic formula or business-school-inspired system.
It comes from his “constant search for better methods of thought,” a willingness to “prepay” through rigorous preparation, and from the extraordinary outcomes of his multidisciplinary research model.
In the 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 of positive effects for which Munger is famous (the “lollapalooza” ).
Finally, a word or two on why this overview of Charlie’s investment philosophy has focused so much on the subject of “what to buy” and so little on “when to sell.” ‘the answer, in Charlie’s own words, serves as a wonderful summation of the “Munger School” of highly-concentrated, focused investing described here:
“We’re partial to putting out large amounts of money where we won’t make another decision. If you buy something because it’s undervalued, then you have to think about selling it when it approaches your calculation if its intrinsic value. That’s hard. But, if you can buy a few, great companies, then you can sit on ass. That’s a good thing.”
Like his hero, Benjamin Franklin, Charlie Munger painstakingly developed and perfected unique approaches to personal and business endeavors.
Through these methods, and the development and maintenance of sound, lifelong habits, he has achieved extraordinary success.
- The Importance Of Thinking Backwards, And 5 Inverted Questions That Will Flip Your Thinking Upside Down
- Why Margin Of Safety Is Misunderstood And Not Used Enough
- 5 Successful Qualities of Buffett, Graham, Munger and How to Acquire Them