In my last article I discussed Munger's lattice work of mental models. In this article I will discuss Charlie's investment philosophy. Munger, like Buffett, believe that a successful career in investing boils down to only a handful of investment decisions. When he finds an investment that he likes, he really commits a lot of money and holds for a long time. In his own words, "you're paying less to brokers, you're listening to less nonsense, and if it works, the tax system gives you an extra one, two, or three percentage points per annum."
In his view, three stocks is adequate diversification. Warren shares this view as he spoke of having a punch card with twenty slots representing all the investment decisions that you get to make in a lifetime. "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."
Charlie is content to follow his own judgment even if it runs counter to the crowd. Graham cautioned the investor to use their own unemotional reasoning rather than follow the manic-depressive behavior of the markets. Munger considers the psychology of misjudgment some of the most important mental models that can be applied to the investment process. He said: Personally, I've gotten so that I now use a two-track analysis.
First, what are the factors that govern the real interest involved, rationally considered? And second, what are the subconscious influences where the brain at a subconscious level is automatically forming conclusions in various ways...but which often malfunction? One approach is rationality the way you'd work out a bridge problem, by evaluating the real interest, the real probabilities and so forth. And the other is to evaluate the psychological factors that cause subconscious conclusions-many of which are wrong." First, Munger eliminates the universe of what not to do.
At the 2004 Berkshire Hathaway meeting, a young shareholder asked about how to succeed in life. Charlie answered, "Don't do cocaine. Don't race trains. And avoid AIDS situations." The answer reflects both his views about avoiding trouble in life and avoiding missteps in investing. Second, he follows up with a fluent multidisciplinary attack on what remains. He then acts decisively when the right circumstances appear. To stay within his circle of competence, he limits his investments to simple understandable businesses. Charlie wants a dominant business franchise that can sustain itself and thrive in all business environments.
Few companies survive this screen. Pharmaceuticals, technology, and IPOs go straight to the 'too tough' pile. He next applies an intense screening to the remaining candidates using his mental model approach. Munger takes into account all relevant aspects, both internal and external to the company and its industry. He takes into account the overall ecosystem theme: sometimes the maximization or minimization of a single factor-notably specialization-can make that single factor disproportionately important. In his own words, "If there are twenty factors and they interact some, you'll just have to learn how to handle it-because that's the way the world is. But you won't find it that hard if you go at it Darwinian-like step by step with curious persistance. You'll be amazed at how good you can get."
In his view, three stocks is adequate diversification. Warren shares this view as he spoke of having a punch card with twenty slots representing all the investment decisions that you get to make in a lifetime. "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."
Charlie is content to follow his own judgment even if it runs counter to the crowd. Graham cautioned the investor to use their own unemotional reasoning rather than follow the manic-depressive behavior of the markets. Munger considers the psychology of misjudgment some of the most important mental models that can be applied to the investment process. He said: Personally, I've gotten so that I now use a two-track analysis.
First, what are the factors that govern the real interest involved, rationally considered? And second, what are the subconscious influences where the brain at a subconscious level is automatically forming conclusions in various ways...but which often malfunction? One approach is rationality the way you'd work out a bridge problem, by evaluating the real interest, the real probabilities and so forth. And the other is to evaluate the psychological factors that cause subconscious conclusions-many of which are wrong." First, Munger eliminates the universe of what not to do.
At the 2004 Berkshire Hathaway meeting, a young shareholder asked about how to succeed in life. Charlie answered, "Don't do cocaine. Don't race trains. And avoid AIDS situations." The answer reflects both his views about avoiding trouble in life and avoiding missteps in investing. Second, he follows up with a fluent multidisciplinary attack on what remains. He then acts decisively when the right circumstances appear. To stay within his circle of competence, he limits his investments to simple understandable businesses. Charlie wants a dominant business franchise that can sustain itself and thrive in all business environments.
Few companies survive this screen. Pharmaceuticals, technology, and IPOs go straight to the 'too tough' pile. He next applies an intense screening to the remaining candidates using his mental model approach. Munger takes into account all relevant aspects, both internal and external to the company and its industry. He takes into account the overall ecosystem theme: sometimes the maximization or minimization of a single factor-notably specialization-can make that single factor disproportionately important. In his own words, "If there are twenty factors and they interact some, you'll just have to learn how to handle it-because that's the way the world is. But you won't find it that hard if you go at it Darwinian-like step by step with curious persistance. You'll be amazed at how good you can get."
