My views on the market, tech, and everything else

A Dozen Things I’ve Learned from Charlie Munger about Mistakes

1. “There’s no way that you can live an adequate life without many mistakes.” “Of course, there’s going to be some failure in making the correct decisions. Nobody ‘bats a thousand.’” “I don’t want you to think we have any way of learning or behaving so you won’t make mistakes.” Everyone makes mistakes sang Big Bird on the first episode of Sesame Street. Albert Einstein said once that anyone who has never made a mistake (if there is such a person) has never tried anything new. Warren Buffett agrees: “I make plenty of mistakes and I’ll make plenty more mistakes, too. That’s part of the game. You’ve just got to make sure that the right things overcome the wrong.” Charlie Munger has learned about business in the best way possible: by making mistakes and being successful actually being in business. Reading about business is vital, but Munger has said that there is no substitute for wading in and actually taking the plunge as a business manager or owner. Yes, you can learn vicariously by watching others and by reading. Learning from the mistakes of others is essential. To maximize how much he learns Munger reads five newspapers a day and has been described as a book with legs sticking out. It is far better to learn vicariously when it comes to many of the more painful mistakes in life.  At one shareholder meeting Munger when describing Berkshire’s mistakes in the shoe business quoted Will Rogers: “There are three kinds of men. Some learn by reading. Some learn by observation. The rest of them must pee on the electric fence for themselves.”

2. “For a security to be mispriced, someone else must be a damn fool. It may be bad for the world, but not bad for Berkshire.” The flip side of mistakes for an investor is that they are not just a source of problems, but also the underlying source of opportunity for investors. Howard Marks writes: “In order for one side of a transaction to turn out to be a major success, the other side has to have made a big mistake. Active management has to be seen as a search for mistakes.” This inescapable math explains the old folk wisdom that if you don’t see who the sucker is at the poker table, it is you. Munger believes: “You have to look for a special area of competency and focus on that…. Go where there’s dumb competition.” If you don’t see who is the dumb competition, it is you. Mr. Market is often not wise so don’t treat him as if he is.  Mr. Market is your servant, not your master.

3. “Forgetting your mistakes is a terrible error if you are trying to improve your cognition. Reality doesn’t remind you.” Hindsight bias is the tendency of people to believe that their forecasts and predictions were more accurate than they were in reality. People tend to forget their mistakes and exaggerate their successes. In retrospect, events often appear to be much more predictable than at the time of any given forecast. One way to reduce hindsight bias is to write down your decisions in a journal and to go back and take an objective look at your decision-making record. Shane Parrish points out: “A decision journal will not only allow you to reduce your hindsight bias, but it will force you to make your rationale explicit upfront. We often get the outcome we think will happen, but for the wrong reasons.” Neal Roese, a professor of marketing at the Kellogg School of Management at Northwestern University, has said: “You begin to think: ‘Hey, I’m good. I’m really good at figuring out what’s going to happen.’ You begin to see outcomes as inevitable that were not.”

4. “Why not celebrate stupidities?” “I like people admitting they were complete stupid horses’ asses. I know I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn.” It is through the process of making mistakes and having success in the real world that you can learn and establish sound business judgment. Buying Berkshire Hathaway itself can arguably be put into the mistake category. The New England textile mill when bought in the 1960s was a lousy business. Buying the textile business was certainly valuable in one way in that it taught Buffett and Munger what not to do. Munger notes: “Chris Davis [of the Davis funds] has a temple of shame. He celebrates the things they did that lost them a lot of money. What is also needed is a temple of shame squared for things you didn’t do that would have made you rich.” Learning from mistakes does not mean wallowing in failure too much. Buffett says: “it is better to learn from other people’s mistakes as much as possible. But we don’t spend any time looking back at Berkshire. I have a partner, Charlie Munger; we have been pals for forty years—never had an argument. We disagree on things a lot but we don’t have arguments about it.”

5. “A trick in life is to get so you can handle mistakes. Failure to handle psychological denial is a common way for people to go broke.” “Warren and I aren’t prodigies. We can’t play chess blindfolded or be concert pianists. But the results are prodigious, because we have a temperamental advantage that more than compensates for a lack of IQ points.” Munger is getting at the importance of temperament to success as an investor. Most mistakes are psychological and emotional. Munger believes that he and Buffett have an advantage that is based more on temperament than IQ. If you can’t handle mistakes, Munger suggests that you buy a diversified portfolio of low fee index funds and leave active investing to others. Unfortunately, even if you do select an index-based approach you still must make some investing decisions such as assets allocation, fund selection and asset rebalancing periods.

6. “Terribly smart people make totally bonkers mistakes.” “Smart people aren’t exempt from professional disasters from overconfidence. Often, they just run aground in the more difficult voyages.” Munger is saying that smart people are not exempt from making mistakes. Overconfidence can cause a person with a high IQ to make more mistakes than someone who has an IQ that is 30 points lower. It is the person with the high IQ who falsely thinks that is 30 points higher than it really is that gets you into serious trouble says Munger. People who are genuinely humble about their IQ can sometimes make far fewer mistakes if they do the necessary work, have a sound investment process and think in rational ways.

7. “Most of Berkshire’s success grew from stupidity and failure that we learned from.” Berkshire has made many mistakes. Paying too much for Conoco Phillips was a mistake as was Berkshire buying US Airways. The best way to become a millionaire is to start with a billion dollars and buy an airline is an old joke in business. Munger has said that: “Hochschild, Kohn the department store chain was bought at a discount to book and liquidating value. It didn’t work [as an investment.” He added on another occasion: “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” Buying Dexter Shoes was definitely a multi-billion dollar mistake for Berkshire. In doing the Dexter due diligence analysis Buffett and Munger made the mistake of not making sure the business had what they call a “moat” and being too focused on what they thought was an attractive purchase price. Buffett said once about Dexter: “What I had assessed as durable competitive advantage vanished within a few years.” Capitalism inherently means that others will always be trying to replicate any business that is profitable and that means you are always in a battle to keep what you have. Dexter lost that battle in a very swift fashion. If you make a mistake, capitalism’s competitive destruction forces will expose it swiftly and sometimes brutally.

8. “Where you have complexity, by nature you can have fraud and mistakes.” “In terms of business mistakes that I’ve seen over a long lifetime, I would say that trying to minimize taxes too much is one of the great standard causes of really dumb mistakes. I see terrible mistakes from people being overly motivated by tax considerations. Warren and I personally don’t drill oil wells. We pay our taxes. And we’ve done pretty well, so far. Anytime somebody offers you a tax shelter from here on in life, my advice would be don’t buy it.” “We try more to profit from always remembering the obvious than from grasping the esoteric.” Complexity can be your friend or your enemy depending on the circumstances. I am somewhat surprised by the fact that fees and incomes in finance are so high when there seem to be a lot of competition. There is clearly an asymmetric information problem in finance. But it would seem like technology should have brought fees and incomes down faster in finance as it has in some other sectors. The answer must lie in the fact that humans tend to make so many psychological and emotional mistakes and what Professor Cialdini calls “compliance professionals” are able to milk that tendency to keep fees high.

9 . “The most extreme mistakes in Berkshire’s history have been mistakes of omission. We saw it, but didn’t act on it. They’re huge mistakes — we’ve lost billions. And we keep doing it. We’re getting better at it. We never get over it. There are two types of mistakes [of omission]: 1) doing nothing; what Warren calls “sucking my thumb” and 2) buying with an eyedropper things we should be buying a lot of.” “Our biggest mistakes were things we didn’t do, companies we didn’t buy.” “Since mistakes of omission don’t appear in the financial statements, most people don’t pay attention to them.” Munger and Buffett not investing in Wal-Mart is just one example of a mistake of omission. Buffett has said that just this one mistake with Wal-Mart cost them $10 billion. In 1973 Tom Murphy offered to sell some television stations to Berkshire for $35 million and Buffett declined. “That was a huge mistake of omission,” Buffett has admitted.  Buffett also has said: mistakes of omission…are where we knew enough about the business to do something and where, for one reason or another, sat they’re sucking out thumbs instead of doing something. And so we have passed up things where we could have made billions and billions of dollars from things we understood, forget about things we don’t understand.”

10. “It’s important to review your past stupidities so you are less likely to repeat them, but I’m not gnashing my teeth over it or suffering or enduring it. I regard it as perfectly normal to fail and make bad decisions. I think the tragedy in life is to be so timid that you don’t play hard enough so you have some reverses.” Of course, you can also learn from success, particularly if you remember that success can be a lousy teacher since what you may believe is the outcome of skill may instead be an outcome based luck. As noted above they try to learn from mistakes but them to move on. Use the feedback from mistakes to improve the process if you can’t but spend no time wallowing in failure. If you never make mistakes, you are not being ambitious enough.

11. “Banking has turned out to be better than we thought. We made a few billion [dollars] from Amex while we misappraised it. My only prediction is that we will continue to make mistakes like that.” “Well, some of our success we predicted and some of it was fortuitous. Like most human beings, we took a bow.” Munger has said that more than once that he and Buffett have made a mistake only to be bailed out by luck. Confusing luck with skill is easy to do. If luck does happen, embrace it.  Bad luck may arrive soon enough to balance the score. On the topic of the relationship between luck and skill, read Michael Mauboussin. http://www.michaelmauboussin.com/books.html or watch him.  https://www.youtube.com/watch?v=zSgYqwuguPc  One of the luckiest things that ever happened to me was becoming his friend. As just one example, I would not have written my book on Charlie Munger if not for his friendship.

12. “You can learn to make fewer mistakes than other people- and how to fix your mistakes faster when you do make them.”“Confucius said that real knowledge is knowing the extent of one’s ignorance. Aristotle and Socrates said the same thing. …. Knowing what you don’t know is more useful than being brilliant.” “Around here I would say that if our predictions have been a little better than other people’s, it’s because we’ve tried to make fewer of them.”  Charlie Munger freely admits he still makes mistakes even after many decades as a business person and investor. But Munger does advise people to strive to make new mistakes rather than repeat old mistakes. Munger has said that he made more mistakes earlier in life than he is making now. In other words, even though he continues to make mistakes like everyone else, he has marginally improved his ability to avoid mistakes over the years. Munger likes to be able to understand why he made a mistake, so he can learn from the experience. The mistakes can be a source of clues for improving a decision making process. For example, if you can’t explain why you failed, the business was too complex for you to have invested in the first place or outside your circle of competence. Munger is fond of quoting Richard Feynman: “The first principle is that you must not fool yourself – and you are the easiest person to fool.”

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