a16z Podcast - a16z Podcast: The Best Way To Be Smart ... Is To Not Be Stupid

Episode Date: September 11, 2015

Legendary investor Charlie Munger (Warren Buffett's financial partner and vice chairman of Berkshire Hathaway) invokes a set of interdisciplinary "mental models" involving economics, business, psychology, ethics, and management to keep emotions out of his investments and avoid the common pitfalls of bad judgment. In a new book focused on lessons learned from Munger, Tren Griffin (who works at Microsoft and has long focused on lessons learned from many investors) shares insights on decision making and the psychology of human judgment -- especially as it applies to investing and risk. But Griffin believes that these lessons can be applied to all of us in our daily lives, not just by investors. (He also argues that investing may be one of the last liberal arts). So how then do we channel our inner Munger? In this episode of the a16z Podcast, we discuss how to think about thinking; why the best investors and business leaders spend more time on what they DON’T know; and how the best way to be smart is to ... not be stupid.

Welcome to the A16Z podcast. I'm Michael Copeland. Today, Sonal and I host Tren Griffin, who, among other things, works at Microsoft and writes a lot about decision-making and the psychology of human judgment, especially as it applies to investing and risk. Griffin has a new book out, and the title is Charlie Munger, The Complete Investor. In this episode of the pod, we discuss how all of us, not just investors, can channel our inner munger how the best investors and business leaders spend more time on what they don't know and why the best way to be smart is to not be stupid welcome trend today in the pod we have um a couple of questions for you because we're a huge fan of your work and we see that you have a new

book out called um charlie munger the complete investor what we wanted to start off talking about is actually not your book but the way i came across your work is that you write a very popular series of posts on your blog, and among them is a series of 12 things you learned from different folks, and a lot of them are investors. And so my first question is why you're focusing on investors so much. Well, for me, it goes back to the Buffett idea that business fundamentally makes you a better investor and having an investing mindset. makes you better at business. And so there was that.

And then also I needed something to write about, which didn't intersect completely with my work here because I don't want to be in a situation where I can't write freely about topics because of where I work. So what I did was I chose investing as a place where I could basically express myself and get ideas that I have out

and get feedback on those ideas. So fundamentally, those two things sort of push me in that direction. I guess the last piece is I was looking for a community of people on Twitter and on the blog who like to think about thinking and who like to think and read. And I sort of found this little niche and people are civil and nice and polite and fun. And what's nothing like about that? Yeah. Well, why do you think there's such a parallel, or not a parallel, but why is there such a

connection between thinking about thinking and investing. And how does that play into the new book that you've recently written about Charlie Munger as the complete investor? Well, I think, I guess the key thing in both business and investing is that most mistakes that people make are psychological and emotional. The process of business, the process of investing is simple, but first. it says, but not easy. And it's not easy because we all make mistakes because we have psychological and emotional biases, which causes us to make less than perfect decisions.

So what I learned from them and people like Michael Maldiveson is if you think about thinking and do things like Reed Conneman and Thaler and really analyze your process and keep a journal and write things down, you can get better at thinking. You'll always make mistakes, but you can learn to make fewer mistakes. So speaking about Conneman and Tversky and some of Thaler and some of the other thinkers of basically, I guess the school was of behavioral economics, I felt like there was a period where people were suddenly dissing behavioral economics and sort of saying it's no longer relevant, but I feel like what you argue is that it's more relevant today than ever.

I'm kind of curious to hear your thoughts on why it might have come out of favor in the first place and some of the heuristics and biases that you think are particularly interesting to pay attention to? Well, I think the key thing is a lot of the people who do economics and do finance understand that what they do has failed in some cases in a really spectacular ways. And I think, you know, sort of like the hype cycle, people thought, okay, well, behavioral economics is going to appear and fill in the theory and it'll be predictive. And I think the key thing with behavioral economics and with complexity theory, which I think has some of the same criticisms, is both of those things teach you not that you can create a predictive theory, but that you should be humble and that you should build in a margin of safety.

And so when people criticize like complexity theory, they say, well, it's not predictive. Well, but it's really valuable, Charlie Munger says, to know what you don't know and know what you can't know. And once you know that, then you can do things like build in margin of safety and not be overconfident and all these other things. And knowing what you don't know is really valuable. And a key message of the book is probably the key message is the best way to be smart is to not be. stupid. Well, I'm going to maybe be a little bit stupid, but you say that investing can help you in business. And it sounds to me like what you learn in investing in part is kind of these behaviors and psychologies that you may not recognize in yourself. But is it helpful because

the sort of the binary is there, like either you made money or you lost money. So it's easier to see the outcome than it is in business. And does it go both? ways. Does business then help you in investing as well? I think it absolutely works in both directions. And the key thing for me is, is rationality, which is there's a certain logic to business and there's a certain logic to investing. And it's really pretty simple. You know, you need a break on supply, which is a sustainable competitive advantage, or moat, whatever you want to call it. And then there are certain execution aspects that people like Jim Barksdale are amazing at and there are all these things and they're relatively simple but the hard part is

dealing with things like confirmation bias and and hindsight bias and survivor bias and all those sorts of things and when you look at people who fall uh it's usually hubris and the in the problem with hubris is it can have many sources and the air can be essentially a lullapalooza or a situation where the hole is greater than the sum of all the biases. And so you really sort of have to guard against that. So the munger process is be rational, go through a logical process. And then you go through this double and triple and quadruple, and you just keep going on and on process of saying,

okay, but am I suffering from hindsight bias? You know, am I, is this an emperor, it has no close situation, and my colleagues aren't giving me input. it. So it's sort of this two-step, he calls it a two-track analysis, which is first be rational and then look for decisional errors. So it's interesting, trend, because a lot of what you're describing feels like evaluating businesses. But at the same time, a lot of these mindsets can be brought to decision-making in all areas of our life, it feels like. Oh, absolutely. You know, when you're, you know, Charlie's a big believer in this opportunity cost mode of thinking,

when you're making a decision about your personal life, one of the things you should do is trying to avoid certain things are going to make you unhappy. So another sort of funny line he has is basically, you know, if basically if you want to be happy, you know, avoid things that make you miserable. And you could say, well, that's obvious. But it isn't obvious because people don't do that.

You know, people just don't think. And this is part of his whole, actually the post-examination, the post I have for this weekend is on his idea of inversion, which is one great way to solve problems is to think about things forwards and backwards. And by looking at things backwards, you can say, okay, well, this is what's making me miserable. Do you mean the famous line invert? Invert? Wasn't that like a Jacoby or who? Yeah, exactly. Exactly. But, you know, what he's saying are things that are simple. Like, you know, if you want a better spouse, be a better spouse you know you sort of turning things around you know the best way to have a great marriage is

deserve a great marriage um you know the best way to be a good parent is to deserve to be a good parent be a good be a good dad you want good kids be a good dad i mean that all sounds very rational um but how do you reconcile the sort of human and the personal with the rational because it sounds to me like and we all know people like this who are much more spock like shall we say that for whom this would come much easier than for for others so if i'm on the sort of non-spock spectrum how do i how do i get more rational one of the things i've done in my blog post is i've interviewed a series of of individuals and it's now well well over 120 and what i see consistently are certain personality traits and the key personality trait i've seen in in what i've read

about it, but also what I've experienced my life with people like Marksdale and McCaw and Bill Gates and others, is they surround themselves with people who complement their weaknesses. And when you look at great people, inevitably there's a great team, and the team around

them tends to not be the same as they are, but actually have a different set of skills. And, you know, those people really create a lullopalooza situation where the some of the parts is a lullapalooza situation where you're benefiting from synergies. You know, the Munger-Buffet partnership is an amazing set of synergies.

You know, Frank Wells and Eisner, you know, start going down the list. You know, even in the A16C case, you know, you've got Ben and Mark, right? Right. And they do surround themselves as lots of people who disagree with them, including me sometimes. Yeah, and Ben and Mark are different sides. of a coin for sure and and it's not just you know that they disagree but that they have different interests and skills and so that's why i'm a strong believer in diversity in the broadest possible sense which is you get a situation where you have many people some people more quantitative

some people have this attribute some people are more reflective some people are action oriented you know you get a guy like like bill campbell coach campbell you know you you get all these this sort of mix of people. And then if you look at sort of wise Silicon Valley, you know, so interesting, why is there's so much creativity going on. And a lot of it is there's so many different types of people with different backgrounds and different cultures and just every, you know, thinking, all of that. And then the key thing about going to go back to the Munger book is that Munger's a real believer in investing is the last liberal art. There's a book actually by Hags from where he actually That was the original title.

And basically, to be a good investor, you really need to know a lot about a lot. And this whole mental models concept is really about taking a problem and using all of the models that exist in the world. And there's about 100 major models, and you sort of go at every problem with all these models in your head. I've actually compiled a list of 100 models that you can use. Could you go ahead and explain what a mental model is and how it plays out in this context? The key thing is it's a way of looking at the world.

It's a way of modeling the world. And so, you know, you have psychology, you have mathematics, you have physics, you have biology, you have architecture, you have philosophy, you have all the different schools of literature. And what he believes is by taking all those things together and analyzing problems, you can basically find solutions that you wouldn't with only one model. And this is why I'd love the cover of my book because he calls himself basically a book with legs sticking out or his children do. And the important thing there is read widely and understand a lot about a lot and a lot of different disciplines. And an investor who only understands business isn't going to be a very good investor. And I don't, in my view, I don't see great people who are good at business who are one-dimensional.

I think somebody said today on Twitter, I forget who it was, but basically, it might have, well, whoever it was, but the point was made by the person, which is that the really great founders have a lot of different interests and read a lot and know a lot about a lot. They tend not to be extremely narrow. If they are extremely narrow, they tend to have somebody or people around them who basically provide that breadth. Because you think about the founder, they've got to know finance, they've got to know people, they've got to know product, they've got to know Mark. You know, just this sort of this amazing breadth. And I've watched Bill Gates over the years. I watch Craig McCaw up very, very close. I watch some of these people.

And, you know, they're just, they're people who are interested in everything. And they're acquiring and they read. do you think our kids in college or young people in university are we sort of forcing them down a narrower path and those people who who choose to be widely read and like you say have all these wide areas of interest and also areas of expertise they're unusual and i just think that like the idea of liberalta has gone out of fashion in some sense and you're saying that we shouldn't be so quick to to toss it aside yeah one of the things that that charlie's talked to about is, for example, in business schools, he believes that it really should be more taught from a historical case presented format that you learn from pattern recognition. And in order to learn from pattern recognition, you've got to see a lot of examples and a lot of patterns. And you can get people who are so caught up in formulas and teaching formulas like value

at risk or things like that, the students sort of lose track of the forest. and they also become sort of unduly reliant on models which may have tail risks which are unapparent and so anyway so having this you know this the style of of learning and the amazing thing about munger is is that his hero is Franklin and the reason why he works so hard to get wealthy when he was young in life is he wanted to be like Franklin which is what he loves about wealth is the independence and the ability to read whatever books he wants He reads five newspapers a day. And actually to read broadly, if you look at the books, he recommends, Jared Diamond, you know, Connaman, you know, just sort of a wide range of books.

And that all contributes to basically a deeper understanding in the world and in the other pieces, the more you know, the more humble you should be. Because the more you know, the more you know that there's more that you don't know. So one theme that's coming up a lot here, Trend, is this theme of humility in sort of the hubris around decision making. But yet to be a risk taker, you have to have a certain element of hubris to be able to say, I'm going to take this risk. So how do you see that playing out? Like, how does that balance out? Well, so the key thought there that Munger has is that occasionally in life, if you work really hard and pay close attention, you're going to find an amazing opportunity. And he equates it to playing poker, which is the great poker players don't play

many hands. But when they have a hand, they play it extremely aggressively. And so his thesis is basically, occasionally in life, you'll see an amazing bet. And you have to basically be super aggressive. So, for example, one of the most amazing bets, anytime, anywhere, was when Paul Allen and Bill Gates were in Harvard Square and they saw the magazine and they realized that Bill had to drop out of Harvard and start a company right then. And the point is the great entrepreneurs know that this is the big opportunity and they just go for it right then. And so it's this weird combination that he describes of people need to be patient and read and understand. But then when they see the big opportunity, you know, like social networking or, you know, something in computational biology, you know, name the field, when you see it, you'll know it. And when you see it, you got to bet big. And so just sort of machine gun style aggression in all kinds of areas really doesn't make a lot of sense to Munger. But occasionally in life, if you work really hard, you'll find a bet with you. huge potential payoff. And usually it's, it has exhibits extreme optionality. And you just go for it. Where do you think Taleb's notion of skin in the game comes into play? Because one of the

thoughts that I have is, is Munger also more of an analyst versus like, say, the entrepreneurs that we come across every day who are building businesses in high risk scenarios? Like, what are your thoughts on that? So, so one of the great contrasts in, life is between people who know a moat when they see it and people who know how to build one potentially out of nothing. And it's very clear that Buffett and Munger are people who basically know a great moat when they see it and they know one that's undervalued and they know one that has attractive characteristics. A completely different attribute is somebody like Craig McCaw who said, wow, you know, these mobile phones are going to be a hugely valuable.

and hugely important thing, and I'm going to double down. I'm going to sell all my cable businesses, put everything into the mobile phone. That's an example of somebody who saw something that didn't exist. And I'm sort of fascinated by this whole idea of emergence, which is, I think, it's a lot. What Munger says, he says, I can see Mount Everest. That's my job. The person who actually has to see Mount Everest that's going to come out of nowhere,

that's like, you know, Zuck or Gates or, you know, the great entrepreneurs see this thing that isn't there yet. And that's not a monger attribute. That was my question. If we're talking about moats or mountains for that matter, you know, there comes a day when nobody's trying to get across your moat anymore because the actions moved on to the other castle, as it were. how do you see that playing out is it again just the ability to see the next everest the next moat well the difference is is um all moats are constantly under attack you can't see it but they're constantly under attack and what munger says is the future of every business is worse than the present so they're all you know they're all being attacked all the time

and but some are bigger and some are stronger than others and some are going to last longer and understanding that can help you basically buy something at a bargain occasionally. But then you also get into a situation where there are some moats that aren't big and they're super valuable and you can buy at a bargain, but they're never going to be sort of a Facebook style, sustainable competitive damage doesn't come along very often. But the point here is that there's two ways to do it. the one way is to is to basically find the next Facebook the other way to do it is to find

uh seize candy at a at a substantial discount and and munger does the the substantial discount uh but it's a different approach because because they have to have a very high a success rate you know the the average venture business the average fund has two or three two or three monsters that determine the success of the fund. Right. We talk about the slugging versus batting average here a lot. Tren, let's talk about the category of people that are building the moats and not just spotting them, to your point, the two groups. And in your book, you have an entire chapter dedicated to moats and why they're important and what are some of the factors.

I'd love to hear some of your insights for our audience, especially on what it takes to actually build those moats. We talk about that a lot around here. yeah i think you know in the technology business there's no bigger factor um the network effects today they're super super powerful and there was a great discussion actually um on twitter last night about the bloomberg moat for example you know it has amazing network effects and it's it's made a enduring franchise and the question uh that was being what was being discussed is sort of what's the nature in that moat and can that be attacked there people are trying to do it And the key thing there is network effects are extremely powerful.

And they scale better than anybody's ever been able to scale things before. But they're extremely fragile as well. What built your network effects can disappear. You just take the Blackberry, you know, sort of rise and fall. You can realize that what built you can tear you down at the same time. And so to some extent, it's an amazing thing. So the good news is it's amazing you can get more value than anybody. anybody's ever gotten before. The bad news is

the rise is just as fast on the way down as opposed to a moat that might be based on a regulatory advantage or like a railroad, which is how would you ever put together the land required to make another one? There are different modes and there are different attributes and

you sort of have to look at them all holistically and there are a lola paloosa elements of all of these things that indicate that the sum of a moat is is greater than the parts in many instances. So just to clarify some of the, I mean, I'm not saying you're necessarily saying there's a hierarchy of moats, but like you said, regulatory capture, even patents and IP.

I mean, in some cases, not all cases, obviously, but in some cases, there are some businesses who actually don't really care about their patents or hold down to their patents or IP because they have such strong network effects. They don't need to rely on that to build their business value. And then there are other types of moats that people build. Well, I think probably one of the all-time great moats was regulatory in nature in that Vail basically was able to convince the government. You've probably seen pictures of neighborhoods where there are 9,000 cables going down the street

and all kinds of telephone companies. And basically, Vail was able to create a situation where the government granted him a monopoly in return for only accepting a regulated rate of return. So some modes are based on basically regulation. Now, there were pluses and minuses to that and resulted in Bell Labs, but it also resulted in a lot of stagnation. You know, the word thing about the Bell system

was over 100 years of work in only seven apps, right? Voice message, you know, you'd call for it, and you just go down the list. You know, so that was the bad news. The good news was there was Bell Labs because there was capital to basically do basic R&D. And so, you know, in the end, it was decided that really was more important that there be innovation. And, you know, people talk about Moore's Law sort of being a hugely powerful thing that helped create Silicon Valley. But it was also basically when the Bell system was basically, the Carterphone decision was massive in terms of creating these connected networks.

and creating the MECF's law phenomenon. It's not really a law, but the network effects kicked in as a result of the AT&T-Kartophone decision. What about a network effect due to something like brand? I think brand is an important one. I think it's, you know, Michael Mubleson has some nice literature on it. You know, it's one of the hardest things to do,

and it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, it's, Squishier than the other ones, but, you know, there are some amazing studies around Coca-Cola around, you know, you give somebody a Coke and they don't prefer it to a Pepsi, but you show them the brand and they prefer the Coke. They're just certain brands that are extremely, you know, just powerful. And yeah, but even today, the Coke brand is obviously under threat by a whole range of innovative competitors. And, you know, you start. to go down the list of the iconic brands. I think the Nike brand's amazing. But I also think they have great technology and they've got a lot of solid execution and they're a very impressive company that has a number of elements. I mean, what I've done in the chapter on MOTS, which was originally in the book itself, it was originally its own chapter, but I figured that people were going to bog down in it. The ordinary person who's reading the book, who I wanted to come away with a better decisional framework was going to say this is boring you know to me it's super

exciting but so anyway so it ended up in an appendix uh and that was sort of a call of mine on how do i get people to read how do i get people excited about this stuff and and you know it's difficult because financial education is so hard yeah because people get bored by it my question is, you know, for people who, you know, how do we channel our inner monger? You know, you've read the book, how do you then step off into the world to really make it more than just reading the book, to make it part of what you do and how you move through the world? Yeah, that's where, you know, it's difficult because we've got Conneman, who's an amazing guy who spent decades studying behavioral economics, and he says, flat out, he still falls for

the same problems. When it came to writing, thinking fast, and slow. He was overconfident about how long it would take to finish it. So what he's saying is we're always going to be flawed human beings. But we can get better and we can be aware of things. And then you can also reach a decision and say, you know what? This isn't interesting to me. I should do something else. And so there's this weird thing of when you go into pitch a firm like yours, one of the things you're looking for in the pitch is can this person sell? It's a generalizable skill. It's a test.

With a book, if you can't read my book, if you can't get through it, you should be buying a diversified portfolio of index funds. Don't try and make big bets. And so this is, in some sense, it's sort of a litmus test, which is if the chapter on moats bores you, you're not going to be a good investor. If the chapter on moats bores you, you're not going to be able to understand a good business from a bad business. And so the bulk of people, Buffett thinks 90% plus of people should be buying a diversified portfolio of low-fee index funds.

But most people are still buying active funds. Only 35% of people are buying indexes. So it indicates that when people do invest, they don't think clearly, they don't understand fees, they're lazy, they spend more time picking out their refrigerator than their mutual funds. you know, these range of things which indicate that people aren't rational. And when people aren't rational, I guess they can do some harm. But in the world today, we all have to handle our own retirement. And that's kind of scary because all those people are sort of approaching retirement, not all of them, but so many people are approaching retirement with insufficient funds to provide for a comfortable retirement.

trend i feel like we've covered a lot of uh of here a lot here in a short amount of time but could you sort of wrap up for us some of the high level takeaways both from people who have read the book or haven't or do will or won't read the book um and for people who are investors and who aren't like what are some of the just main principles that people should take away from them the key things are are learning to make good decisions and that means learning how to to to sort of recognize certain key problems. And then the other thing is sort of, you know, stay humble and try and avoid things. You know, I guess the key point that one, the one point we didn't really make was about risk.

Risk doesn't come from volatility. Risk comes from not knowing what you're doing. And I wrote a post on that two weeks ago, in my post two weeks ago. So the other thing. And then the final point is, and the way to not know, to be in fewer situations, where you don't know what you're doing is to avoid things that have a lot of downside and to read like mad and to think about thinking. So yes, Trend, let's talk more about risk because I think we need to focus on that a little bit more. What are some of the things that you think

we should take away about risk? The key point about risk is that it should be defined in the dictionary sense, which is a possibility of harm or injury. And it could be financial harm or it can be personal harm. And the key point about that in a financial sense is the risk you need to worry about is permanent loss. The fact that stocks may go up or down in any given day should not be causing people to trade in and out of the market. So permanent loss of capital is the key financial risk that people should be thinking about. So if we want to live like Charlie Munger Moore, at least to the extent that we can, how do you advise us? starting on that path?

I guess the... Besides reading your book, obviously. Buy the book, read the book. Okay, step one. That's step one, but the key point is to be smart by not being dumb, to avoid situations where you're going to have a substantial

possibility of loss or injury. And there are ways to do that, which is to be aware of life. and to read, which we just talked about. But there are other ways, which is to be intentional about the sources of human misjudgment. In other words, we all are, as humans, very human. And we know what that means. It means that we make mistakes.

And mistakes are inevitable, and we'll keep making them. Charlie makes them. Buffett makes them. The two of them say, it's amazing they did so well by being so dumb. but the important point is if you basically are aware and you study and you learn from experience you can get better and you only have to be substantially better but awareness is key study is key and then inversion is key which is which is be smart by not being dumb well trend that's all we have time for but thank you again for joining the a6 and z podcast yeah trend thanks so

much very good