Motley Fool Hidden Gems Investing - Buffett's Advantage

Episode Date: October 22, 2023

When you have about $150 billion in cash on hand, you’re never out of position for making a decision. Shane Parrish is the founder of Farnam Street, the host of “The Knowledge Project” podcast, and the author of “Clear Thinking: Turning Ordinary Moments Into Extraordinary Results.” Mary Long caught up with Parrish to discuss: - Decision making lessons from Warren Buffett, Charlie Munger, and Daniel Kahneman. - How to create rules to become a more disciplined investor. - Tips for writing an investment thesis. Tickers discussed: BRK.A, BRK.B Host: Mary Long Guest: Shane Parrish Producer: Ricky Mulvey Engineer: Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

How does somebody like Charlie Munger and Warren Buffett and Peter Kaufman and all these people, why is it they never seem to make bad decisions? Well, they're never in a position where the circumstance is thinking for them. They're always in a position of strength. And if you look at sort of Berkshire Hathaway today, they have what, $150 billion on the balance sheet. Well, if the stock market goes up, they win. The stock market stays the same, they win. The stock market tanks, they win. All these scenarios are good for them. They win no matter what. I'm Mary Long, and that's Shane Parrish, the founder of Farnham Street and author of the new book, Clear Thinking, turning ordinary moments into extraordinary results. I caught up with

Shane to discuss why Warren Buffett and Charlie Munger are never caught on their back heels, avoiding the Ebenezer Scrooge problem, and how to check your intuition when making investment decisions. You are a self-proclaimed wisdom seeker. Your first book, Clear Thinking, hit shelves earlier this month, but you've been writing Farnham Street since 2009. You've hosted the Knowledge Project for eight years. And through that, you've interviewed experts from Apollo Ono to Michael Malbison. What's been the biggest shift in your thinking between when you began this pursuit and now? I think the biggest shift has sort of been, I don't have to come up with any original ideas. I can just master the best of what

other people have figured out. And that's a really good, solid approach for me. It seems to work really well. At the start of this, I was so focused on synthesizing other people's ideas in the hopes of coming up with my own ideas and my own unique insights. And I think at the end of the day, I realized that it's a lot easier to sort of chew on, digest, and make your own other people the best of what other people have already figured out. And that's so helpful in life and in business. In that time, since you started Farnham Street, you've not just gotten to collect and synthesize knowledge from people, but kind of along the way, you've built a brand and a business for yourself. Along that journey, what do you consider to have been your

smartest business decision? And I'd also love to hear about your dumbest. Well, the smartest business decision was sort of betting on myself. And I had to quit my job at a three-letter agency. And basically, at the time, I had just gotten divorced. I didn't have a clear path to any income once I quit my job. And I thought I would figure it out. I have what I call next step confidence, which is I don't have the confidence to get to the end, but I have the confidence to take the next step and the confidence in myself to be able to figure out how to do that and then take the next step. And then the destination you think you have in mind is not the one you have in mind. And betting on myself and sort of doing that in the way that

I did it out. So, I mean, a lot of people who listen to this are financial. So I cashed in my pension from the government and, you know, that's a terrible financial decision, but it was a great psychological decision because it put all this pressure on me and I needed that pressure and I needed to know nobody was going to come save me. I burned the ships, if you will. And then sort of the worst decision I've made, oh man, I've made so many bad investments. I remember investing in JCPenney back in the day when Ron Johnson, I got caught up in that hype. That was terrible. I lost a lot of money doing that. Business-wise, I don't know. I just take it slow and try to grow. We've done a lot of investments. We've done over 30 now through Cyrus over the years. And most of

them have kind of worked out as we anticipated. And so there's no real bad decisions there that I would speak of. And then with people, I mean, sometimes the worst decisions are in a way betting on friends and working with friends because it becomes hard to hold people to higher standards than they hold themselves, especially when they're friends. And so I wouldn't say I've stopped working with friends. I'm just a lot more careful about how I enter those relationships. And I much prefer those relationships to be equity-based than boss subordinate-based. You mentioned the importance of slowness. And I think so much of clear thinking seems to come down to patience and like forcing yourself to allow for the time and the space to

actually process what's in front of you. Even when we make that time though, you highlight in the book four defaults that we mere mortals can fall susceptible to. The emotion default, the ego default, the social default, the inertia default. Can you tell us a bit about those and maybe when those defaults can be a good thing versus when they get in our way? Yeah. So basically what I was trying to do is come up with what are the circumstances that tend to think for us instead of we think for ourselves. And emotional decision-making is a great example of that. It doesn't mean that we can't sort of control our emotions. It just makes it really hard to do that. And so you make decisions when you're angry. I mean, that's

one that everybody sort of resonates with, but you also make decisions out of fear. And those decisions don't tend to be as well thought out as other decisions. Ego is self-explanatory, but it's when you're trying to prove yourself right instead of trying to get the best outcome. Social is just following what everybody else does. I have a saying in the book, which is lemming. Lemmings rarely make history. And I think that if you're just blindly following what everybody else does, that's no problem. But if you're expecting different results than everybody else gets, then there's a problem. And inertia, we just keep doing the same things we've always done. We keep going to the same job that we hate. We keep staying in the same relationship that

isn't serving us. And I think that all of those things are just tend to create these situations that think for us. So circumstances tend to think for us. So we're not thinking. And they're usually in ordinary moments. And I mean, who hasn't got into a spat with their partner, sent an angry email, blindly, you know, had dessert at a restaurant because everybody else was doing it, said yes to something they don't want to do because they felt social pressure and they didn't want to disappoint somebody else or worked in a job or stayed in a relationship too long that they knew they should have exited. And why aren't we doing these things? Well, it's because the situation is mostly thinking for you. And so I like to think about that.

And the other component that you mentioned is sort of patience, which I think a lot of people miss, right? If you look at sources of advantage or differentiation in life, there's talent, there's effort. You can do something different. You can have a different process. You can collect talent or be easy to work with. But patience also comes into play here. You can be more patient than other people. And the ability to take pain is also part of patience. It's also part of going against the social. It's like, not only do you have the self-confidence to do something different, but can you withstand the inevitable looking like an idiot for a while while you try something different? And I think people underestimate that. And just to go back to

other sources of advantage, there's temperament. You can partner with other people. Energy, curiosity, luck, and positioning. And positioning ties into the book. And it's something I talk about in the opening chapter and a little bit throughout the book. But what positioning does is when you study the greats of history and you look at how does somebody like Charlie Munger and Warren Buffett and Peter Kaufman and all these people, why is it they never seem to make bad decisions? Well, they're never in a position where the circumstance is thinking for them. They're always in a position of strength. And if you look at sort of Berkshire Hathaway today, they have what? $150 billion on the balance sheet. Well, if the stock market goes up,

they win. The stock market stays the same, they win. The stock market tanks, they win. All these scenarios are good for them. They win no matter what. And that's what the very best people do in life. And if you think of positioning, well, you can position yourself to manage your defaults better too. And positioning is how I talk about this with my kids is like, you're putting life on easy mode or hard mode. And if you position yourself really well, you're going to be on easy mode. If you position yourself poorly, you're going to play on hard mode. It doesn't mean that you're not going to get emotional. It doesn't mean you're not going to have an ego. It doesn't mean you're not going to be part of the crowd. But if you're positioned

really well, it reduces the impact of those things and allows you to think a little bit more. Yeah. Temperament is so essential there. And the importance of thinking like an optimist, but preparing like a pessimist and knowing what those worst case scenarios might be and what you would do should they hit is so essential to life, but also investing. I think investors in particular probably fall prey to that emotional default, like succumbing to fear when you see everything going down. And also maybe the social default, looking at what other investors are doing and being swayed so easily by that. How do you think investors in particular can recognize these defaults? And then once they've recognized them, act accordingly?

Well, you have to know yourself first and foremost. If you don't know yourself, then And self-awareness is a huge aspect to this, to building strength around these things. And so there's little things you can do to position yourself better. It sounds so trivial and so simple, but like sleeping, working out, eating well, if you do those things and you do them consistently, then your emotions are going to, you're still going to be fearful when you see the market panic, but it's going to have less of a grip on you than it otherwise would. And it sounds so basic.

We think about recognizing these things and we think about decision-making in the moment we make the decision. We never think about, well, what does the preceding week look like? How do I put myself in the best position? Because we always think for whatever reason, there's like this intuitive sense in us that it's like, we're going to have warning. We're going to have, you know, before the stock market goes down, somebody is going to tell us we're going to be able to exit.

We're just going to be able to see the signs, but life doesn't work that way, right? Like, you know, often there's no warning for divorce. Your relationship ends. There's no warning for a health crisis that hits you. There's no warning for the market going down. You can't see that coming. If you could, you would be the richest person in the world right now. And so you can't see this.

You have to prepare in advance and you have to prepare like you know this is coming. And when you do position yourself and you do prepare, these things still happen, but now they have a less toll. You can keep your head when everybody else is losing theirs. And if you look at sort of the greats of history, like Carnegie and Rockefeller and even Berkshire Hathaway, which is a company most listeners have probably heard of or studied, what did they do? They were always positioned to take advantage of panic. Now, we intuitively think we're going to know when the panic comes. I'm going to be able to see it. There'll be blood on the streets and

I'll be the one to invest. But that's not really how it works because there's no warning that that's going to happen. You always have to be ready to take advantage of these things. And we know through history that we can't time panics. We can't time financial crisis. We can't predict any of this stuff, but we can predict that it's going to happen. We just don't know when it's going to happen. And so when these things happen, you really want to be in a position where they're not overriding you. So that's avoiding a whole host of errors and tamping these things down. But the other way to handle this is most books talk about, oh, just recognize that you're angry. And then all of a sudden, recognize that you're scared and you'll make

better decisions. Well, it doesn't really work that way. I mean, that might work 20% of the time, but it doesn't actually work. And so the way to circumvent all of this is through automatic rules or creating other safeguards and creating an artificial environment that helps your desired behavior become your default behavior. One of the ways to do that with investing is sort of, you know what, I'm not going to sell stocks on the first day I have a thought of selling them. I'm not going to buy stocks at the market opening. You can have all these rules and these rules have to be unique to you. I mean, I can give you prescriptions for them. You know, one of my automatic rules is just investing in an index fund every month, but you have to come up with

your own rules, but those rules are turning your desired behavior into your default behavior. So if you're worried that you're going to get emotional and sell something, and you've done that in the past, and you can see that in your trading history, then you can just create these rules. Like I'm not gonna, you know, when I have this idea about selling something, instead of selling it, I'm going to walk away from the computer. I'm going to write down what I think, why I think it. And then the next morning, if I look at that and it still makes sense, then I'm going to sell. Well, now you've just created an automatic rule to get around your emotion. And you don't have to recognize that you're feeling angry in the moment. You just

have to follow your rule. And the cool thing about rules is we've been taught our whole life to follow rules. Everything is a rule. The tax law is a rule. The speed limit's a rule. And nobody tells you to follow the speed limit every day. You realize it's a rule and you follow it. And And so we have the exact same rules in our head. And I learned this from Daniel Kahneman. I was at his penthouse one day and he was on the phone with somebody. And just towards the end of the call, he was like, you know, my rule is I don't say yes on the phone.

I'll have to get back to you tomorrow. And he hung up and I was like, whoa, tell me about this. Like you've studied cognitive biases for 65 years and I've never heard you publicly use the term rule. And he's like, oh, I just found I was in these situations where I didn't want to disappoint other people. social pressure, right? I ended up saying yes to things that I really didn't want to do because it was really hard for me to say no on the spot. So I created a rule.

And the rule is I don't say yes on the spot. I'll get back to you tomorrow. And he's like, 90% of the time, I don't say yes. But on the phone, I was saying yes, like 90% of the time. And I was like, that's so fascinating. What other rules do you have? And he's like, none. And I was like, what? This is the most powerful thing you've probably come up with. This is worthy of a Nobel Prize because we can create these automatic rules so that when we're in these situations, we don't have to recognize what's happening and act because that requires a consciousness in these ordinary moments that is really hard to achieve. We can just circumvent all of that by creating a rule. A great example is one of my friends who eats out a lot for his work.

He's a salesperson, goes to all these restaurants. He was starting to gain weight. And after I got back from common, I was like, let's try this. I was like, your rule is going to be, you eat the healthiest thing on the menu and you don't eat dessert. And he's like, what? And I was like, just tell me that's your rule. And so he goes to restaurants and he does this for a couple of weeks. He's like, this is life changing. He's like, I don't think about it. I don't have a choice. It doesn't depend on willpower. You know, eventually if you're relying on willpower, everybody loses the battle with willpower. And so you have to put yourself in a situation where you create an artificial environment. And remember, environment determines behavior.

It's like this tailwind to your behavior. You're choosing the path of least resistance, but the environment doesn't have to be your physical environment. You can create all of these mental sort of environments. And one way to do that is with rules. In your book, you talk about the importance of exemplars and asking yourself like, okay, this person that I admire, what standards would they have? And how can I strive to reach and perhaps exceed those standards day to day? The name of your blog, Farnham Street, comes from Berkshire Hathaway's Omaha address. You're a Charlie Munger acolyte, a regular attendee of the Berkshire Conference. I'd argue that Charlie Munger and Warren Buffett are probably

two exemplars for you. What have you learned about decision-making from the two of them? Well, I've learned, I mean, the biggest lesson from them is always put yourself in a position where nobody's forcing you into a decision you don't want to make. The biggest single aid to judgment is being in a good position. And I've learned that because they've never been on their back heels throughout all the time that I've studied them. They've never had to raise money when they didn't want to raise money. They never had to get debt renewed when they didn't want to get debt renewed. They were always in a position to play offense. The other thing I learned is sort of creating your environment. And you can think of it as physical, but it's also mental

and curating your environment to be conducive to the things you want to do, right? like Buffett doesn't hang around people who doesn't want to hang around. He doesn't do things he doesn't want to do. He has somebody else do all of those things for him. And he gets to spend his time doing the things that he wants to do. And he's not sort of like sacrificing. He's not trying to fit other things in that he doesn't want to do. And I think while most of us can't go that extreme, one of the questions I always ask myself on a quarterly or at least annual basis is like, what am I doing that I don't want to be doing? How do I do less of that? And what am I doing that I really love doing? And how do I do more of that? And these things change. I mean, when you're

20, they're going to look one way. And when you're 50, they're going to look a different way. And it's just important to keep reevaluating that to make sure that you're doing things the right way. The other big lesson from them that appears in the book is sort of, they know where they want to go and they do it the right way. And so often we let other people dictate what we go after. We let other people dictate the scoreboard. Who do we know? Peter Kaufman told me this story. Who do you know, that wanted to be the world's most richest, you know, most well-known, most famous person and got all those things. And it's like Ebenezer Scrooge, right? He got all these things that society tells us to want. And what did he want at the end of his life?

He wanted a do-over. Why did he want a do-over? Because he got, not only did he get things that were meaningless, but he did it in a way that was mutually exclusive from living a life of meaning. He stepped on people. He didn't go into win-win relationships with him. He didn't, you know, And I think one of the lessons from Buffett and Munger is like, they're almost always win-win with other people. I mean, they were a bit more ruthless sort of in the early days, but they pivoted probably in the 70s to be partnership-based and win-win. And they think in terms of decades.

And I think that that type of thinking, when you take that approach, eliminates a lot of poor behavior. I have a saying that a lack of patience changes the outcome. And I think that's true when it comes to investing too. We all know how to get rich. We all know how to get wealthy, but we try to circumvent that or we try to speed it up. And because we do that, we end up in trouble. You talked to Michael Malbison quite a few times. I think he was the first guest on your podcast, The Knowledge Project back in 2015. And in that episode, you talk about the importance of intuition and trusting your gut.

How should investors factor risk and intuition into decision-making? Yeah. So investing is hard to develop an intuition around, right? Because the environment's often changing, the feedback loops are really long, and you're not making the same decision repeatedly. And so when you look at Kahneman's criteria for honing your intuition, you have none of those things. And I think that that's a really interesting factor to keep in mind. I don't think you should ignore intuition, but I think you should check intuition. And the way to do that is to delay your intuitive response and give it some time for your conscious brain to process things. One way to do that is, hey, I want to buy this stock. Well, just slow down. So make the invisible visible.

Write down what it is you want to do, why you want to do it, what you think the most likely outcome is, what variables matter, what variables are going to determine whether this is a good investment or not. And then read that in the morning. And that allows your intuition to sort of check in with your rational brain. But it also allows you to see, to calibrate how well you are. Are the variables that you said matter really the ones that matter? How niche are those variables? Are you searching for information? One of the big lessons I learned with JCPenney is I was up every night searching for information. The reason I was searching for information is because I didn't know what mattered and what didn't matter. And that led me to always feel like I needed more information.

But if I knew which variables mattered and I knew which variables govern the situation better, which is something I spent a lot of time studying after losing all that money, I walked away going, okay, well, when I'm confident that I have the right criteria and the right information. I'm not searching for information anymore. I'm reading and digesting information, but I'm not looking for one more insight. I'm not looking for one more piece of something. I'm not looking for what I might be missing. And I think that that's a really good sign that you're on the right track. But you really want to slow down your intuition with investing. You talk a lot in the book also about how results can sometimes make a bad decision

making process look good? Because if you get a bad result, but you had a bad process in getting there, that wasn't actually a good decision. It was just luck. And so you talk about the importance of showing your work. You just mentioned making the invisible visible and writing stuff down. Can you show us your work a little bit? What do you look at when you're building out an investing thesis? Yeah. So I've made a lot of different investments from startups to private companies to public companies. I sit on the board of a public company. I've also done real estate transactions, done a wide variety of investing with all of those investments, with the exception of venture investments or investments to friends.

I always write down, what do I think is going to happen? Why am I doing this? What's important to me? What are the variables I need to track? And then I calibrate those. I look at them sort of on a six month basis or depending on the investment or an annual basis. And I'm like, how are these variables tracking? What have I learned since then? And I use a different color pen. So on the same sheet, I'll write something new, right? So if I ever make another, you know, we did a large multifamily real estate transaction a few years ago. And if I ever do another investment, I've added to that since then. So I'll review that beforehand. And I'll be like, oh, here's what I thought originally. Here's what I've developed my thinking into. And it's grown

and it's scaffolded and I've added it. So now I want to pay attention to those too. And now I have a framework. I'm starting from a better place than I started before. And I think that's really important. When it comes to friends, I love to invest in friends. I love to invest in what they're doing. I would rather fail and invest in my friends than be successful and not invest in them. But the minute I write that check, I write it off to zero. I don't think about the investment again. If it works out, great. I don't want it affecting our friendship. And with venture, I've done very little non-profitable sort of investing, but the stuff I have invested in, I just really want those things to exist in the world where I think they have a shot at

making the world a better place. Again, mentally write it off to zero the minute the check is written. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow. Bye.