We Study Billionaires - The Investor’s Podcast Network - TIP494: The Worldly Wisdom of Charlie Munger

Starting point is 00:00:00 You're listening to TIP. Hey, everyone. Welcome to The Investors Podcast. I'm your host, Clay Fink, and boy, do I have a fun episode for you today. A few weeks back, I did a couple of episodes covering Warren Buffett's story, and I thought it would only be right if I also covered Buffett's right-hand man, Charlie Munger, as well. So I picked up a copy of Poor Charlie's Almanac to learn more about the wisdom Charlie has accumulated over his life. I also read through William Green's chapter on Charlie Munger in his incredible book, Richer, Wiser, Happier, As There Are Just Some Fantastic Insights There As Well.

Starting point is 00:00:38 During this episode, I'll be chatting about Munger's background, his mental models for living a good life and being a good investor, his thoughts on committing to a life full of learning, the biggest mistakes he and Warren have made over the years, and I wrap up the episode with his life advice for others. I am fully confident you will enjoy this episode. as there is just so much to learn from the worldly wisdom of Charlie Munger. Without further ado, let's get right into it. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most.

Starting point is 00:01:17 We keep you informed and prepared for the unexpected. All right, so I wanted to get this episode kicked off covering his background and story, and then I'll dive into some of the biggest lessons I picked up from studying Charlie Munger. Similar to Warren Buffett, Charlie is someone who we can learn so much from in regards to how to invest in compound wealth, but that is really just a side benefit compared to the wisdom we can gain from him on how to live a good life. Things such as how to act rationally, behave with honesty and integrity, learn how humans operate and think, and my money isn't so important after a certain point in our journey. Buffett highly respects Munger, as he noted that Munger has, quote,

Starting point is 00:02:11 the best 30-second mind in the world, and that he sees the essence of everything before you can even finish the sentence. Bill Gates said that Munger is the broadest thinker he has ever encountered. Monash Pabri regarded Munger as a quantum leap above Warren in terms of intelligence. To give some background on who Charlie Munger is today, Munger is the vice chairman of Berkshire Hathaway, was a previous chairman at the Daily Journal until March of 2022, and was the chairman of WESCO Financial Corporation from 1984 through 2011. Munger has also been a director at Costco since 1997. I actually discussed Costco in my previous episode covering Nick Sleep, episode TIP 492. Munger to this day is still a large shareholder in Costco, as he recently stated,

Starting point is 00:03:04 quote, if I were investing money for some sovereign wealth fund or some pension fund and I had a 30, 40, 50 year time horizon, I would buy Costco at the current price. I think it's that strong in enterprise and that's admirable a place. I'm not saying I'm buying Costco at this price, but I'm certainly not selling any. I think it's going to be. be a big, powerful company as far ahead as you can see, and I think it deserves its success. I think it has a good culture and has a good moral ethos, and so I wish everything else in America was working as well as Costco did. Think what a blessing that would be for us all, end quote. As of the end of 2021, his stake in Costco was worth $81 million, while his estimated total net worth

Starting point is 00:03:51 was roughly $2 billion. Touching a bit on Munger's childhood, like Buffett, Munger grew up in Omaha, Nebraska. He was born in 1924, which feels very long ago as he's 98 years old now. So he saw from an early age how difficult it was for his family to weather through the Great Depression. After high school, he bounced around at a couple different colleges studying different subjects. and in his second year at school, he enlisted in the Army. When he was in the Army, he was still very keen on learning. He reflected on his time playing poker in the Army, as he stated, quote, playing poker in the Army and as a young lawyer honed my business skills. What you have

Starting point is 00:04:37 to do is learn to fold early when the odds are against you, and if you have a big edge, back it heavily because you don't get that big edge often. Opportunity comes, but it doesn't come often. So seize it when it does come." Eventually, Munger went on to go to Harvard Law School to follow his father and grandfather's footsteps, and upon getting his law degree, he moved to Southern California to join a law firm in the big city. During his time as a lawyer, Munger was always interested in ways he could earn more money and build wealth, so he invested in stocks and entered business deals with his law clients who own their own companies. Law was always a means to an end for Charlie. Since it was his specialty, he used it to provide for his family and fund his

Starting point is 00:05:23 investment deals, so being a lawyer was definitely not his ideal lifestyle. He discovered what he really wanted to do when he met Warren Buffett when Buffett was 29 and Munger was 35. In 1957, in the early days of the Buffett partnership, Buffett was talking with a potential investor about how he manages his partnership and invests other people's money. The guy really wasn't that interested in what Buffett had to say, but he actually still agreed to invest $100,000 with Buffett, which was a huge sum for him at the time. Buffett asked him why he chose to invest with him, and the guy said, quote, you remind me of Charlie Munger. Buffett didn't know who Charlie Munger was, but he was already a big fan of him prior to even meeting him. It wasn't until

Starting point is 00:06:13 two years later that the two met and they clicked immediately and became friends. Buffett, who was primarily obsessed with investing, was impressed by the breadth of knowledge on different subjects Charlie had, as he mentioned that Charlie was someone who read hundreds of books and biographies every single year and had an incredible memory to recall what he had read. Charlie treated reading biographies as a way to peer into the lives of the most successful people and even make friends with them. He was always in search of the right ideas, and Munger's favorite biography that he had read was on Benjamin Franklin, and he really took to heart the way in which Franklin lived with such honesty and integrity, as well as philanthropy. He liked the way in which biographies

Starting point is 00:06:57 actually showed basic concepts put into action for those who succeeded. Charlie regards it as extremely important to read every day in order to become wiser and improve as an individual. When addressing USC law students in 2007, he stated that, quote, the acquisition of wisdom is a moral duty. It's not something you do just to advance in life. And there's a corollary to that idea that is very important. It requires that you're hooked on lifetime learning. Without lifetime learning, you people are not going to do very well. You are not going to get very far in life based on what you already know. You're going to advance in life by what you learn after you leave here. Consider Berkshire Hathaway, one of the best regarded corporations in the world. It may have the best

Starting point is 00:07:47 long-term, big assets involving investment record in the history of civilization. The skill that got Berkshire through one decade would not have sufficed to get through the next decade with comparable levels of achievement. Warren Buffett had to be a continuous learning machine. The same requirement exists in lower walks of life. I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night, a little wiser than they were that morning. And boy, does that have it help, particularly when you have a long run ahead of you, end quote. That alone just goes to show how seriously Charlie takes reading and learning in his daily life. Now, Munger and Buffett had many things in

Starting point is 00:08:32 common, one being their desire to become financially independent and wealthy. Not just so they could buy the fancy car, fancy houses, but they wanted that so they didn't need to rely on anyone else to make a living and spend their days how they really truly wanted to. That's really what it was all about. It was a freedom to spend their time how they really wanted, because time is the one thing you can't get more of once it's been spent. Similar to Buffett, Munger was not a part of a rich family in his childhood, and he built his fortune on his own. Early on, Munger recognized that it was much more valuable to have been taught the right values and way of living life than being handed money straight out the gate. So Munger went on to start his own investment partnership,

Starting point is 00:09:17 similar to Buffett to really kickstart his journey to build tremendous wealth. Munger did agree with some of the investments Buffett was doing, as they communicated quite often, and his fund actually achieved a 19.8% annual return over its 14-year tenure from 1962 through 1975, while the Dow had a return of 5%. Now, what I'm really excited to dive into during this episode is what Charlie Munger is well known for, which is the mental models he uses to invest as well as live a good life. Charlie Munger stated, quote, I've long believed that a certain system, which almost any intelligent person can learn, works way better than the systems most people use. What you need is a lattice work of mental models in your head. And with that

Starting point is 00:10:06 system, things gradually get to fit together in a way that enhances cognition, end quote. Instead of making a standalone investment on a company's financial information, Charlie conducts a comprehensive analysis of the internal workings of a business as well as the ecosystem in which that business operates. The mental models that Munger uses is borrowed from a variety of disciplines including history, psychology, mathematics, engineering, biology, physics, statistics, economics, and many others. From Munger's point of view, it's important to be multidisciplinary and study a variety of different subjects to better understand the extremely complex world we live in. In regards to mental models, Munger stated, you must know

Starting point is 00:10:54 the big ideas and the big disciplines and use them routinely, all of them, not just a few. Most people are trained in one model, economics, for example, and they try to solve problems in one way. You know the old saying, to the man with a hammer, everything looks like a nail. This is a dumb way of handling problems. You need a different checklist and different mental models for different companies. You have to derive it yourself to ingrain it in your head for the rest of your life, end quote. One of the first mental models discussed in poor Charlie's almanac is the idea of not fooling yourself. John Keen stated, quote, it's not bringing in the new ideas that's so hard, it's getting rid of the old ones, end quote. Munger says that the ethos of not fooling yourself

Starting point is 00:11:41 is one of the best mental models you can have, and that it's powerful because it's so rare. I think when it comes to investing, a lot of people are their own worst enemy, and they let their emotions get the best of them in both up and down markets, buying enthusiastically in the bull market when everyone else is getting rich and everyone's a genius because it's a bull market, and then selling into the bear market when the outlook becomes bleak. This is the exact opposite of how you make money with investing. In William Green's book, Richer Wise or Happier, he even included a chapter about Charlie Munger entitled it, Don't Be a Fool. In William referred to Charlie as, quote, the grandmaster of stupidity reduction.

Starting point is 00:12:25 William highlights that Munger strives to consistently reduce his capacity for foolish thinking, idiotic behavior, unoriginal error, and standard stupidities. Munger stated at the 2015 annual shareholder meeting that he has slightly more consistency than others in terms of avoiding being an idiot. While other people are trying to be smart, all he's trying to do is be non-idiotic. And this is much harder to do than people seem to believe. Related to this, Munger was also largely influenced by the idea of inversion and solving problems backwards.

Starting point is 00:13:01 He thinks about what a really bad investor would do and knows that what a bad investor would do is the choices you should first avoid before determining what you actually should do. When considering a choice or decision anywhere, whether it be investing or life, he asks himself, is this going to be a disaster? Before asking, is this going to be wonderful? This allows him to find out the bad things and trying to avoid that prior to finding out the good and trying to get it. But you have to do both. This idea of inversion is what really keeps him out of the big troubles and messes. When approaching investing your life, Munger puts a big emphasis on what not to do first rather than what to do. He's been known for saying, all I want to know is

Starting point is 00:13:48 where I'm going to die, so I don't go there. He also stated that, quote, a lot of people are so interested in reaching for the prize that they don't even think about the stupidities that might prevent them from getting it, end quote. In terms of what to avoid as investments, general rules of thumb for me include not investing in funds with excessive fees, not chasing hot fads or trends, not overpaying for a business, don't invest in management teams that aren't honest and trustworthy, and don't invest in anything I don't truly understand. Now, I'm by no means perfect here, but these are just some good general rules of thumb, I think. Looping back to the content in poor Charlie's Almanac, in one speech smugger gave to USC graduates

Starting point is 00:14:33 in 1994, he explained the need for mental models to develop what he would call worldly wisdom. He stated that 80 or 90 important models will carry about 90% of the freight of a worldly wise person. And of those, a handful carry a very heavy freight. When I hear this, I'm thinking, okay, what types of models does he believe are important? Like, how complicated are these? Luckily, he does touch on a few of these in his speech.

Starting point is 00:15:01 He said to be a really good stock picker, you're going to have to have a good understanding of mathematics, which is pretty obvious. This includes things like basic arithmetic, compound interest, as well as statistics, such as things like permutations and combinations in order to think about the probabilities of different outcomes playing out for a business. Buffett and Munger are masters at thinking about things like decision trees and thinking about the probabilities of certain outcomes. We can't know for certain what's going to happen in the future, but what we can do is research to determine what is most probable. Next, he states that investors need to understand accounting

Starting point is 00:15:41 and how accounting has its limitations for use as investors. For example, accountants have to determine the useful life of a machine or warehouse that Amazon purchases, for example, it may or may not be accurate to what actually happens in the business. In the assumption of, say, the useful life of a piece of machinery impacts of financial results that everyone is looking at. Munger stated, quote, if Berkshire has made modest progress, a good deal of it has been because Warren and I are very good at destroying our best love ideas. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:20:32 For those of you who have studied Buffett, you know that Buffett made the transition from buying the cheapest businesses he could find to buying quality businesses. And this transition was largely because of Charlie Munger. Looking back, Buffett would have walked away if he had to pay slightly more for a quality company like Seas Candy. But even with this $25 million purchase price, that seemed rich for Buffett at the time, and it produced $2 billion in pre-tax profits. since they purchased it in 1972.

Starting point is 00:21:05 This furthered their belief that is definitely worth paying up for quality businesses. Part of what makes Buffett and Munger great is their continuous ability to evolve as investors and as individuals. I think this is a good transition to talk about how we shouldn't be afraid to reexamine our views and beliefs and to be open to changing our minds when the facts change. William states in his book, quote, the reluctance to re-examine our views and change our minds is one of the greatest impediments to rational thinking. Instead of keeping an open mind, we tend to consciously and unconsciously

Starting point is 00:21:43 prioritize information that reinforces what we believe, end quote. Now, this quote reminds me really of social media and how all these algorithms on Twitter and Instagram and the like, they can suck us into an ecosystem where we only see one point of view. This is why it's so critical to not get sucked into these holes where we only see one side of the story. And we need to be constantly looking out for different viewpoints, whether it be on podcasts or discussing with others who have the opposite opinion as you. When you seek out the opposite opinion is when a tremendous amount of learning can take place as you better understand the big picture in how other people see things.

Starting point is 00:22:26 Oftentimes, an investor's biggest enemy is himself in the willingness to not be open to changing their opinion. So I'd encourage the listeners to be humble and be open to the idea that you might not be right in your strong convictions. If you do have strong convictions in something, be sure to seek out the evidence that might suggest that you're wrong or those ideas that might disprove your beliefs. Related to this, Munger has also warned from falling under specific ideologies. He says that heavy ideology is one of the most extreme distortors of human cognition.

Starting point is 00:23:03 If you get a lot of heavy ideology young and then you start expressing it, you're really locking your brain into a very unfortunate pattern. Warren saw how political his father had been, and he thought that having this strong ideology towards one side or the other to be very dangerous, actually, as this can cloud our judgment. Charlie said that following this approach has helped Warren enormously. with the accuracy of his cognition. Charlie learned the same lesson Warren did, but a different way because his father actually

Starting point is 00:23:33 hated ideology. Being heavily ideological, pounds ideas into your brain better than it convinces it out, which is a very dangerous thing to do. Transitioning to talk more about how mental models can apply to business, in one of Munger's speeches, he dove into the potential benefits of a business operating at scale. First off, we are all aware that businesses that are larger tend to have economies of scale, meaning that the fixed costs are spread out across a very large number of units that are produced. For example, Amazon has a massive advantage over a lot of other e-commerce businesses

Starting point is 00:24:11 because of the massive fulfillment network they've built, so they can offer their products cheaper, which gives them a competitive advantage because of the scale they've reached. Munger talks about how scale can give businesses a tremendous advantage in many other ways as well, and further entrenched their competitive position. Many businesses operating at scale can spend more on advertising, which makes their brand more well-known and recognized by consumers. Brand awareness and scale is a huge advantage. I'm from the U.S., so if I travel to Europe and happen to want a can of pop, for example, and I see side-by-side Coca-Cola and some brand I've

Starting point is 00:24:50 never seen in my life, odds are I'm going to pick the Coca-Cola because I know what I'm getting, and I really don't care to spend a little bit extra to make sure I like the product I'm purchasing. Another aspect of scale is social proof, which ties into psychology. If all my friends won't stop talking about how much they love shopping at Costco, then at a certain point, I'm going to want to check out Costco because who doesn't love saving money on these great deals, you can't really get anywhere else. Even if the deals are similar to other places, people generally just want to fit in with others, and if they're the only one that's not shopping at Costco, then there's this almost

Starting point is 00:25:28 social pressure that they should do it too. Another advantage of scale is that the larger the company, the more each individual within that company can specialize and become extremely good at one specific thing. All these aspects of operating at scale can make it incredibly difficult for competitors to dislodge their position. Assuming that the leader in the industry doesn't become complacent, which can be a disadvantage of operating at scale. Bureaucracy and speed at which things get implemented are other big potential disadvantages of scale. Another thing that strikes me with Warren and Charlie is that they seem to be entirely content

Starting point is 00:26:09 with living a very simple life, despite all the tremendous wealth they've built over their lives. Trust me, I have lived in Nebraska my whole life, and there's nothing particularly special or inspiring about living in Nebraska or in Omaha. But that is what Warren has done for decades. So there is something to the life philosophies that Warren and Charlie have developed that really stands out to me. Charlie believes that life is much more than just accumulating vast amounts of wealth

Starting point is 00:26:39 and that you shouldn't worry so much about what others are doing, such as getting rich on the popular growth stock or meme stocks, as most of you listening can probably relate to to some degree. He was also big on living out a conservative financial lifestyle, such as living within your means, don't buy too many extraordinary things, avoid debt the best you can, and to continue to seek out ways to increase your income. Just basic ways to build wealth that we all know we should be doing, and it can be a helpful reminder in today's day and age of constant social media posting of someone's new hot item. Munger also has given career advice stating that, quote,

Starting point is 00:27:19 You have to play in a game where you've got some unusual talents. If you're 5 foot 1, you don't want to play basketball against some guy who's 8 foot 3. It's just too hard. So you've got to figure out a game where you have an advantage. And it has to be something you're deeply interested in, end quote. Regarding partnerships, Munger is a testament to the idea that quality relationships with good, trustworthy people make life really special. He stated that if you want to have a good partner, good friend, or good spouse, then you need

Starting point is 00:27:50 to be a good one in return. Munger has always put a high priority on surrounding himself with honorable people he admires and wants to spend his life with. Next, I wanted to talk about Munger's overall investment approach a bit. One of Charlie Munger's more well-known characteristics is not buying and selling very often. When he finds a quality business he likes, he tends to make a very large business. bet and hold it for a very long time as he believes that a successful investment career is made from only a handful of decisions. He doesn't take a small starter position or take minuscule

Starting point is 00:28:26 speculative bets. Munger has talked about different investment strategies and studied different strategies, but he says that focusing on quality businesses is where the majority of Berkshire's money has been made. Some of the benefits that Munger acknowledges from this approach is that You're paying less to brokers and transaction fees. You're listening to less nonsense from the media and such, and the tax system is giving you a few more percentage points in return per year. From Munger's point of view, a portfolio of three companies is enough diversification,

Starting point is 00:28:56 which goes totally against conventional wisdom, which I just love from Munger. It's just so typical of him to really go against the grain. Munger recognizes that the market is relatively efficient, but from time to time, the odds are heavily stacked in his favor, and that is when it's time to act in size with his investments. He points out that most other managers don't act in this manner. Most managers, when they receive money, they just simply invest it. Also, many other investment managers

Starting point is 00:29:25 are expected to know a lot about a lot of things, which can really cloud their judgment. And most managers are in a position where they aren't really incentivized to go against the grain in the way Buffett and Munger are. Buffett and Munger are their own bosses and they are not going to get fired and they are very honest and transparent with their shareholders. They're just focused on finding a few things they're super confident on and then acting at the right moment that feels right to them. Munger revealed that a great majority of his family fortune sits in just three investments,

Starting point is 00:29:59 Berkshire Hathaway, Costco, and a portfolio of Chinese stocks selected by Li Liu. Like Buffett, Munger also focuses on his circle of... of competence and is sure to only invest within that circle and what he knows really well. Additionally, he's looking for an easy-to-understand dominant business franchise that can sustain itself during all market environments. A huge emphasis is placed on the moat of the business and that the company's moat is expanding each year. He is laser-focused on this issue because very few companies are able to survive over multiple generations. Because of Charlie's exhaustive process in determining a particular company to invest in, his process requires considerable

Starting point is 00:30:43 self-discipline and considerable periods of inactivity. Munger being someone who likes playing games such as poker, which I mentioned earlier, when a hand or an investment goes bad, he thinks not so much about whether the hand actually went in his favor or not, because much of that is just due to luck and factors outside of his control. He wants to figure out if he played his hand well, given the circumstances. He's focusing on what he could truly control, given the information available at the time. Next, I wanted to read a question and answer presented to Charlie at Stanford Law in 1996. Question, how do you incorporate psychology in your investment decisions? I think it would be more just picking products that will appeal to everybody like Coke.

Starting point is 00:31:30 After all, there are a lot of smart people out there who obviously think just the way that you showed us today. So are you looking for failure in the thinking of other investors when you go about picking successful companies? End of question. Then Munger says, what makes investment hard, as I said at USC, is that it's easy to see that some companies have better businesses than others. But the price of the stock goes up so high that all of a sudden the question of which

Starting point is 00:31:56 stock is the best buy gets quite difficult. We've never eliminated the difficulty of that problem. In 98% of the time, our attitude towards the market is that we're agnostics. We don't know. Is GM valued properly versus Ford? We just don't know. We're always looking for something where we think we have an insight, which gives us a big statistical advantage. And sometimes it comes from psychology, but often it comes from something else. And we only find a few, maybe one or two a year. We have no system for having often. automatic good judgment on all investment decisions that can be made. Ours is a totally different system.

Starting point is 00:32:36 We just look for no-brainer decisions. As Buffett and I say over and over again, we don't leap seven-foot fences. Instead, we look for one-foot fences with big rewards on the other side. So we've succeeded by making the world easy for ourselves, not by solving hard problems. End of answer. To wrap up the discussion on investing, on page 73 in poor Charlie's Almanac, there is a an investing principles checklist. The checklist is actually quite long. The list is four pages to be exact, but there are some pieces that I wanted to highlight. The reason it's not so much

Starting point is 00:33:11 important to cover the whole thing is because an investment process is very complex for someone like Charlie. No single podcast episode or no single speech he's given would be able to encapsulate all the complexities with how someone like Munger thinks and invests. Also, since I see a lot of similarities between Munger and Buffett, I wanted to point out that some of the items I may have already mentioned in my previous episodes talking about Buffett, so I didn't want to just rehash the same points. Now let's get to some of those points. Munger highly values independent thinking, as objectivity and rationality require independence of thought. It's important to remember that just because other people agree or disagree with you doesn't make it right or wrong. The only

Starting point is 00:33:56 The only thing that matters is the correctness of your analysis and judgment. Munger mentioned that if you want to get smart, the question you have to keep asking yourself is why over and over and over again. In regards to intellectual humility, never fool yourself. Remember that you are the easiest person to fool. For capital allocation, proper capital allocation is an investor's number one job. Remember that the highest and best use of capital is always measured by his next best use, which relates to the term opportunity cost. Also, do not fall in love with an investment.

Starting point is 00:34:33 Be situation-dependent and opportunity-driven. Continually challenge and willingly amend your best-love ideas. Recognize reality even when you don't like it. The last part of the checklist is related to 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 and be careful to exclude unneeded information. A small leak can sink a great ship. And face your big troubles. Don't sweep them under the rug. As you can see, there is no magic formula for a successful investment approach as the overall approach is constantly changing as the world changes. However, we can pick up many of these principles that

Starting point is 00:35:21 don't change in order to help us shape our own framework, and I find them very helpful for me when I think about investing. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. Vantanza automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC to or running an enterprise GRC program, VANTA keeps you secure and keeps your deals moving.

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Starting point is 00:38:50 All right. Back to the show. Munger's most basic fundamental principles include four things. Preparation, discipline, patience, and decisiveness. The author mentions that, quote, each attribute is in turn lost without the other. But together, they form the dynamic critical mass for a cascass. for a cascading of positive effects for which Munger is famous, which is also referred to as

Starting point is 00:39:16 the Lala Pallusa effect, end quote. Since Munger is so well known for helping Warren transition from being a cigar butt value investor to investing in more higher quality businesses, I really wanted to pull in a clip of Warren and Charlie talking about the importance of this transition. Here's a few minutes of them chatting about it. My first question is, Mr. Munger, you are largely credited with moving Warren away from the Cigar Butt approach to investing as it was practiced by Ben Graham. It's been stated that it was the purchase of Seas Candy that taught you this important lesson of buying good businesses.

Starting point is 00:39:49 At what point did you realize that this concept of buying good businesses was a better long-term investment strategy and what was it in your discussions with Warren that allowed you to persuade him to move in that direction? Mr. Buffett, what was it in Mr. Munger's arguments for buying good businesses that persuaded you to abandon the cigar butt approach and move in his direction. My second question is, in both your experience, have you or Mr. Munger ever known of a company that has regained or replaced its competitive advantage once it was lost? Charlie, do you want to answer the first question about how you... Yeah, well, I think there's some mythology in this idea that I've been this great enlightener of

Starting point is 00:40:35 Warren Buffett. Warren hasn't needed much enlightenment, but we both kept learning all the time so that the man we were five years earlier was less sensible than the man who ultimately was there. And Seas Candy did teach us both a wonderful lesson, and it'll teach you a lesson if I tell you the full story. if C's candy, it asked $100,000 more. Warren and I would have walked. That's how dumb we were at that time. 10,000 more. And one of the reasons we didn't walk is while we were making this wonderful decision,

Starting point is 00:41:22 we weren't going to pay a dime more. Ira Marshall said to us, you guys are crazy. There are some things you should pay. up for, body, business quality and so forth. You're underestimating quality. Well, Warren and I, instead of behaving the way they do in a lot of places, we listened to the criticism. We changed our mind. And that is a very good lesson for anyone. The ability to take criticism constructively is a, well, think of all the money we made from accepting that one criticism. And if you count the indirect effects from what we learn from buying C's, you can say that Berkshire's been built

Starting point is 00:42:07 partly by learning from criticism. Now, we don't want any more today. We also like the peanut brittle. So, Charlie is playing. I had learned investment and got an enormous benefit out of that learning from a fellow who concentrated on the quantitative aspects, Ben Graham, and who, who didn't dismissed the qualitative aspects, but he said you could make enough money focusing on quantitative aspects, which were a more sure way of going at things and would enable you to identify the cigar butts. He would say that, you know, the qualitative is harder to teach. It's harder to write about. It may require more insight than the quantitative. And besides, the quantitative works fine, so why try harder? And on a small scale, you know, there was a very good point to that.

Starting point is 00:42:58 But Charlie really did. It wasn't just Ira Marshall, but Charlie emphasized the qualitative much more than I did when I started. He had a different background to some extent than I did. And I was enormously impressed by a terrific teacher and for good reason. But it makes more sense, as we pointed out, to buy a wonderful business at a fair price than a fair business at a wonderful price. and we've changed our, or I've changed my focus anyway, and Charlie already had it over the years in that direction. And then, of course, we have learned by what we've seen. I mean, it's not hard when you've watched businesses for 50 years, you know, to learn a few things about them as to

Starting point is 00:43:43 where the big money can be made. Now, you say when did it happen? It's very interesting on that because what happens, even when you're getting a new, important idea, is that the old ideas are still there. So there's this flickering in and out of things. I mean, there was not, there was not a strong, bright red line of demarcation. So those are the items I wanted to mention in regards to his investment strategy. Next, let's talk about the mistakes he's made. Since Buffett and Munger are really good at being patient and not too eager to act, Munger stated that their biggest mistakes have been acts of omission in which they saw an opportunity but didn't act on it. effectively. This could mean doing nothing or what Warren would call sucking his thumb or buying

Starting point is 00:44:30 an eye dropper of an amount that they should be buying a boatload of when the opportunity struck. Despite their incredible success, I just love how open and honest he is in the mistakes he's made. They realized that Google, for example, was a great business. They saw how much money GEICO was spending on ads on Google's platform and just how powerful of a tool in business it was. But they admit, their mistake was never buying it. Walmart was another example of a great company that they really never pulled the trigger on because they just thought the price was too high years and years ago. Munger has admitted at the shareholder meetings that he failed shareholders by not capitalizing on these opportunities. They are very vocal about their mistakes if you've ever

Starting point is 00:45:14 been to any of the meetings. They act like they're just like the worst investors out there, even though their track record is literally the best. I think very few people would have the human to continually publicly admit the mistakes like this, a lot of people I think will ignore the mistakes they've made or underplay the true impact of their mistakes when they're brought to light and highlight their and just go highlight their successes instead. Or they give an excuse as to why they made a mistake. Munger believes that bringing the mistakes to light allows him to reflect on them further, not make the same mistake in the future. It almost seems that Munger actually brings to light his mistakes more often than his successes and underplays his success to shareholders.

Starting point is 00:46:00 You know, it's this idea of underpromising and over-delivering and setting proper expectations for shareholders, which I find quite admirable from someone that's in the spotlight like he is. Another one of my favorite lessons from studying Buffett and Munger is the power of incentives. Benjamin Franklin stated, quote, If you would persuade, appeal to interest and not to reason, end quote. I want to repeat that again because it's so powerful for what Munger's message is. If you would persuade, appeal to interest and not to reason. In regards to this, Munger said, this maxim is a wise guide to a great and simple precaution in life.

Starting point is 00:46:42 Never ever think about something else when you should be thinking about the power of incentives. incentives are incredibly important in all areas of life, whether it be at your job, with your investments or in analyzing the habits of people. Let's take investments, for example. All else equal, it's much better to own a stake in the company where the managers actually have active stakes in the business. Management that has a lot of the stock that you own, the incentives are aligned between the two parties because you want the stock to go up, but they also do too over the long run, because the management team are the ones that make the critical decisions for the ultimate success of the business. I can't help but think of the incentives between an employee

Starting point is 00:47:27 and an employer as well. For example, if an employer has a fixed path to climb the corporate ladder that everyone has to follow, I find that the incentives are actually misaligned between the two parties. If you have a new employee that knows that he must put in two years with the company before getting promoted. And he may not be incentivized to work very hard if time is one of or the most important aspects of how to climb the ranks. Rather, I think if the employer focused more on the actual performance of the individuals and their attitude and their way of approaching their work, rather than focusing on the time spent with the firm, I feel that this much better aligns the incentives between the two because those who perform naturally rise the ranks,

Starting point is 00:48:15 And those who don't perform need to change their habits and change their work habits and become better employees. This is just one example out of countless that I could provide that could be used to describe the importance of incentives within our world. Another important one, I think, are the salespeople in the finance industry or in the investment industry. Oftentimes, when you're being told about the benefits of this incredible financial investment or insurance product, The person telling you how great the product is is oftentimes being paid a hefty commission. And that commission is ultimately paid by the consumer or by you. So this person will highlight the benefits of such a product while underselling how much it costs

Starting point is 00:49:01 and all the bad things and all the fees that you as a consumer are ultimately paying. This may have their best interests at heart rather than yours. and there's a misalignment of incentives within that structure, and it creates a tremendous amount of conflict of interest. Benjamin Franklin highly influenced Munger. He influenced him to behave in a very honest and transparent manner and with a high level of integrity. Munger stated that doing the right thing can pay big dividends both personally and professionally. On one occasion, Charlie was involved in a business deal in which he was to buy half of the enterprise. The individual offered Charlie a price of $130,000.

Starting point is 00:49:44 And Charlie knew that this was way too cheap, so he told the man that he'd pay him $230,000 for the deal, $100,000 more than what he offered. As Charlie said, I'm right and you're smart. And sooner or later, you're going to see that I'm right. Taking advantage of a cheap stock price on the stock exchange is one thing, but taking advantage of partners is something entirely different. and Charlie regarded doing such a thing as unethical and in his mind not the right thing to do. Charlie realized that behaving in this manner led him to have a totally different shareholder base than most other companies.

Starting point is 00:50:21 Having the longtime, loyal, trustworthy shareholders that trusted him allowed him not to worry about the inevitable quarters or inevitable years that happened to not turn out as well as they would have hoped. Therefore, Warren and Charlie are able to focus on what's truly important, which is the long-term outcomes of the business. The ironic part of behaving in this way, not only because it's the right thing to do, but also because Warren and Charlie actually end up making more money acting in this manner. It's pretty crazy to think about because so much of our world is geared towards short-term thinking, misaligned incentives, and Warren and Charlie just flipped this entirely on its head and say, no, we're going to do business in an ethical manner where we treat

Starting point is 00:51:08 the other person right and we align incentives. And you can think of it as Wall Street and most companies, they're focused on the current quarter. That's what they really care about and optimizing profit for that quarter. But the real goal is to build long-term wealth and produce long-term results. So while Wall Street is focused on the short term, they are actually making long-term sacrifices, because sacrifices are going to be made eventually. While Warren and Charlie are doing the exact opposite, they're making the sacrifices today to have that long-term performance. They still have that mindset, even though they're in their 90s today. They truly care about the long-term shareholders. Warren and Charlie are well aware that for some shareholders or some

Starting point is 00:51:53 families, Berkshire-Hathaway stock is all they own for their investments. And it goes to show how much people truly trust them. Therefore, they just have this deep culture of conservatism and taking great care of people's capital. They entrusted with them through Berkshire Hathaway. They're adamant about never taking on unreasonable levels of risk or using leverage to achieve reasonable returns going forward. According to poor Charlie's almanac, which was released in 2005, Charlie had 90% of his net worth in Berkshire Hathaway. So there it is again. His and incentives are highly aligned with those of his shareholders. Over the years, Buffett and Munger have worked persistently on making purchases they thought were right for Berkshire. This meant that they

Starting point is 00:52:41 were sifting through countless deals just to acquire one to two per year over a 20-year period. Oftentimes, they came to an agreement with managers of a business whom they admired the way in which they lived their lives. Making acquisitions for Berkshire isn't about just increasing the bottom line. It was about partnering with people they truly wanted to do business with and they were willing to sell to them. Partnering with the right managers allows Buffett and Munger to take a step back and let the managers go about doing what they do best. And that's just for the owners to stay out of the way and let them operate the business.

Starting point is 00:53:17 I think that's just a huge benefit when you're partnering with people that you trust and admire. You trust what they do. You believe they're going to do the right thing. And it really just makes things a lot easier for both parties, I think. Warren and Charlie are often asked, what happens to the business when they're gone? What happens to Berkshire Hathaway? Charlie believes there is a ton of momentum because of the great businesses they own.

Starting point is 00:53:40 Plus, they obviously have that cash trove on the side, so if the stock goes down, management can go ahead and buy back shares at a discount. Charlie stated that when Warren is gone, the acquisition side of the business won't be as effective, but will do just fine. Despite Warren being around or not, he expects the returns of the business. to naturally decline over time as it's harder to grow at a high rate of return as, say, $500 billion compared to $50 billion or $5 billion. They're simply operating at a much larger scale than before.

Starting point is 00:54:12 To wrap up the episode, I wanted to read a response from Charlie when he was asked what life advice he has for young people. Here's what his response was, quote, spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully. and well. Step by step, you get ahead, but not necessarily in fast spurts, but you build discipline by preparing for fast spurts. Slug it out one inch at a time, day by day, and at the end of the day, if you live long enough, like most people, you will get out of life what you deserve.

Starting point is 00:54:47 Life in its various passages can be hard, brutally hard. The three things I have found helpful in coping with its challenges are, have low expectations, have a sense of humor, and surround yourself with the love of friends and family. Above all, live with change and adapt to it. If the world didn't change, I'd still have a 12 handicap." Such simple but sound advice. When Charlie Munger addressed USC School of Law in 2007, he also outlined the core ideas that helped him in life. He stated that the safest way to try to get what you want is try to deserve what you want. He calls it the golden rule.

Starting point is 00:55:29 You want to deliver to the world what you would buy if you were on the other end of the deal. By and large, the people who have had this ethos win in life, and they don't just win with money and honors. They win with respect and the deserved trust of the people they deal with. And there is a huge pleasure in life to be obtained from getting that deserved trust. Man, there is just so much to be learned from studying someone like Charlie Munger, from his humility, his straightforward life advice, his honesty, integrity, and obviously his humor at the meetings sitting next to Warren, I think there is a lot we can pick up and try and emulate in our

Starting point is 00:56:08 own lives. If I had to distill Charlie Munger's message down to one point, it would be this. If you never stop learning, you never stop rising. Charlie was one of the masters of reading biographies and studying other people. And because of that, I think there is a ton we can learn from him as well. All right, that concludes my episode on Charlie Munger. There are no shortage of nuggets in poor Charlie's Almanac. I actually wasn't able to make it all the way through that lengthy book for this episode, but I hope you picked up some of the big ideas and that you found them useful. If you would like to learn more about how Charlie Munger invests, I would recommend you go back and check out my previous episodes I put together on Warren Buffett and Nick's Sleep,

Starting point is 00:56:54 if you haven't checked those out yet. The episode on Nick's Sleep is titled TIP 492, the best investor you've never heard of. And for the Buffett episodes, you can just look for Warren Buffett's name. It should be in the title. Nick Sleep specifically admired Charlie Munger's approach, and I believe he has a very similar investing style when looking at these quality companies that he's purchased over the years. All right, that wraps up. up today's episode, you guys can connect with me on Twitter at Clay underscore Fink, C-L-A-Y-U-N-C-K. If you enjoyed this episode, I would love it if you shared it with just one friend who may already be a fan of Charlie Munger for someone who you think might enjoy this type of content.

Starting point is 00:57:38 This will help us continue to grow the show and provide you free content. So we'd really appreciate it if you just shared it with one friend and take one second out of your day to help us out. With that, thank you so much for tuning in. I really enjoy putting together this episode for you, so I really hope you found a ton of value in it. With that, we'll see you again next week. Thanks. Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purpose.

Starting point is 00:58:19 only before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

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