Charlie Munger (Trades, Portfolio) is usually referred to as Warren Buffett (Trades, Portfolio)’s right-hand man, but he is also an accomplished investor in his own right.
In Buffett's famous essay, “The Super Investors Of Graham Doddsville,” he mentions Munger as being one of his superinvestors, tilting his hat to Munger’s impressive partnership returns. And in many ways, Buffett is who he is today thanks to Munger’s influence. It was Munger who convinced him to depart from his deep value mindset and acquire See’s Candies and then change his investment style away from deep value toward quality at a reasonable price.
Over the years, both Buffett and Munger have said they rely on each other to bounce ideas around and discourage bad ideas from finding their way into Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial) portfolio.
While Buffett is best known for his love of numbers and investing acumen, Munger is more of a thinker. This combination makes the duo extremely formidable.
Munger’s thoughts and musings are always highly informative, but one of his most acclaimed speeches is a lecture to the students of Professor Guilford Babcock at the University of Southern California Marshall School of Business, which was later published in the Outstanding Investor Digest on May 5, 1995. The lecture was titled "A Lesson On Elementary, Worldly Wisdom As It Relates To Investment Management & Business." While highly informative, this lecture is also lengthy.
As a result, in the next two parts of this series, I will highlight some of the lecture's most important lessons in order to hopefully help improve your investment process.
Education is needed before investment
"I'm going to play a minor trick on you today - because the subject of my talk is the art of stock picking as a subdivision of the art of worldly wisdom. That enables me to start talking about worldly wisdom - a much broader topic that interests me because I think all too little of it is delivered by modern educational systems, at least in an effective way.
And therefore, the talk is sort of along the lines that some behaviorist psychologists call Grandma's rule - after the wisdom of Grandma when she said that you have to eat the carrots before you get the dessert.
The carrot part of this talk is about the general subject of worldly wisdom which is a pretty good way to start. After all, the theory of modern education is that you need a general education before you specialize. And I think to some extent, before you're going to be a great stock picker, you need some general education."
There’s one key financial concept you need to grasp before all others
"Obviously, you've got to the able to handle numbers and quantities - basic arithmetic. And the great useful model, after compound interest, is the elementary math of permutations and combinations…
Many educational institutions - although not nearly enough - have realized this. At Harvard Business School, the great quantitative thing that bonds the first-year class together is what they call decision tree theory. All they do is take high school algebra and apply it to real life problems. And the students love it. They're amazed to find that high school algebra works in life....
So you have to learn in a very usable way this very elementary math and use it routinely in life - just the way if you want to become a golfer, you can't use the natural swing that broad evolution gave you. You have to learn to have a certain grip and swing in a different way to realize your full potential as a golfer.
If you don't get this elementary, but mildly unnatural, mathematics of elementary probability into your repertoire, then you go through a long life like a one-legged man in an ass-kicking contest. You're giving a huge advantage to everybody else."
Accounting has its limitations, even though it may look like a precise science, there are plenty of grey areas
"But you have to know enough about it to understand its limitations - because although accounting is the starting place, it's only a crude approximation. And it's not very hard to understand its limitations. For example, everyone can see that you have to more or less just guess at the useful life of a jet airplane or anything like that. Just because you express the depreciation rate in neat numbers doesn't make it anything you really know."
The human mind also has its limitations, and you need to understand these limitations to improve your investing ability
"The elementary part of psychology - the psychology of misjudgment, as I call it - is a terribly important thing to learn. There are about 20 little principles. And they interact, so it gets slightly complicated. But the guts of it is unbelievably important. Terribly smart people make totally bonkers mistakes by failing to pay heed to it. In fact,
I've done it several times during the last two or three years in a very important way. You never get totally over making silly mistakes…"
To help, you need to understand the real interests and psychological factors
"I've gotten so that I now use a kind of two-track analysis. First, what are the factors that really govern the interests involved, rationally considered? And second, what are the subconscious influences where the brain at a subconscious level is automatically doing these things - which by and large are useful, but which often misfunction."
Disclosure:Ă‚ The author owns no stock mentioned.
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