Why It Is Important to Follow Charlie Munger and Break Down Your Ideas

Thoughts on Munger's process of breaking down investment ideas

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Dec 17, 2019
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To be a successful investor, you need to be open to changing your mind as soon as possible when new information presents itself. Charlie Munger (Trades, Portfolio) is a devoted supporter of this point of view.

Munger believes that it is essential to destroy your best ideas frequently, going through a mental challenge of breaking down why you made decisions and choices to re-affirm the principles behind the ideas and establish if they're still valid. According to Munger, "Any year that you don't destroy one of your best-loved ideas is probably a wasted year."

A leading reason why investors fail is an inability to admit mistakes. Failure to handle psychological denial is a common reason why investors tend to hang on to losing stocks for longer than they should or put more capital into a failing business.

Breaking down your ideas regularly and understanding where you went wrong and why is critical in the process of learning how to handle psychological denial. The process is also fundamentally important for avoiding deprival super-reaction syndrome, as Munger wrote in his book "Poor Charlie's Almanack:"

"One trick in life is to get so you can handle mistakes. Failure to handle psychological denial is a common way for people to go broke. You've made an enormous commitment to something. You've poured effort and money in. And the more you put in, the more that the whole consistency principle makes you think, 'Now it has to work. If I put in just a little more, then it'll work.'Â

Deprival super-reaction syndrome also comes in: You're going to lose the whole thing if you don't put in a little more. People go broke that way—because they can't stop, rethink, and say, 'I can afford to write this one off and live to fight again. I don't have to pursue this thing as an obsession—in a way that will break me.'"Â

Another psychological barrier investors have to overcome is the best ideas principal. This is based around the idea that investors have a positive attitude towards their "best" ideas, aka the ideas they have spent the most time and money researching.

Because investors have spent so much time and effort on these ideas, they feel committed to them and overlook the negatives, concentrating overwhelmingly on the positive factors of the business. In many ways, these investors become blinded by their own positivity.

Unfortunately, this is always going to be an occupational hazard of investing. To be a successful investor, you need to do hours and hours of research on each potential opportunity. The more time you spend on an opportunity, the more likely it is that you will become convinced it is a good idea.

There are psychological shortcuts to this problem. Mohnish Pabrai (Trades, Portfolio), for example, has said that he tries to throw out ideas as soon as possible before he has a chance to become psychologically addicted. Meanwhile, Warren Buffett (Trades, Portfolio) will only concentrate on ideas that fall squarely inside his circle of competence.

Even with these shortcuts in place, it will always remain essential to destroy your own ideas. The investment world is an ever-changing and ever-evolving place. As investors, we have to adapt and change to the information as it is presented to us at any one point in time. Investors should be looking to grow and adapt continuously.

I hope to be wiser and have a much better understanding of certain sectors and industries 12 months from now. As part of my continuous learning process, I should be able to take this information and apply it to historical ideas, and then correct any mistakes as swiftly as possible.

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