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Rupert Hargreaves
Rupert Hargreaves
Articles (1299)  | Author's Website |

Charlie Munger on How to Think Like an Investor

The guru's advice on breaking down ideas to improve the chances of investment success

July 15, 2020

Developing a framework to think like an investor is one of the greatest challenges one faces when they decide to start buying stocks and investing for the future.

Multiple studies and research projects have shown the average human is not a good investor—the main reason why seems to be that our brains are not wired correctly.

To give an example, humans seem to be more impacted by losses than gains, which can cause them to make bad decisions based on short-term market movements, rather than long-term company fundamentals.

Mental biases

Human brains are also extremely biased. We like our own ideas, and we often like them so much that we won't listen to anything else. This causes several significant metal biases that are bad for investing.

The most damaging of these is confirmation bias, the tendency to search for, interpret, favor and recall information that confirms or supports one's prior beliefs or values.

Anchoring bias can also be detrimental. This tendency is to have an overreliance on the first piece of information obtained in the research process, which can lead to false outcomes during the rest of the process.

How to avoid biases

There are two ways to get around these issues. The first is to simply be aware of how biases impact our decision-making process. If we're aware of the impact these biases can have, it's easier to avoid them.

The second is to follow Charlie Munger (Trades, Portfolio)'s advice and break down your ideas:

"We all are learning, modifying, or destroying ideas all the time. Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side."

"It's bad to have an opinion you're proud of if you can't state the arguments for the other side better than your opponents. This is a great mental discipline."

Using this approach forces investors to think outside the box and seek out new information. There is still a chance that mental biases will take over here and influence the eventual outcome, but by breaking down the idea and combining this process with the awareness process above, investors can reduce the chances of this happening.

One of the easier ways to break down ideas is to look for different views. This could be anything from a sell-side research report to a bad customer review, anything that gives an opinion on the business or investment that's different from your own.

Just the process of seeking out this information can be enough. For example, I like to visit investment forums on the stocks I own or want to buy. A considerable percentage of the information on these forums is rubbish, but every once in a while some information will appear that I've not considered previously. I also follow review websites and trade magazines. Looking at company reviews on Glassdoor is now one of the first things I do in my research process.

I added this last point after an experience several years ago with a stock I owned that looked perfect from an investment perspective. However, employees had been warning on Glassdoor that management was overlooking customers at the expense of growth. The company had long-term supply agreements with its customers in place, so these problems weren't immediately apparent, but when the contracts came up for renewal, it started losing customers.

If I had sought out more disconfirming evidence before making my investment, I might have avoided the business or waited before buying. Luckily I was bailed out by an acquirer.

Put simply, even though we might like to think we know everything as investors, we don't. We must acknowledge this fact to avoid big mistakes.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website


Rating: 5.0/5 (2 votes)

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Comments

kennys
Kennys - 2 months ago    Report SPAM

Thanks for the education. I just started using glassdoor to study companies. It's a great idea!

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