Whatever one thinks about Charlie Munger (Trades, Portfolio), in my opinion, there is no other person who has provided so much valuable advice about psychological biases and how they can impact investors and investing decisions. I think all investors should read his work simply because understanding these principles really helps us defend against our tendency to accidentally sabotage our own investing decisions.
Investors' thoughts are their own worst enemy. Conquering these issues is a lifelong process that does not stop even if you think you know everything about the markets. It can be easy to fall back into old habits after a period of success and profits. The key is to stay humble and keep learning, and Munger's strategy for doing this is to continually review past mistakes:
"I spent a lifetime trying to avoid my own mental biases. A.) I rub my own nose into my own mistakes. B.) I try and keep it simple and fundamental as much as I can. And, I like the engineering concept of a margin of safety. I'm a very blocking and tackling kind of thinker. I just try to avoid being stupid. I have a way of handling a lot of problems — I put them in what I call my' too hard pile,' and just leave them there. I'm not trying to succeed in my' too hard pile.'"
— 2020 CalTech Distinguished Alumni Award interview
There's a lot to interpret here, from just one simple paragraph. As Munger noted right off the bat, the first way to avoid mental biases is to analyze one's own mistakes. Of course, this is easier said than done. It requires a high level of emotional intelligence to take a step back and ask what went wrong and if you could have done anything better the second time around. Removing the emotion can help, and one way to do that is to consult a third party or use a checklist, although there is no perfect strategy.
Munger also proposed his own strategy to avoiding mental biases, and that is to keep things simple. This is a wonderfully straightforward piece of advice. Many investors over complicate and overthink situations, which can lead to poor decisions and allow mental biases such as confirmation bias to creep in.
Like his lifelong business partner, Warren Buffett (Trades, Portfolio), Munger makes use of what he calls a "too hard pile." This is a pile of ideas that are too difficult for him to understand, so he doesn't try.
This concept is quite tricky to explain without an example. Let's say one has read about a great investment opportunity in an investment magazine, such as rare earth metals or a gold mine in Canada. The article lays out how attractive the company is, and why investors should grab a piece of the action.
In reading this article, one may become susceptible to the fear of missing out. From there, an investor might try to research the opportunity themselves. This is where confirmation bias will creep in. The investor may begin to seek out information that confirms their view that the stock is a great opportunity. And the more time one spends on an opportunity, the more likely one is to buy in order to justify the time spent, allowing another bias to creep in.
With such a confusing maze of potential psychological biases, it is no wonder Munger's approach is to avoid any opportunities he doesn't understand. This approach might seem simplistic, but it is incredibly clever. It means one never has to worry about something one does not understand, and this instantly removes the chances of certain biases creeping into the thought process. If there is no opportunity for a bias to creep in, there's no need to control it, and the whole timeline for making these mistakes is stopped dead in its tracks.
