I've recently been on a sort of a virtual Charlie Munger (Trades, Portfolio) pilgrimage, seeking out interviews and writings the billionaire has given over the years, and tips he's presented on how to be the best you can be at life.
Over the past few weeks, I've written about some of the findings of this exploration of knowledge. At the end of May, I highlighted advice from him on how to succeed in life, which he gave during a speech at the University of Michigan Ross School of Business:
"It's amazing how if you just get up every morning and keep plugging and have some discipline and keep learning and it's amazing how it works out okay, and I don't think it's wise to have the ambition to be president of the United States or a billionaire or something like that because the odds are too much against you. Much better to aim low. I did not intend to get rich I wanted to get independent. I just overshot."
And along with Munger's tips on how to succeed in life, I've also uncovered a simple four-step checklist for finding investments that he detailed in an interview with the BBC during 2009:
1. "We have to deal with things that we’re capable of understanding."
2. "Once we’re over that filter we need to have a business with some characteristics that give us a durable competitive advantage."
3. "Then, of course, we would vastly prefer management in place with a lot of integrity and talent."
4. "Finally, no matter how wonderful it is, it’s not worth an infinite price. We have to have a price that makes sense and gives a margin of safety considering the normal vicissitudes of life."
With the essentials (how to find investments and how to succeed in life) covered in that article, I'm looking at Munger's advice for making decisions.
The decision process
Munger is well-known as one of the investment world's most thorough thinkers. His tips and advice have helped Warren Buffett (Trades, Portfolio) get to where he is today, helping the Oracle of Omaha make critical investment idea and, more importantly, stopping him from making any serious mistakes.
According to Munger's "A Lesson on Elementary Worldly Wisdom," his process for making all decision is relatively simple, involving two steps designed to help him arrive at the best conclusion in a relatively simple matter. Here's Munger's process:
"Personally, 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.
One approach is rationality -- the way you'd work out a bridge problem: by evaluating the real interests, the real probabilities and so forth. And the other is to evaluate the psychological factors that cause subconscious conclusions -- many of which are wrong."
The first step in the process is establishing what you do and do not know about the subject matter in question. This comes back to the circle of competence. What do you know an understand about the topic being discussed and can you make a reasonably informed conclusion on the matter?
Of course, most decisions (from an investment perspective) will never be simple; there will be multiple factors to consider. However, by knowing your subject you've already done the bulk of the heavy lifting. You should be able to tell with a quick glance if the business under consideration is worth a more in-depth look.
The second part of the process is probably the most important and something most investors overlook.
Psychology is a large part of investing and can be hugely influential in investment decisions -- something Munger is well aware of -- so it should not come as a surprise that an assessment of psychological factors impacting a decision forms part of his process.
It's fascinating that Munger is trying to acknowledge and eliminate these biases at the beginning of his process. He's clearly well-aware of the effect psychology can have on the investment process and wants to get rid of any potential influencing factors as soon as possible -- something many investors could benefit from adding to their processes.
Disclosure: The author owns no stock mentioned.
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