At the 2002 Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) annual meeting, Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) took the time to respond to a question about how they keep each other in check. Specifically, they were asked about how they limit confirmation bias - i.e., the tendency to seek out information that supports your prior conclusions and to discount data that does not. Here is what the legendary duo had to say on the subject.
Keep track of yourself
Obviously, having a partner like Buffett or Munger to bounce ideas off of is an incredible rarity, but it can be helpful to get a second opinion on your calls from almost anyone else. Often a new set of eyes is all that is required to see the truth. Buffett went on to say:
“There’s no question that what human beings are best at doing is interpreting all new information so that their prior conclusions remain intact. That is a talent that everyone seems to have mastered. How do we guard ourselves against that? Well, we don’t achieve it perfectly. Charlie and I have made big mistakes because in effect we have been unwilling to look afresh at something. That happens.”
Buffett went on to say that having feedback mechanisms is a good way of keeping oneself in check. For himself, he finds that having an annual report to compile every year helps to clarify his thinking and provide a backstop against a slide into confirmation bias. Not everyone can or needs to compile an annual report, but every investor should consider keeping an honest record of their own efforts. A daily journal is a good way to do this - write down every investment decision you make the moment you make it, making sure to take note of your mental state and your thought process at that point in time.
Doing so provides two big benefits. First, it prevents your brain from creating after-the-fact rationalizations for why you bought a stock. If you have a written record of why you did something, it is a lot harder to fool yourself into thinking that you had other reasons. Second, a written record can help to uncover damaging patterns that you may be falling into. Perhaps you are prone to making hasty decisions when you are upset by a loss. Or maybe you risk too much of your capital per trade, which makes it difficult for you to stay emotional about your investments. Everyone has their cognitive blind spots, and there is no shame in making mistakes. The only shame is not learning from them.
Munger then added:
“I think that it also helps to be willing to reverse course even when it’s quite painful. As we sit here, I think that Berkshire is the only big corporation in America that is running off a derivative book. We originally made the decision to allow the General Re derivate book to continue. And it’s a very unpleasant thing to do to reverse that decision, yet we’re perfectly willing to do it. Nobody else is doing it, and yet it’s perfectly obvious, at least to me, that to say that derivative accounting in America is a sewer is an insult to sewage.”
Of course, we all know the role that derivatives would play in the meltdown of financial system just six years later. What now seems obvious in retrospect (that the decision to wind up General Re’s derivative exposure was the right thing to do) was clearly not obvious at all in the early 2000s, perhaps because doing so meant forgoing profits in the here and now. Munger and Buffett’s ability to make decisions that go against their immediate desires (making profit today) for the greater good of the company is what makes the pairing so rare in the corporate world.
Disclosure: The author owns no stocks mentioned.
Read more here:
- George Soros' Investment Philosophy, Part 3
- George Soros’ Investment Philosophy, Part 2
- George Soros’ Investment Philosophy, Part 1
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