“How can smart people so often be wrong? They don’t do what I’m telling you to do: use a checklist to be sure you get all the main models and use them together in a multimodular way.” - Charlie Munger
Welcome to Special Situation Investing Episode 66.
Last week, on February 15th, the 99-year-old Charlie Munger spoke for over two hours at the Daily Journal Corporation annual shareholder meeting. In contrast to the Berkshire Hathaway annual meetings where Munger shares the stage with Warren Buffett and often says very little, during this meeting, shareholders and fans were treated to hours of Charlie’s no-holds-barred wit and wisdom.
Over the course of the meeting, Munger answered questions on topics as far ranging as his thoughts on Berkshire’s investment in BYD, on China as an area for future investment, and of course on crypto currencies. But to me, one answer Munger gave stood out amongst all the rest. He was asked:
You’ve described too much diversification as “diworsification.” In light of that thought, if one was allowed only one stock to hold for a very long time and it would be the most important asset to him, his family, and their future well-being, please describe what you would look for in that stock?
Munger replied with a general statement about finding great businesses with great management. But then about ten minutes later, after answering further questions, unprompted, Munger returned to this question. He said:
That question somebody asked — what one stock would you buy if you had to just rely on that one stock only for your sole living expenses? You weren’t allowed to earn any income at all, just invest $1 million and live on that one stock. How many people would give an intelligent answer to that question in America? I don’t think it’s one in a hundred. They wouldn’t even know how to begin.
That answer touches on a topic Munger repeatedly returns to in his talks and speeches, one he is clearly passionate about—the ability to think intelligently, or as Munger calls it, elementary wisdom.
Munger bemoans the fact that far too many of our fellow humans operate their daily existence bereft of wisdom. This is a topic that I’m passionate about as well. Think about it, in every facet of our lives whether it’s our occupation, our relationships, our day-to-day activities, or our strategic planning, critical thinking—or wisdom—is a critical component.
But here’s the strange part. Did any of you take a critical thinking class in school? Or were any of you deliberately taught how to acquire wisdom or deliberately taught critical thinking tactics? If you’re like me the answer is no. But I’m sure all of you, like I was, were told by a caring parent or a crotchety teacher, that you needed to be a critical thinker. I guess it was assumed we would each pick up critical thinking through experiences.
Munger has a different opinion.
He believes wisdom is a skill to be taught and to be deliberately acquired. In fact, he’s said if he were “czar” of a law school he’d teach a course called “Remedial Worldly Wisdom.” He admits a bit of derision is baked into that hypothetical title as its intent is to communicate “this is really basic and everyone has to know it.”
His course, he explains, would be full of mental models, pithy and powerful examples and principles. But Munger is not a law school czar and unfortunately for all of us, he has never created such a course or ever written a book on the topic. But what he has done through his rare talks and speeches is share a blueprint of his critical thinking model that he developed and used over his lifetime.
So if you’re like me, as an investor, as a parent, or just as a human being, it’s probably worth looking at what he has to say.
Munger states he uses a two-track analysis or two-track thought process. He says:
Personally, I’ve gotten so that I now use a 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 forming conclusions in various ways?
I think most of us might be able to say that we are at least decent at following the first step. When faced with a decision, most of us can break it down and figure out the pros and cons. We can answer if something is good or bad for us. Most often we can understand what rational factors are at play in a decision.
If I had to wager though, I’d say that’s were the majority of us end our process. No further steps involved. But Munger’s second step is just as important. Perhaps even more so.
The subconscious influences on our brains are very real but often go unnoticed. These are our own biases, the biases of others, and the myriad of other psychological influences affecting yourself and anyone else involved.
Take for example the decision to purchase a stock. Step one will lead you to consider various things such as valuation, company historical success, company moat, industry trends, and other sundry facts and factors. But step two will cause you to consider whether you’re being affected by FOMO, or giving in to hysteria or fear, or buying only because you got a hot tip from someone you respect, and whether your biases are causing you to be blind to warning signs.
The questions and factors Munger runs through in each of the two steps are guided by a collection of fundamental truths—often called mental models— that he acquired over the years.
Munger is responsible for popularizing the concept of mental models. And it’s common now a days to find self-help and personal development gurus throwing the term around. Munger says:
You’ve got to have models in your head. And you’ve got to array your experience—both vicarious and direct—on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and fail in life. You've got to hang experiences on a latticework of models in your head.
But what exactly is a mental model?
Munger describes them as “big ideas.” Another way to think of them is as laws of nature, or as stated above, as fundamental truths of reality.
So once again, an example. Gravity.
The law of gravity is definitely one of those big ideas that should be considered a mental model. While its clear how gravity is helpful when calculating physics questions in school, using the law in everyday decision -making is probably less clear. But consider the sayings ‘what goes up must come down,” “trees don’t grow to the sky,’ and “getting over your skis.” Each of these is based on the law of gravity and can be immensely helpful when making decisions, investing or otherwise.
The law of gravity is just one example of a big idea, there are hundreds of others. Some that Munger mentions in his talks compiled in the book Poor Charlie’s Almanack include the following:
The laws of arithmetic, compound interest, bell curves, permutations and combinations. Others are the models of backup systems, breakpoints, critical mass, and cost benefit analysis. And still others include the law of economies of scale, inversion, the trap of ideologies, as well as dozens of psychological biases.
As there are hundreds of big ideas that can be used as models it can be immensely overwhelming. But Munger provides a note of encouragement, saying:
It isn’t that tough—because eighty to ninety important models will carry about ninety percent of the freight in making you a worldly-wise person.
So although eighty to ninety is still a large number its encouraging that its at least not hundreds.
It’s important to note Munger doesn’t give opportunity to shortcut the process by learning only a few of the biggest big ideas. Just a few won’t cut it. But it’s not just the large number that’s important, the breath of areas that these big ideas are pulled from is just a critical.
Munger’s system of mental models works so well because he uses the big ideas from all the major areas of study: economics, mathematics, chemistry, physics, biology, psychology, and politics to name a few.
You must know the big ideas in the big disciplines and use them routinely—all of them, not just a few. Most people are trained in one model—economics, for example—and try to solve all problems in one way.
This multidisciplinary approach allows an issue that might not be caught by a law from one area to be caught by a law from another area. This way Munger creates what he calls a latticework of models and it creates for him a sort of filtering mechanism. In the following quote, Munger talks about his early recognition of the importance of a multidisciplinary approach:
For some odd reason, I had an early and extreme multidisciplinary cast of mind. I couldn’t stand reaching for a small idea in my own discipline when there was a big idea right over the fence in somebody else’s discipline. So I just grabbed in all directions for the big ideas that would really work.
By stealing the best ideas from a multitude of disciplines, Munger’s latticework of models helps it’s users avoid what’s referred to as “the man with a hammer fallacy”—as the saying goes, “to a man with a hammer, everything looks like a nail.”
In a world as complex and changing as ours, it’s rarely possible to make a good decision based on knowledge from only one, or even a few, disciplines. But for those of us without the blessing of a photographic memory, recalling eighty to ninety models from a multitude of disciplines seems an impossible task. To help overcome this difficulty, Munger advises the deliberate use of checklists.
Use a checklist
Taking a page out of the training programs for aircraft pilots, Munger sings the praises of using checklists as a tool. He says:
thinking by inversion and through use of checklists is easily learned—in broadscale life as well as in piloting.
Just as a pilot takes out and follows the same checklist whenever starting an aircraft, Munger suggests each of us creates a checklist containing all the major mental models that we can pull out and run through every time we make a decision. This process helps with remembering each step and over time this checklist use can become a habit and can be executed with less deliberate effort.
If nothing else, it’s clear this method worked for Munger. Buffett who’s no dimwit himself, heaps high praises about Munger’s decision-making ability, stating:
[Munger] has the best 30-second mind in the world. He goes from A to Z in one move. He sees the essence of everything before you even finish the sentence.”
Any process for critical thinking would be hard-pressed to earn higher praise.
To wrap up the episode, it’s acknowledged that this is a simplistic, dumbed-down, and horribly incomplete encapsulation of Munger’s multidiscipinary approach. It’s a summary. It’s a starting point. And we hope you do start on a journey of developing your own critical thinking. We all know its desperately needed in our world today.
And one last thought. We shouldn’t expect Munger to spoon-feed us his entire approach. In fact, if we truly want to learn deeply, we should be happy he doesn’t. By working to identify mental models from multiple disciplines and crafting checklists of our own, only then can we fully internalize and fully utilize the processes usefulness. Along that vain, Munger says:
There are a relatively small number of disciplines and a relatively small number of truly big ideas. And its a lot of fun to figure it out. Plus, if you figure it out and do the outlining yourself, the ideas will stick better than if you memorize ‘em using somebody' else’s cram list.
Munger is teaching us even with the words he choses not to say.
With that we hope you enjoyed this latest episode of the show. Although it was a bit different from our normal episodes, we hope you found it enjoyable and educational.
Thank you for the likes, comments, new subscriptions, and bitcoin boosts you’ve been sending our way. Your support is truly appreciate. We’ll see you all next week.
Here are a few Substack articles we enjoyed reading this week.