The best of charlie munger 1994 2011

Table of Contents 2002 Tilson’s column: “Munger on Human Misjudgments” Page 5 1994 Munger on “The Psychology of Human Misjudgment” Page 9 1995 Munger’s speech at USC: “A Lesson on Elemen

The Best of Charlie Munger: 1994-2011

A collection of speeches, essays, and Wesco annual meeting notes

October 2, 2012

Dear fellow BRK shareholders,

I am a faithful BRK shareholder living within reasonable driving distance to Omaha I usually drive up early morning of the BRK annual meeting, attend the meeting until 5pm, and drive back home the same day, just to save a few pennies But I’ve been too cheap

to pay for airfare and hotel rooms to attended Charlie Munger’s Wesco annual meetings

in Pasadena

When I heard that July 2011 would be the last meeting with Mr Munger, I felt real regret for never attending one in the past and was desperately searching for Wesco meeting notes When I contacted Mr Whitney Tilson, he kindly emailed me not only his articles and notes from the many Wesco annual meetings he’d attended, but also many other relevant materials from his archives, dating back to 1994 At his suggestion, I have compiled them, along with some of the materials I’ve collected over time, into one file that he can circulate to the BRK faithful and put on his website I’m happy to do this as a way to give back to the value investing community

I have set up a bookmarks system in the pdf file to ease your navigation, which you can access by clicking View, Navigation Panels, Bookmarks

If you have Wesco meeting notes prior to 1999 or any other materials that you think I should include, please email me and I will revise my compilation

Sincerely

Yanan Ma Bledsoe

Ballwin, MO

yananma@yahoo.com

Table of Contents

2002 Tilson’s column: “Munger on Human Misjudgments” Page 5

1994 Munger on “The Psychology of Human Misjudgment” Page 9

1995 Munger’s speech at USC: “A Lesson on Elementary,

Worldly Wisdom as it Relates to Investment

Management and Business”

Page 36

1998 Munger on “Investment Practices of Leading Charitable

Foundations”

Page 72

1999 Munger’s “Master’s Class” on Foundation Investing Page 77

2000 Munger’s speech to the Philanthropy Round Table Page 83

2001 Munger on “The Great Financial Scandal of 2003” Page 88

2004 Tilson’s column, “Munger Goes Mental”, on Munger’s

Speech at UC Santa Barbara

Page 96

2003 Munger’s speech at UC Santa Barbara: “Academic

Economics: Strengths and Faults After Considering

Interdisciplinary Needs”

Page 100

2009 Munger on “Sacrificing To Restore Market Confidence” Page 125

2011 Munger’s “A Parody about the Great Recession” Page 127

2001 Tilson’s column: “Charlie Munger Holds Court” Page 146

2002 Tilson’s column: “The Best of Charlie Munger” Page 159

2003 Tilson’s column: “Charlie Munger’s Worldly Wisdom” Page 173

Munger on Human Misjudgments

Charlie Munger gave an insightful speech on “24 Standard Causes of Human

Misjudgment,” which has powerful implications for investors Whitney Tilson summarizes some key points and provides a link to the speech, so you can read for yourself

(in September 1999, which seems like an investing lifetime ago, doesn’t it?)

Behavioral finance recently reappeared on my radar screen when I came across an 80-minute

recording of a speech given by Berkshire Hathaway (NYSE: BRK.A) Vice Chairman Charlie Munger, Warren Buffett’s right-hand man and a genius in his own right It’s a brilliant, powerful, and compelling tour de force

In it, Munger highlights what he calls “24 Standard Causes of Human Misjudgment,” and then gives numerous examples of how these mental weaknesses can combine to create “lollapalooza” effects, which can be very positive as in the case of Alcoholics Anonymous or frighteningly negative, such as experiments in which average people end up brutalizing others

I’d like to highlight some of Munger’s most important lessons, especially as they relate to

investing

Psychological denial

Munger notes that sometimes “reality is too painful to bear, so you just distort it until it’s

bearable.” I see this all the time among investors both professionals and average folks Think

of all the people who simply have no business picking stocks, such as the “bull market geniuses”

of the late 1990s, whose portfolios have undoubtedly been obliterated in the bear market of the past two and a half years

You’d think these people would’ve recognized by now that whatever investment success they had in the late ‘90s was due solely to one of the most massive bubbles in the history of stock markets, and that they should get out while they still have even a little bit of money left I’m sure some are doing so, but many aren’t because they’d have to acknowledge some extremely painful truths (e.g., they should not, and should never have been, picking stocks; they speculated with their retirement money and frittered most of it away, and so on)

Instead, I’m still getting emails like this one, from people who, I suspect, are in serious

psychological denial:

Why isn’t anyone suggesting WorldCom as an investment possibility? Assuming

WorldCom survives, and assuming they reach a third of their highest stock value prior to the decline, why not buy shares at $0.19 (as listed now) [they’re now down to $0.124] and hold them for a few years? If WorldCom manages to make it back to $10.00 a share, the profit for a small investor would be more than satisfactory What am I missing here?

It seems like another chance to ‘get in on the ground floor.’

The answer is that WorldCom equity is almost certain to be worthless, and the only sane people buying the stock right now are short-sellers covering their very profitable shorts

Bias from consistency and commitment tendency

Munger explains this bias with the following analogy: “The human mind is a lot like the human egg, and the human egg has a shut-off device When one sperm gets in, it shuts down so the next one can’t get in.” In other words, once people make a decision (to buy a stock, for example), then

it becomes extremely unlikely that they will reverse this decision, especially if they have

publicly committed to it

This is true even if overwhelming evidence emerges indicating the initial decision was

disastrously wrong Have you ever bought a stock such as Lucent, Enron, or WorldCom, seen your original investment thesis torn to shreds by subsequent developments such that you

would never consider buying more of the stock (despite the lower price), yet you didn’t sell? I’ve

written twocolumns on this common, painful mistake

Over-influence by social proof

Human beings have a natural herding tendency to look at what everybody else is doing and do the same, however insane that behavior might be Munger gives a classic example from

Similar behavior led to the tech stock bubble of the late 1990s For more on this topic, see my column The Cocktail-Party Test, in which I argue, “Following the crowd and investing in what is fashionable is a recipe for disaster Instead, look for solid companies with strong balance sheets that are either out of favor with Wall Street or, better yet, not even on Wall Street’s radar

screen.”

Other questions Munger answers

I’ve cited only a few examples of Munger’s powerful observations and the answers he gives to a range of perplexing questions, such as:

Why are boards of directors so consistently dysfunctional and unable to rein in even the most egregious behavior by CEOs?

Why was the introduction of New Coke almost one of the costliest business blunders of all time?

Why didn’t Salomon’s CEO John Gutfreund or General Counsel Donald Feuerstein immediately turn in rogue employee Paul Mozer a failure of judgment that cost both men their careers and nearly put Salomon out of business?

How did Joe Jett lose $210 million for Kidder Peabody (and parent company GE)? How did Federal Express solve the problem of processing all of its packages overnight? Why wouldn’t Sam Walton let his purchasing agents accept even the tiniest gift from a salesperson?

How does Johnson & Johnson ensure that it evaluates and learns from its experience making acquisitions?

How has Tupperware “made billions of dollars out of a few manipulative psychological tricks?”

Why do bidders consistently overpay in “open-outcry” actions?

Why is a cash register “a great moral instrument?”

Why would it be evil not to fire an employee caught stealing?

Why might raising the price of a product lead to greater sales?

Why do some academicians continue to cling to the Efficient Market Theory?

Why are people who grow up in terrible homes likely to marry badly? And why is it so common for a terrible first marriage to be followed by an almost-as-bad second

marriage?

How can real estate brokers manipulate buyers?

How do lotteries and slot machines prey on human psychology?

Why should we be grateful that our founding fathers were “psychologically astute” in setting the rules of the U.S Constitutional Convention?

There is no space here to even begin to summarize Munger’s answers to these questions, so I transcribed his speech and posted it here I urge you to read it

If you find his thinking and the field of behavioral economics as fascinating as I do, I suggest reading Influence, by Robert Cialdini, Why Smart People Make Big Money Mistakes, by Gary Belsky and Thomas Gilovich and, for the definitive work on Munger himself, Damn Right!

Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger, by Janet Lowe

Guest columnist Whitney Tilson is managing partner of Tilson Capital Partners, LLC, a New York City-based money management firm He owned shares of Berkshire Hathaway at the time

of publication Mr Tilson appreciates your feedback at Tilson@Tilsonfunds.com To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com The Motley Fool is investors writing for investors

WESCO FINANCIAL'S CHARLIE MUNGER

"A LESSON ON ELEMENTARY, WORLDLY WISDOM AS IT RELATES TO

INVESTMENT MANAGEMENT & BUSINESS."

from a lecture to the students of Professor Guilford Babcock at the University of Southern California Marshall School of Business

from Outstanding Investor Digest's May 5, 1995 Edition

TABLE OF CONTENTS

"A LESSON ON ELEMENTARY, WORLDLY WISDOM

AS IT RELATES TO INVESTMENT MANAGEMENT & BUSINESS." 1

ALL TOO LITTLE WORLDLY WISDOM

IS DELIVERED BY MODERN EDUCATION 2

WITHOUT MODELS FROM MULTIPLE DISCIPLINES,

YOU'LL FAIL IN BUSINESS AND IN LIFE 3

YOU'RE GIVING A HUGE ADVANTAGE TO OTHERS

IF YOU DON'T LEARN THIS SIMPLE TECHNIQUE 4

NEXT, YOU HAVE TO KNOW ACCOUNTING

- ALONG WITH ITS LIMITATIONS 5

AN IRON RULE OF WORLDLY WISDOM:

ALWAYS, ALWAYS, ALWAYS TELL PEOPLE WHY 6

ENGINEERING HAS MORE THAN ITS SHARE OF MODELS

AND THEY'RE THE MOST RELIABLE ONES, AS WELL 7

THE HUMAN MIND HAS ENORMOUS POWER,

BUT IT ALSO HAS STANDARD MISFUNCTIONS 8

ORGANISMS, PEOPLE & COMPANIES WHO SPECIALIZE

CAN GET TERRIBLY GOOD IN THEIR LITTLE NICHE 9

AND THERE ARE OTHER ECONOMIES: GEOMETRIC,

ADVERTISING, INFORMATION, EVEN PSYCHOLOGICAL 10

THINGS TEND TOWARD WINNER TAKE ALL

THEREFORE, IT PAYS TO BE #1, #2 OR OUT 11

HOWEVER, BIGGER ISN'T ALWAYS BETTER -

THERE ARE ALSO DISADVANTAGES OF SCALE 12

A CASE STUDY IN ECONOMIES VS DISECONOMIES

- WAL-MART VERSUS SEARS, ROEBUCK 13

A MODEL WE'VE HAD TROUBLE WITH -

ANTICIPATING COMPETITION AND ITS SIDE EFFECTS 14

A FEW WORDS ON PATENTS,

TRADEMARKS AND FRANCHISES 15

A BASIC LESSON OFTEN FORGOTTEN:

NEW TECHNOLOGY CAN KILL YOU 16

THE NATIONAL CASH REGISTER MODEL

IS EXACTLY WHAT YOU'RE LOOKING FOR 17

FIGURE OUT WHERE YOU HAVE AN EDGE

THEN, PLAY THERE AND ONLY THERE 18

TO A MAN WITH PROFICIENCY IN MATH,

EFFICIENT MARKET THEORY LOOKS LIKE A NAIL 19

BETTING ON HORSES AND PICKING STOCKS

HAVE MORE THAN A LITTLE IN COMMON 20

AS USUAL, IN HUMAN AFFAIRS

WHAT WINS ARE INCENTIVES 21

IF SECTOR ROTATION IS VERY LUCRATIVE,

WE'VE NEVER SEEN THE EVIDENCE 22

RICH OR POOR, IT'S GOOD TO HAVE

A HUGE MARGIN OF SAFETY 23

GRAHAM WASN'T TRYING TO PLAY OUR GAME

- I.E., PAYING UP FOR BETTER BUSINESSES 24

FROM THE VIEWPOINT OF A RATIONAL CLIENT,

INVESTMENT MANAGEMENT TODAY IS BONKERS 25

IF YOU DON'T LOAD UP ON GREAT OPPORTUNITIES,

THEN YOU'RE MAKING A BIG MISTAKE 26

MAKE A FEW GREAT INVESTMENTS

AND SIT ON YOUR ASSETS 27

AND THERE'S THE ULTIMATE NO-BRAINER

- LIKE FINDING MONEY IN THE STREET 28

MODELS FROM BERKSHIRE HATHAWAY INVESTMENTS:

COKE, GILLETTE, GEICO & THE WASHINGTON POST 29

THE INVESTMENT MANAGEMENT BUSINESS:

DON'T PRACTICE PSYCHOLOGICAL DENIAL 30

-

A particularly astute student of human nature - particularly insofar as it relates to business and investing - Charlie Munger's counsel is highly prized and relied upon by friend and partner Warren Buffett His insights are equally valued and sought after by more than a few OID

subscribers and contributors (and editors)

Therefore, we were very pleased to be allowed to sit in on Munger's lecture at the University of Southern California last year on "investment expertise as a subdivision of elementary, worldly wisdom" and very gratefully acknowledge his generous permission to share it with you

As always, we highly recommend a very careful reading (and re-reading) of his comments and insights and hope that you find them as valuable as we do:

ALL TOO LITTLE WORLDLY WISDOM

IS DELIVERED BY MODERN EDUCATION

-

To be a great stock picker, you need some general education

Charlie Munger: I'm going to play a minor trick on you today - because the subject of my talk is the art of stock picking as a subdivision of the art of worldly wisdom That enables me to start talking about worldly wisdom - a much broader topic that interests me because I think all too little of it is delivered by modern educational systems, at least in an effective way

And therefore, the talk is sort of along the lines that some behaviorist psychologists call

Grandma's rule - after the wisdom of Grandma when she said that you have to eat the carrots before you get the dessert

The carrot part of this talk is about the general subject of worldly wisdom which is a pretty good way to start After all, the theory of modern education is that you need a general education before you specialize And I think to some extent, before you're going to be a great stock picker, you need some general education

So, emphasizing what I sometimes waggishly call remedial worldly wisdom, I'm going to start

by waltzing you through a few basic notions

WITHOUT MODELS FROM MULTIPLE DISCIPLINES,

YOU'LL FAIL IN BUSINESS AND IN LIFE

-

Without a latticework of models, you'll fail in school and life

Munger: What is elementary, worldly wisdom? Well, the first rule is that you can't really know anything if you just remember isolated facts and try and bang 'em back If the facts don't hang together on a latticework of theory, you don't have them in a usable form

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 experience on a latticework of models in your head

Absent enough models, your brain will torture reality

Munger: What are the models? Well, the first rule is that you've got to have multiple models - because if you just have one or two that you're using, the nature of human psychology is such that you'll torture reality so that it fits your models, or at least you'll think it does You become the equivalent of a chiropractor who, of course, is the great boob in medicine

It's like the old saying, "To the man with only a hammer, every problem looks like a nail." And

of course, that's the way the chiropractor goes about practicing medicine But that's a perfectly disastrous way to think and a perfectly disastrous way to operate in the world So you've got to have multiple models

And the models have to come from multiple disciplines - because all the wisdom of the world is not to be found in one little academic department That's why poetry professors, by and large are

so unwise in a worldly sense They don't have enough models in their heads So you've got to have models across a fair array of disciplines

Fortunately, it isn't all that tough

Munger: You may say, "My God, this is already getting way too tough." But, fortunately, it isn't that tough - because 80 or 90 important models will carry about 90% of the freight in making you a worldly-wise person And, of those, only a mere handful really carry very heavy freight

So let's briefly review what kind of models and techniques constitute this basic knowledge that everybody has to have before they proceed to being really good at a narrow art like stock

picking

YOU'RE GIVING A HUGE ADVANTAGE TO OTHERS

IF YOU DON'T LEARN THIS SIMPLE TECHNIQUE

-

The great useful model is permutations & combinations

Munger: First there's mathematics Obviously, you've got to he able to handle numbers and quantities - basic arithmetic

And the great useful model, after compound interest, is the elementary math of permutations and combinations And that was taught in my day in the sophomore year in high school I suppose by now in great private schools, it's probably down to the eighth grade or so

It's very simple algebra And it was all worked out in the course of about one year in

correspondence between Pascal and Fermat They worked it out casually in a series of letters Your brain isn't designed to figure it out spontaneously

Munger: It's not that hard to learn What is hard is to get so you use it routinely almost everyday

of your life The Fermat/Pascal system is dramatically consonant with the way that the world works And it's fundamental truth So you simply have to have the technique

Many educational institutions - although not nearly enough - have realized this At Harvard Business School, the great quantitative thing that bonds the first-year class together is what they call decision tree theory All they do is take high school algebra and apply it to real life

problems And the students love it They're amazed to find that high school algebra works in life

By and large as it works out, people can't naturally and automatically do this If you understand elementary psychology, the reason they can't is really quite simple: The basic neural network of the brain is there through broad genetic and cultural evolution And it's not Fermat/Pascal It uses

a very crude, shortcut-type of approximation It's got elements of Fermat/Pascal in it However, it's not good

Without it, you're giving a huge advantage to others

Munger: So you have to learn in a very usable way this very elementary math and use it routinely

in life - just the way if you want to become a golfer, you can't use the natural swing that broad evolution gave you You have to learn to have a certain grip and swing in a different way to realize your full potential as a golfer

If you don't get this elementary, but mildly unnatural, mathematics of elementary probability into your repertoire, then you go through a long life like a one-legged man in an ass-kicking contest You're giving a huge advantage to everybody else

One of the advantages of a fellow like Buffett, whom I've worked with all these years, is that he automatically thinks in terms of decision trees and the elementary math of permutations and combinations

NEXT, YOU HAVE TO KNOW ACCOUNTING

- ALONG WITH ITS LIMITATIONS