Hey Kris, this was absolutely fantastic! Any more recommendations on decision making?
To which Kris Abdelmessih answers:
@ejames_c blog: https://commoncog.com/blog
Look up @AnnieDuke
At SIG we had to read Decision Traps and also Winner’s Curse (sidenote: Decision Traps: The Ten Barriers to Decision-Making and How to Overcome Them by J. Edward Russo and Paul J. H. Schoemaker.
The Winner’s Curse: Paradoxes and Anomalies of Economic Life by Richard H. Thaler.) . This was 20 years ago, probabily more updated books now.
And then adds:
]]>I’m reading [the book The Laws of Trading] now by @AgustinLebron3 and after a few pages I’m certain this is gonna be good (sidenote: The Laws of Trading: A Trader’s Guide to Better Decision-Making for Everyone by Agustin Lebron.)
Simkin talked about common mistakes we make when making decisions under uncertainty. One is to be excessively afraid of being wrong:
Simkin: Nobody ever goes out and buys a printed book of Sudoku puzzles that are already printed and completed. But there are other contexts where people say, “I’m afraid that if I don’t know the answer here, and I don’t know who to ask for the answer, that I’m going to look foolish by trying to figure it out on my own. I’m going to make mistakes as I try to go through this.”
And in the world [of trading] that I live in, for better or worse, we know that we’re going to make mistakes all the time, that we’re effectively just running experiments and getting feedback, and then updating our approach and running a new experiment again, the next day. Experiments fail. [In fact] that’s one of the ways that they eventually succeed is because you’ve found enough ways that they fail.
Another common mistake is failing to incorporate the necessary nuance and the grades of probability into our thinking:
Simkin: The other thing that that happens when people want answers is they want certainty. [But] 20% chances happen, and we don’t think through things probabilistically, right? The world is just not set up for probabilistic thinking.
I think it was Phil Tetlock who I heard say that, “We talk about things with probability numbers but what we really have are three probability states. It certainly won’t happen, it certainly will happen, or it might happen.” And those are the only three [states] that we can process.
In order to think probabilistically, we need to constantly compare our guesses with the actual outcomes, and then update our beliefs accordingly:
Simkin: It’s really hard to say anybody’s wrong about a single probability prediction, unless they said that something was zero percent or 100%.
It’d be great if you could look back at all the times that you said something had a 20% chance of happening, and see how many times it [did happen]. If it only happened 10% of the time, you’re making a mistake. It’s certainly a mistake if it happened 70% of the time, and you said it was 20%. But importantly, you might be making the mistake of being too conservative in your estimate, not discriminating enough in using the probability distribution available to you.
He talked about two examples of people that have been able to think probabilistically about the world:
Simkin: Phil Tetlock has built an entire solution around this, which is to look for superforecasters. The way he measures the performance of the superforecasters is by giving them lots of things to predict, to come up with probability assessments on it. [And also] to be able to change their probability assessment as the information set changes, which is a really important thing in decision making. [It] avoids the binary “will or won’t,” and leads to much better nuance in the middle, and really understanding the probabilities. When you have lots of measurements, then you have feedback that you can use to to improve the quality of your predictions.
Weather forecasters are really good. I mean, just stupid good. And if you were to plot how often it rains, when they say there’s a 30% chance of rain, it’s like 30% of the time. It’s not 25 or 35%, that would be a pretty bad weather forecast. But that’s because they get daily feedback, right? They’re making predictions all the time. And they always know whether or not their prediction came true. And sometimes they say there’s a 30% chance of rain and it rains and that doesn’t mean they were wrong. It does mean that the people we’re talking about in the next day are going to say they were wrong. They’re gonna say, you know, I was listening to Andrew Freiden, my local news weather forecaster, and he said it was 30% chance of rain. So I didn’t bring my umbrella, now here I am all wet. Thanks, Andrew, right? But I know that if I listened to the local forecast over and over and over again, that that prediction is going to be pretty accurate.
That is not to say that thinking probabilistically is easily applied in all circumstances. Of course it has shortcomings:
Simkin: If you predict many different things — particularly if they’re uncorrelated, so you have a lot of repetitions, where you’re going to get feedback — then you’re going to have learning.
[But] if the only thing that you predict are very hard-to-predict outcomes, and you predict them very rarely, you’re not going to be able to calibrate very well at all.
And the places where, where people are terribly inaccurate or places where they’re making predictions about things where they either haven’t had the opportunity for a lot of feedback or where nobody’s going to hold them accountable for being wrong.
And the worst forecasts are often from people who are experts and make extreme forecasts. When they’re right, they’re going to be really right because they said something extreme. And that means that they’re going to get on the news program. They’re going to be interviewed on the cable program that night, because they were the ones who said, “There’s 100% chance that Chelsea wins the Premier League.” Then the people who have the more nuanced view and say, “Well, this is what I think the probability is. But if things shake out this way, then the probability is going to shift.” Those people don’t get the spotlight,
My bullet-point summary:
Simkin talked about a seemingly trivial conversation technique that help others think clearer (and realize things by themselves):
Simkin: [There is] something that I learned while I was in college from a book called Teacher Effectiveness Training. When I read it in the book, and we talked about it in class, I said, “This is the dumbest piece of advice anybody’s ever put down on paper.” And it was around reflective listening. The idea was that instead of trying to step in and do problem solving, instead of trying to reframe, instead of trying to provide context or dig deeper, all you do is tell the person what you heard them say.
So that night, a friend of mine was over at my apartment for dinner. And she was talking about a problem that she was having with a roommate. And I was like, just for kicks, I’m going to give this a shot. And she’s, you know, salting the chicken or whatever it was, and she’s like “my roommate never puts her dishes away, and it bugs the hell out of me.” I reply, “So it sounds like you’re really bothered when she doesn’t put away your dishes.” She says, “Yeah, and it’s not just that, it’s also that she doesn’t appreciate it. When I do clean up.” Then I said, “So, it sounds like part of the problem here is that you’re not feeling appreciated.”
[I thought that] she was gonna think I’m the dumbest guy that she’s ever known, right? All I’m doing is, is repeating what she’s saying. And I was like, “Well, this certainly feels dumb, and I guess at some point, I got to call myself out on and point out that I’m just doing this stupid thing from the stupid book.” And then she turned to me and said, “Todd, this is the most beneficial conversation I’ve had about my relationship with my roommate ever. I feel like I’m coming away with this understanding myself better and her.”
Her experience was totally different from mine! She felt heard, she felt seen. And she felt like she now had the power to make a better decision about her relationship going forward.
And I thought, “Okay, well, maybe this guy’s not so stupid. Maybe this book isn’t so stupid. And maybe these methods work in places that I wouldn’t have thought they would work.” And it’s not always the solution. But it’s a much better solution than I would have thought it would be. And it’s something that I find myself doing with my kids all the time, and it no longer feels forced to me. It no longer feels fake.
To me, it’s very clear that what I’m doing is allowing the space for them to finish their own thought. That’s one of the things that I do with my kids that I think has been really beneficial.
This surely sounds like the proverbial rubber duck of software engineers. The mere act of verbalizing something helps us seeing our own problems from a different, and potentially insightful, perspective.
Here’s another conversation technique — “How do you feel about that?” — that Simkin employs with his kids:
Simkin: Another one that’s sort of related to that was pointed out to me yesterday by my 16 year old’s friend, who was over in the house. Her friend had said something that was happening with her parents, who were away. And she was talking about an argument that she had with her parents, and something that her father said to her.
My daughter said, “Well, how do you feel about that?” And her friend’s said, “That is the most Simkin thing that I could hear you say at that point? Instead of asking what I want to do next, you start with, ‘How do I feel about it?’” — which is something that the friend and my daughter have heard from me and Shelly, my wife, over and over again.
Again, it’s really hard for us to jump in and start providing advice, if we don’t even know where the child is coming from. If we start saying, “Well, it sounds like that other kid was being a jerk?”, and then your kid is like “No, that’s not what I was saying at all. How do you not get me? How do you not understand what this is just starting with?”
So we say “How do you feel about that?” It feels like the Freudian psychologist sitting back, you know, while you’re lying on the couch mumbling something, but turns out to be really helpful.
This other technique is a bit more inquisitive, but still with very soft touch. It’s “I want to support you. But in order to do that I need to understand it better. Tell me more.”
Simkin: I hope to put the same care today that my father had then [when they talked about Todd Simkin’s important decisions], which is that he never erupted. His reaction was never emotional. It was purely inquisitive. It was like, you know, “Help me understand better.” And the question he helped me understand better is exactly the way I approach decisions that my children are making [today]. “Look, you know that I love and support you with whatever it is that you’re doing. But I can either provide context or, at the very least, more support, if I understand better where you’re coming from.”
One of the other teachers of the class at Susquehanna has such a lovely touch, he just says, “Tell me more.” And tell me more doesn’t have any value laid in it, it doesn’t have any judgment in it. It’s just saying, go ahead and add more words to what you’ve already shared. “You want to take this action against this type of order flow? Why? Tell me more.”
And effectively what my father was saying is the same as what as what Mike, my co-teacher says, when he’s talking to our students, which is just, “I cannot reach a conclusion about what you’re saying, until I understand it better. So help me understand it better. Tell me more.”
Parrish: I think that’s really effective. And one of the things that I like about your father’s approach is that it started with “I want to support you. But in order to do that I need to understand it better.” So it comes from this sort of unconditional love and no judgment about your decision. But, not being able to connect the dots for yourself. Which, I assume, would help you communicate constructively about your decisions, and communicate how you’re thinking about things. Which is the beginning of sort of getting better at them.
Simkin: I think that’s exactly right. And the other thing that it does is that it establishes very early that we’re on the same side. That we have, if not all of the same goals, we have alignment with our values and our goals. “I want to support you” says, “All I’m looking for is an excuse to make sure that you and I are facing the same direction, facing the world together. Help me get there. Bring me into alignment with you by telling me more.”
If communication is paramount for a trader at Susquehanna, then this last technique is certainly very handy. For more context, see Todd Simkin on overcoming cognitive biases by communicating well with the right kind of group.
]]>Simkin explained what he calls the principle of charity:
Simkin: When I’m modeling decision processes for my classes or kids, I use this principle of charity.
[Whenever] somebody says something, I assume that they’re not an idiot. I assume that they’re coming from from a place of sincerity and good intentions. And I give them the benefit of the doubt.
On the trading side, this principle of charity is [about] really giving somebody credit for knowing what they’re doing when they’re trading against you. This [humility] is what sort of protects you from being run over by somebody who has better information than you do.
On the interpersonal side, this gift to the other person, is an assumption that that they are well-intentioned, and smart, and approaching this for the same purpose that you are. And therefore you’re going to end up being aligned in your process to reach a resolution to a conflict, or to come to an agreement about whatever it is that you guys are talking about.
Every single negotiation is a cooperation and collaboration. We’re never in a situation where the person has to negotiate with you. They have some alternative, they can walk away, which means that the only reason anybody’s going to engage you in a negotiation is because by doing so they’re going to get a better outcome than by not doing so. If that’s the case, then every negotiation is collaborative. Having a favorable outcome for yourself means that you have to have a favorable outcome for them as well. Otherwise, they’re not gonna be part of this conversation, and definitely not future conversations.
Kris Abdelmessih complements Simkin with a pertinent observation (a):
What stands out for me is the magic that can happen when we combine the principle of charity with a demand for mental rigor and vulnerability.
For more on the other components of this “magic,” see:
]]>Simkin is one of the leaders of Susquehanna training programs, in which they teach newcomers about how to trade in a variety of markets. He talked about how they focus their training more on “modeling” the decision process behind trades, and much less on the financial outcomes per se:
Simkin: One important thing that we don’t do is look at the results of the trading that they’ve had and say, “Well, if they’re winning, then they’ve got it. And we can leave them alone and and assume that they figured things out. And if they’re losing, then we need to step in and intervene.”
Annie Duke, another one of your former guests talks about that as “resulting.” Kahneman refers to that as “hindsight bias.” [This] is something that we look to avoid as frequently as we can.
When people talk about trading decisions that they’ve made to more experienced traders (or to peers who can give them feedback on it), we do everything we can to shield the person giving feedback from knowing the results. “I’m not going to tell you whether or not this trade worked out, I will tell you the information that was available to me at the time that I made the trade, and then what I did, and you can give me feedback on that process.” So the identification [if the apprentice is making progress], in this sort of less formal setting, comes from knowledge about how trading works, or how this particular risk taking works, or whatever it might be. [Not the results per se.]
In our education setting, it’s something that we control a whole lot more cleanly, right? We don’t have to present a very complex trade and see who can figure out sort of the pieces of it until everybody who’s in the trading class is ready to get there. We can build from smaller pieces up to the larger concept, and see who along the way, isn’t processing that smaller piece appropriately.
And a big part of how information is passed from the mentor to the mentee is by “modeling” the decision process. It is not enough to say, “You should have raised vol by two points when this trade came in.” Instead, it’s so much more important to say, “Okay, when this trade came in, I remembered that earlier in the week, somebody had traded this other structure. And when they did, I updated my possible outcome space to look different. This trade confirmed what that other trade did. So now I more heavily weighted this other outcome. And the result was that I took volatility up two points.” Then someone knows not only what to do, which is really not the important thing to take away. But how to do it, which is very much what we’re looking to teach.
Parrish: It sounds like what you’re really doing is knowledge transfer through sharing of reflection. You’re opening up people’s mind, and you’re saying like, “You have an experience, tell me how you process that experience, which is the reflection angle, which comes to an abstraction, which is what you would do in this circumstance, which becomes an action.”
I think of this as the learning loop. You start with an experience, you have a reflection, you draw an abstraction, and then you do an action. So often we’re just drawn to the abstraction, “what should I do?” What should I do, but I don’t see the thinking behind it, then I can’t match the patterns. I can’t see the nuances. I can’t encode it to my brain about when I should deviate, and when I should follow.
Simkin: Yeah, you know, [at Susquehanna] we’re really discussing how we would behave in a situation and modeling, with conversations, [what it] really should look like. And will disagree with each other. The answer to just about every trading question is, “It depends,” which is a really hard thing for someone to hear when they’re first learning because they want the answer. They want to know, “When I’m in this exact situation, again, what is the optimal thing to do?”
The interesting part of the conversation comes in the “what it depends on?” All of these questions lead to some type of answer of “what you could do” or “what should be in the actions that you might take here.” And there are some things that are clearly wrong. And it’s important to talk about that, too.
When we’re talking about it in a trading context, it’s really nice that one teacher can say, “I think that I probably would have shown a bid for this price and this amount.” And someone else says, “Well, I don’t know that I would because this broker’s behaved this way before. So I think that this might be a time where I’d be afraid that I’m opening myself up to selection bias if I were to price it that way. And I would do this [other thing].” And you have these senior traders who are disagreeing. And so there’s this really nice modeling of how to think about, of how to improve the process. So that you can reach an answer that you are tentatively more comfortable with.
In a nutshell:
]]>Simkin: [What we try to the pass on is] the thinking around how to trade, which is that, if we think through trading and build up our understanding of risk and asymmetric information, and the difference between selection bias and noisy outcomes, that you can make the right decision and still get unlucky.
They talked about the need for cognitive shortcuts in everyday decision making. At the same time, they also pointed out that, despite beeing needed, shortcuts carry their own risks (stemming from the social nature of human beings):
Parrish: If you make a personal rule in a way that’s like, “I’m not the person that you eat dessert, so I’m not going to eat dessert.” Well, now, I don’t have to think about it. I just don’t eat dessert. So it can serve you.
But it can also prevent you from accurately weighing new information or contemplating in [new information in] this case. [It’s like we’re] inherently lazy. And we just want if we’re part of a tribe. I don’t have to digest every little new piece of information, I can sort of just go with the flow and fit in. And plus we want to fit in, we want to be a social member of something larger than ourselves.
Is that because we see our identity as the tribe? And then anything that goes against that, isn’t that challenging our sense of self?
Simkin: It’s so much easier if you have a rule than if you tried to have a principle. [A rule like] “I don’t eat dessert” is so much easier than, each time that you have the opportunity to have dessert, to say, “Well, I don’t eat a lot of dessert, is this one of the times that I’m better making a change there?”
I get up and do some type of exercise every morning. And I find it easy to exercise seven days a week, [but] I found it really hard to exercise five days a week. The reason was every morning the alarm goes off at 5am, it’s really easy to not have your feet hit the ground and get going. It’s really easy to say, “Well, I need to take two days off anyway, this can be one of the days that I take off.”
So on the “I don’t eat dessert rule”, I think that’s a great way to pre-decide. [Laziness] has a lot of value laid in it. [It] lightens your cognitive load. I don’t have to stop and think about everything if I’ve already spent the time thinking about it. And it’s led to this conclusion that I’ve reached, which is this rule that I can follow. So I love being able to do that.
But you’re not part of a group of non-dessert eaters, right? This isn’t part of a a broader identity that you’re now wrapped up in. If you decide to change that rule, and you have dessert, you don’t have other people calling you a “dessert denier name only [DDNO],” right? You’re a “DDNO” now. Who cares, right? “Okay, so she used to eat dessert (or used to deny dessert), and now he’s having an ice cream sundae?” Good for her. Maybe it’s her birthday, whatever it is, this is a decision that’s totally fine with her.
And you don’t have to worry that you have now also contradicted all of the other tenets held by the people in the non-desert eating group. If it’s something that is more tribal, where we are the type of people that do this and don’t do that, then a violation of one part of that removes you from this group that you are in.
In essence:
In the same conversation, Parrish and Simkin talked about a possible way out of some cognitive biases: Todd Simkin on overcoming cognitive biases by communicating well with the right kind of group. This also reminds of the partnership between Warren Buffett and Charlie Munger. It seems to me that one of the reasons why Buffett values so much having Munger as his partner is that Munger, being a smart independent thinker, is able to challenge Buffett’s thinking. They sharpen each other. And, through this process, make themselves less prone to errors.
]]>Simkin leads Susquehanna’s trader training programs. In the interview he explained how he and the firm approach teaching:
Simkin: When I was originally studying education [at University of Virginia as an undergrad], I was thinking that I might be teaching sixth grade deaf kids how to do math. Instead, [at Susquehanna] I’ve got MIT graduates who certainly understand math, but don’t know trading. And I’m teaching them how to make these asset allocation decisions with imperfect information. But the approach is still the same.
The approach is still this one of modeling the process, finding out where somebody is, and finding out what they can grow to and providing the appropriate support so that they can grow to be a better decision maker.
The philosophy that always comes to mind when I think about it is [the one put forward by] Lev Vygotsky.
So Lev Vygotsky was a Russian psychologist, born at the end of the 1890s, who grew in prominence in Russia pretty quickly through mid 1930s. He died young, when he was 37 years old, in 1934. The ideas that Vigotsky had around education were contrasted with another prominent psychologist of the day, Jean Piaget. Piaget had this perspective about stages of receptivity to different types of education, that you cannot teach somebody anything until they reach the appropriate developmental stage to be able to learn it. And then, they can learn whatever’s sort of presented to them before moving on to the next stage. And Piaget had, you know, a pretty rigid framework for the stages that you move through, how you move through them. And that education effectively ended at adolescence.
And Vygotsky said, “No, that’s kind of bunk. That’s not how any of this works. All of education is socio cultural, all of education comes from interaction with others. And those others in order for them to be educators have to be more knowledgeable than you are.” And that when you have interaction with more knowledgeable others, what those people are able to do is recognize your zone of proximal development (ZPD). You have a zone of things that you know, and then you’ve got a zone that is just too far out of your reach. No matter what, if I were to sit down my six year old nephew, and try to explain linear algebra to him, he’s not going to get it yet, he just doesn’t have the fundamental tools to do that. But somewhere outside of your zone of mastery is this zone of proximal development, the zone that that you can move into with appropriate support and that support, in the Vigotsky literature, is referred to as scaffolding. And you want it to be the minimal amount of support necessary to appropriately move somebody to be able to handle the next level of mastery.
Over time, you can dismantle that support, dismantle that scaffolding and that zone becomes part of their zone of mastery, and you’ve just pushed out where their zone of proximal development is. So that over time you can move them into an area where they’re learning more and more, and they’ve got greater mastery and competence in whatever area is that that you’ve been teaching them. Eventually, they become more knowledgeable than other people around them. And they can provide the scaffolding as the more knowledgeable other for their peers as well.
Kris Abdelmessih references (a) an academic review (a) that expands on the contrast of Vygotsky vs Piaget:
This use of ZPD defines “teachability” of the child in a specific activity or in problem solving. If an activity or problem can be accomplished by the child with the help of more capable others, this activity or skill is considered possible to teach the child. If, however, the activity or skill cannot be accomplished by the child with the help of more capable others, it is considered not useful to teach to the child.
Unlike Piaget, who believed that instruction should follow development, Vygotskij argued that guidance can, should, and does lead development. They would differently define what is currently called “developmentally appropriate curriculum.” Piaget insisted that learning is essentially an individual endeavor and that adults can only facilitate by providing an enriched stimulating learning environment and opportunities for children to share and discuss their egocentric thinking with each other to promote disequilibrium in the child’s thinking. Adults should not interfere in the child’s individual thinking because it can only lead to imposition of the adult’s ideas onto the child—what Piaget called “sociocentrism.” In contrast, Vygotskij encouraged adults to provide guidance and help and to engage students in activities that are beyond their individual levels of competence (“performance before competence” (sidenote: Whole Language Plus: Essays on Literacy in the United States and New Zealand by Courtney B. Cazden et al., 1992.) ).
Some researchers have tried to develop a “ZPD test” — a standardized assessment of a student’s teachability. However, it is doubtful that a reliable ZPD test could be developed because, as Newman et al. (sidenote: The Construction Zone: Working for Cognitive Change in School by Denis Newman, Peg Griffin, and Michael Cole, 1989.) demonstrate, the notion of ZPD is relational. A student’s teachability depends not only on the student but also on the teacher (and broader communities in which the child participates). Thus, no test of the child alone would accurately determine the child’s teachability — the teacher always counts. (#)
Back to Simkin.
Later in the interview he gives another example — this time in recruiting — of how the idea of ZPD permeates what he does:
Simkin: [Now, talking about our] hiring process. The best outcome for me for an interview is if the candidate walks away and wishes they could have part of the interview back.
That means that I did not spend the entirety of the interview in their zone of mastery, where they just got to show off and primp and preen in front of me. And then I left to decide whether or not they would have the skills to do more.
And [that also means] I did not spend the entire time in their zone of frustration, where they couldn’t do anything. Like, “Okay, I didn’t expect you to [be able to do it] any way, but, you know, if you could, that would have been great to see.” And I still [have to] make a hiring decision.
But, instead, on multiple dimensions, I’ve been able to find the place where, with a little bit of support, they could do a little bit more.
A big part of the reason that I like that is this thing, this openness to feedback. Because when I’m giving them feedback (because I’ve successfully mapped out their zone of proximal development), and now I’m providing a little bit of scaffolding to see what they can do with support.
You will find that some people embrace it and say, “Oh, I think I see where you’re going. Let me see if I can take it from here.” That’s a great answer. You will find some people who are just waiting for you to give them more of the answer. Who will just say “Okay, what else?” [They] wait for you to map out the entire selection process and then they’ll just fill in the numbers. I think you’ll find some people who are totally resistant to it, who will shut you up, who will put their hand up and say, “No, no, no. Let me work on it my way.” And they’re always not working. And I know why it’s not working. And I can help direct them away from it. But they don’t take the feedback.
I don’t want the person who doesn’t take the feedback. And I don’t want the person who’s waiting for more feedback. I want the person who is hungry and eager to use the tools that are presented and available to them to then do the work themselves. That’s what’s going to be successful when they’re trading. And they get to have a small opportunity of doing that in the interview process.
It jumps to me that a lot of experience is required to be able to dynamically assess where others are in their learning journey (while, at the same time, continuously adjust testing questions). But I guess that’s what makes great masters great.
It’s also interesting to note that Simkin is actively selecting for coachability.
How does one assess where others are in their learning paths? Abdelmessih suggests (a) that:
By using the Socratic method (sidenote: Wikipedia: “The Socratic method (also known as method of Elenchus, elenctic method, or Socratic debate) is a form of cooperative argumentative dialogue between individuals, based on asking and answering questions to stimulate critical thinking and to draw out ideas and underlying presuppositions.”) , a teacher can zero in on where the student’s boundaries are.
Cedric Chin points out (a) that knowledge domains that have been “well-structured” are much more ameable to the Socratic method than the “tacit” domains:
]]>By eschewing explanations and relying on repeated questioning, a teacher may quickly learn the map of a student’s existing understanding, and better guide them to the insight that is the goal of their conversation.
But there are also big limitations to the Socratic method. It’s true that the method works for well-structured and well-scoped ideas — ideas like learning a programming construct, for instance, or the key points of a philosophical worldview.
To borrow several terms from epistemology, the Socratic method works wonderfully for “know-what” (facts) and “know-why” (science). But it begins to fail the further we move away from such explicit forms of knowledge, towards embodied or tacit knowledge. This is the technê I’ve mentioned so often on Commonplace — the idea that certain types of knowledge cannot be easily expressed through words, and may only be learnt through practice or apprenticeship. These forms of knowledge are things like applying a martial art, kneading dough, riding a bicycle, or playing a musical instrument.
One of the topics that they discussed was cognitive biases and strategies to keep them in check. Simkin explains that at Susquehanna they train traders to talk over their decisions with others in their teams:
Parrish: What I don’t like about cognitive biases is that they seem to be poor at preventing us from making poor decisions in the future. What I do like about them is they seem to offer a language and a framework for thinking about why we’ve made poor decisions in the past. So how do you use that information to make better decisions in the future?
Simkin: It is definitely true that [having knowledge about cognitive biases is] sort of descriptive of the past. A lot of these heuristics and biases are things that we can see after we’ve already identified that a mistake has been made. And we say, “Okay, why was the mistake made?” Say, “Oh, because I was anchored.” Or “Oh, because of the way the question was framed.”
Whatever it might be we have a really hard time seeing it in ourselves, but a really easy time seeing when someone else’s is making that type of stupid mistake.
A big part of our approach to education [at Susquehanna] is to teach people to talk through their decisions, and to talk about why they’re doing what they’re doing with their peers, the other people on their team.
If we can do that real time, that’s great. Often in trading, you don’t have that opportunity, because things are just too immediate.
But certainly, anytime things have changed, if you’re doing things differently, it’s a really good time to turn to the traders around you, and the quantitative researchers around you, and the assistant traders and your team. And say, “Hmm, it looks like all the sudden Gamestop is a whole lot more volatile than it was a week ago. Here’s how I’m positioning for this trading. What do you guys think?” And have someone say, “Oh, it seems like you’re really anchored to last week’s volatility. If things have changed that much, you need to move much more quickly than you’re moving right now.”
So you don’t realize that you’re anchored, that’s the whole nature of being anchored, is that you don’t recognize the outsized importance that the anchor has on your decision. But somebody else who’s a little bit more distant from it can.
So if we’re good at at encouraging the communication, then we’re going to be really good at getting other people to to help improve your decision process.
Simkin believes that the ability to “bring in other people to the decision process in a constructive way” is the most important success factor for a trader:
Parrish: Is it fair to say that probabilistic thinking is probably the biggest bang for the buck when it comes to improving your decision making ability? If you had to isolate the top three variables that you could teach somebody to improve their ability to see reality (or to do “truth finding”), what would they be?
Simkin: Talk more is number one. That beats probabilistic thinking that beats sort of anything else in truth finding. It is being able to bring in other people to the decision process in a constructive way. So finding good ways to communicate, to improve the input from others in your decision process, I think is pretty important.
Thinking probabilistically, I think, is definitely a very, very important piece of that [as well].
I’m trying to sort of diagnose this, [to think about] what works, by trying to think of where things fall apart, where people fail. The other place that people fail is really falling in love with their decision process, and not being open to being wrong. So in openness to feedback, to finding disconfirming information, to actively seeking out disconfirming information, which is really uncomfortable. But that, I think, is the other piece that is super important for being a good trader.
But of course nothing is completely failproof:
Simkin: I know that you [Shane Parrish] are fond of pointing out that “you are the sum of the five people that you spend the most time with.” So if the people that you’re spending the most time with or your co-workers who are thinking about trading the same way you are, then maybe you’re going to combine the same types of errors. [Nevertheless] that is certainly better than then trying to act on your own.
It is also essential to watch the team dynamics to make sure it’s geared towards truth seeking (and not politics, nor “action”):
]]>Simkin: And [it’s] even better if you have a culture that rewards truth finding, as opposed to rewarding action. If nobody feels personally attacked, because of somebody else pointing out their error, but instead feels like “We together have now done more to get closer to some truth.” [That’s a] better way to act. The more accurate, fair value of this asset that we’re trading, [the more] everybody feels like it’s a win. And they will therefore encourage the involvement of the people around them.
In The Snowball, Alice Schroeder wrote about the differences between their viewpoints:
[Munger’s] impatience stood out more than any theory that was emerging inside his head. He wanted to get really rich, really fast. He and Roy Tolles (sidenote: For more on Roy Telles, read his 2008 obituary in the LA Times (a).) made bets on whose portfolio would be up more than one hundred percent in a year. And he was willing to borrow money to make money, whereas Buffett had never borrowed a significant sum in his life. “I need three million dollars,” Munger would say, on one of his frequent visits to the Union Bank of California. “Sign here,” the bank would reply.
With these huge sums, Munger did enormous trades like British Columbia Power, which was selling at around $19 and being taken over by the Canadian government at a little more than $22. Munger put not just his whole partnership, but all the money he had, and all that he could borrow into an arbitrage on this single stock — but only because there was almost no chance that this deal would fall apart. When the transaction went through, the deal paid off handsomely.
Jack Wheeler had explained to [Munger] that, as a member of the exchange, under its rules he could borrow an additional ninety-five cents for every dollar invested.
Thus, if he put up $500, he could borrow another $475 and invest a total of $975. If the investment earned a profit of twenty-five percent, the profit on Munger’s $500 of capital would be nearly double that (sidenote: Alice Schroeder notes: “The example has been simplified for ease of understanding the concept of leverage. Obviously the exact return on capital depends on how long it took to make the profit, and on the funding rate.”) . While having the potential to nearly double his returns, this borrowing likewise nearly doubled his risk. If he lost twenty-five percent, he would lose nearly half his capital.
But Munger, more than Buffett — far more than Buffett — was willing to take on some debt if he was positive the odds were right.
]]>By the early 1960s, the Buffetts had begun to vacation in California, so that Warren could spend more time with Graham and Munger. Once Warren and Susie took the kids on a long trip up and down the coast, but usually when they came to visit, they’d settle into a motel on Santa Monica Boulevard, and he and Munger would talk stocks for hours.
The differences in their philosophies made for long conversations. While Buffett made many of the same investments, he would forgo the chance of profits any day to avoid too much risk, and viewed preserving his capital as an almost holy imperative (sidenote: Schroeder, again: “[Buffett] tended to extrapolate mathematical probabilities over time to the inevitable (and often correct) conclusion that if something can go wrong, it eventually will.”) . Munger had the attitude that unless you were already wealthy, you could afford to take some risk — if the odds were right — to get rich. His audacity put him in a different category from all the others who cultivated Buffett, for his deference to Buffett was limited by his high opinion of himself.
But whenener he’s asked for advice about his special advantages, Munger does not encourage people to copy him and go full-time into generalist mode. What he does advise is that everyone devote a small percentage of their time (say, 10%) to figuring out the basic big ideas (sidenote: I believe Munger makes this recommendation with the intention to help everyone avoid the “standard inanities”.) .
Here are exchanges that took place in the 2017 Daily Journal Annual Meeting (a):
Questioner: As an 18-year-old interested in many disciplines, I was wondering how you can thrive as a polymath in a world that celebrates specialization?
Munger: Well, that’s a good question. I don’t think operating over many disciplines as I do is a good idea for most people. I think it’s fun, that’s why I’ve done it. I’m better at it than most people would be. And I don’t think I’m good at being the very best for handling differential equations. So it’s in a wonderful path for me, but I think the correct path for everybody else is to specialize, get very good at something that society rewards, and get very efficient at doing it.
But even if you do [specialize], I think you should spend 10 or 20% of your time into trying to know all the big ideas in all the other disciplines. Otherwise — I use the same phrase over and over again — otherwise you’re like a one-legged man in an ass-kicking contest. It’s just not going to work very well. You have to know the big ideas in all the disciplines to be safe if you have a life lived outside a cave.
But no, I think you don’t want to neglect your business as a dentist to think great thoughts about Proust.
And:
]]>Questioner: My perception is that the [oil and gas] industry itself has continuously gotten more complex and technical, and as the economy expands and you have more division of labor and specialization, it seems to me that it can be very hard for investors unless there’s more specialization.
Munger: Of course.
Questioner: Do you think that capital allocators are going to need to become more specialized going forward?
Munger: Well, you, petroleum people, of course, have to get more specialized because the oil is harder to get and you have to learn new tricks to get it. And so you’re totally right. Generally, specialization is just the way to go for those people. It’s just I have an example of something different. It’s awkward for me because I don’t want to encourage people to do it the way I did, [and] because I don’t think it will work for most people.
I [do] think the basic ideas of being rational and disciplined and deferring gratification, those will work [for everyone]. But if you want to get rich the way I did, by learning a little bit about a hell of a lot, I don’t recommend it to others.
Now I’ve get a story there that I tell. A young man comes to see Mozart, and says, “I want to compose symphonies.” And Mozart says, “You’re too young to compose symphonies.” He’s 20 years old and the man says, “But you were composing symphonies when you were 10 years old.” And Mozart says, “Yeah, but I wasn’t running around asking other people how to do it.”
I don’t think I’m a good example to the young. I don’t want to encourage people to follow my particular path. If you’re a proctologist, I do not want a proctologist who knows Schopenhauer, or astrophysics. I want a man who’s specialized. That’s the way the market is. And you should never forget that. On the other hand, I don’t think you’d have much of a life if all you did was proctology.
First, on how and why he started his career in law.
It seems like he started as a lawyer because, at the time, he hadn’t realized what he was particularly good at. The fact that his family was well-connected in the field seems to have contributed to his decision as well.
From a Caltech event in December 2020:
Munger: My father had gone to the Harvard Law School, and my grandfather was a distinguished judge in Nebraska. So that was a natural course of activity for me.
I went into law because I didn’t want to be a surgeon, I didn’t want to be a doctor, I didn’t want to be a college professor. I finally got through them, there was only one [option left]. I just went down the family path. And it wasn’t the wisest decision I ever ran.
From a 2017 interview (a) (YT) by Scott DeRue at the Ross School of Business:
Scott DeRue: So, when you went to Harvard Law — why law?
Munger: Well, my grandfather and father had been lawyers, and I knew I didn’t want to do everything else, it’s very simple. I didn’t want to be a doctor. I didn’t want all the blood and misery and so forth, and the repetitive work.
I knew I didn’t want to go to the bottom of a big organization, and crawl my way up. I’m a natural contrarian and that was not going to work for me. I found that people could tell me when I thought they were idiots, and that is not a way to rise in a big organization, and so I couldn’t do that.
So now I’m left with law. I admired my father and grandfather, and they had a good life for them, so I naturally drifted into it. I think people are still going to law school for that reason. It’s the least bad of options considering their interests and ability.
I guess now people go to business school, some of who would have gone to law school. Many of the people in this room, I think, thought they were going to go to business school because that was the least bad of their options. And all I can say that that’s the way it worked for me, and it’ll probably work for you.
DeRue: So, you moved to California you actually start a law firm and then practice law for some period of time.
Munger: I had no alternative, I had an army of children almost immediately. I painted myself into quite a corner.
Second, on how he started his own law firm and started investing.
From The Snowball by Alice Schroeder:
In 1962, Munger had gone into partnership with his poker buddy Jack Wheeler. Wheeler was a trader on the Pacific Coast Stock Exchange, the Wild West version in miniature of what was going on back east: a floor full of screaming traders, aggressive men looking to make a killing the fastest way they could. He owned an investing partnership, Wheeler, Cruttenden & Company, which included two “specialist posts” on the exchange, where traders took orders from brokers to trade stocks on the floor. They renamed the business Wheeler, Munger & Co., and sold the trading operation to Rick Guerin (sidenote: Alice Schroeder writes: “Most of the traders at the stock exchange had ignored Munger’s arrival on the scene, but one of them, J. Patrick Guerin, took note. Guerin had bought the trading part of Wheeler’s partnership when Wheeler had spun it off and gone into business with Munger.
“A rough-and-tumble guy who was scrambling like mad to better himself, Guerin had grown up with a ‘divorced father,’ says Munger, ‘and his mother was a drunk, so he raised himself on the streets. He was high IQ, rebellious, and maladjusted.’
“After a stint in the Air Force, Guerin had worked as a salesman for IBM, then became a stockbroker at a couple of small firms that peddled third-class stocks because they carried the highest profit, or ‘spread,’ for the firm. This was a part of stockbroking Buffett had detested; Guerin, too, found it a relief to escape life as a ‘prescriptionist.’“
Also read Guerin’s obituary (a).) .
Munger continued his law practice but bolted from his old firm together with several other lawyers, among them Roy Tolles (a) and Rod Hills. They founded a new firm, Munger, Tolles, Hills & Wood, that suited their ideals of how a law firm should be managed. All along, Munger had naturally resisted following the rules of a law firm run by anyone but himself.
[Alice quotes Buffett:] “It’s no coincidence that the year he started his partnership was the same year he started his new law firm. The partners at the old firm found it abhorrent that a young lawyer in their firm would want to be a member of that gambling den, the Pacific Coast Stock Exchange. When Charlie and Roy left the firm, they sat down with the senior partners and said that they wanted these senior partners to understand that the day would come when every first-rate law firm had a member of the Pacific Coast Stock Exchange. This is probably apocryphal, but you can easily picture Charlie delivering that message to them as a parting shot.”
At their new firm, Munger and Hills imposed an elitist, Darwinian ethos designed to attract the brightest and most ambitious. The partners all voted on one another’s pay, which was circulated for everyone to know.
In 1963 [Munger] and Buffett were not partners. Munger had just opened a partnership of his own after waiting until he had accumulated a fair amount of money — around $300,000 — by investing in real estate. But this was peanuts by Buffett’s standards, a fraction of Warren and Susie’s wealth [at the time].
[Buffett, again:] “Charlie had a lot of children early on. That hindered him a lot in getting independent. Starting early with no encumbrances is a big advantage. Even when I came back from Graham-Newman (a) [in 1956] I had my 174,000 bucks, I felt like I could do what I wanted to do. I could take courses with my father-in-law the psychologist. I could go out there to the university and sit in the library and read all day.”
In fact, Buffett had been encouraging Munger to think seriously about investing as a career ever since they first met. He would say to him, “It’s nice to be a lawyer and to do real estate on the side, but if you want to make some real money, you ought to start something like my partnerships.”
Third, on how and why Munger switched from law to full-time investing.
From The Snowball:
Even as [his law] firm launched, however, Munger was already spending a significant amount of time at the Pacific Coast Stock Exchange. Within three years, when he was forty-one, he abandoned the law altogether to work full-time at investing. But he still consulted to the firm and kept an office there, where he remained an important, almost spiritual presence. Tolles, too, shifted most of his attention to investing. Hills, by far the most ambitious and dedicated to law of the three, ran the firm and kept it going.
From the 2020 Caltech event interview:
Munger: There were things I didn’t like about law practice, but I had an army of children to support, and no family money or anything to start with. So I had to make my way in life for this army of children.
What happened was: my pitifully small earnings as a young man I kept underspending them, and I kept investing fairly boldly and fairly smartly. And at the end of my first 13 years of law practice I had more liquid investments than I made in all those years of law practice pre-tax!
I’d done that [growing the investments] in my spare time with these little tiny sums. So it was natural for me, partly prompted by Warren Buffett’s success, to think I should just start working for myself instead of for other people. [If I had done that] in my spare time, I thought, “Well, what will happen if I do it full time?”
From the 2017 Ross interview:
DeRue: So you practice law, and then you leave law, in the firm that you helped found, and move over to investments?
Munger: Well, that sounds miraculous. In fact, it was rather interesting. I probably got paid about $350,000 in my first 13 years of law practice, total. And I had an army of children, and no capital to start with. When I chose this alternative career, I had over $300,000 in liquid instruments, and that was 10 years of living expenses, so I was not a courageous venturesome or some admirable man. I was a cautious little squirrel, saving up more nuts than I really needed it and not going very deep into my pile of nuts.
It wasn’t that courageous, and I kept one foot in the law firm while I tried my capitalist career, but as soon as the capitalist career succeeded I intended to lift that second foot. Because I recognized that the potential of law practice, as I saw it then — I didn’t anticipate the boom that came to the big [law] firms. I just saw it as being more difficult [than investing].
I wanted more independence than I was going to have as a lawyer. I hated sending other people invoices and needing money from richer people. I thought it was undignified. I wanted my own money, not because I loved ease or social prestige, I wanted the independence.
DeRue: So you founded Wheeler, Munger, & Co, so that was the investment firm.
Munger: Yes, and I had 5 real estate projects. I did both side by side for a few years. And in a few years I had three or four million dollars.
Fourth, on why he closed his investment partnership in 1976 and started to manage only his own money.
From the 2017 Ross interview:
]]>DeRue: And for a number of years you outperform the market 2x, 3x, and so why did you then leave Wheeler, Munger, & Co? And then move to now what you’re doing?
Munger: Well, I had three or four million dollars, which was a lot of money then. I also knew how to handle that three or four million dollars very well by that time. I knew I didn’t need to get fees and override some other investors.
And I found that when you got into things like this 1974-75 crunch, which was the worst since the 1930s, I didn’t suffer. I knew everything was going to work out. But the quoted prices of these things really went down to ridiculous levels. And some of my investors were suffering, because they needed the money. Of course, I have enough of fiduciary gene that pained me greatly.
It was like when they asked my grandfather how he felt after my aunt divorced my uncle. He said, “I feel just the way I did when they lanced my carbuncle.” I had a carbuncle. My fiduciary gene was giving me pain, and I lanced the carbuncle and I just lived on my own money. No fees, no overrides, no salary. Just seemed more manly to do when I knew it would work.
Right at the beginning of it, Charlie explains the factors that he believes explain Buffett’s success as an investor:
]]>Question: What makes Warren’s mind unique?
Munger: Well, there’s a big correlation between success in life and an early start. And Warren had a passion for doing well competitively, in getting money, as a little tiny child. And he just kept it.
Now, you add [to that] a very high IQ and a lot of energy.
And he got a flying start. He was an old Graham-Newman (a) follower, and he made a lot of money buying thinly-traded securities, that were incredibly cheap, statistically. And with small amounts of money — which is what he [was] working with — he could find enough of those to earn pretty high returns on capital year after year after year.
]]>Question: Question in regards to someone early in their career trying to figure out which of several paths to pursue. Two thoughts that seem helpful for this purpose are: (1) figuring out which work you have the possibility to become the best at, and (2) ascertaining which line of work would most help society. Do you think these ideas are the right ones to focus on, and if so, how would you go about answering them?
Munger: Well, in terms of picking what to do, I want to report to all of you, that in my whole life I’ve never succeeded much in something that I wasn’t interested in. So I don’t think you’re going to succeed if what you’re doing all day doesn’t interest you. You’ve got to find something you’re interested in because it’s just too much to expect of human nature that you’re going to be good at something that you really dislike doing. And so that’s one big issue.
And, of course, you have to play in a game where you’ve got some unusual talents. If you’re 5’1”, you don’t want to play basketball against some guy whose 8’3”. It’s just too hard. So you gotta figure out a game where you have an advantage and it has to be something that you’re deeply interested in.
Now, you get into the ethical side of life.
Well, of course, you want to be ethical. On the other hand, you can’t be just dreaming how you think the world should be run and that it’s too dirty for you to get near it.
You can get so consumed by some ideological notion particularly in a left-wing university. It’s like you think you’re handling ethics, [but] what you’re doing is not working. And maybe smoking a little pot to boot. This is not the Munger system.
My hero is Maimonides (sidenote: Wikipedia: “Moses ben Maimon (1138–1204), commonly known as Maimonides, was a medieval Sephardic Jewish philosopher who became one of the most prolific and influential Torah scholars of the Middle Ages.”) . And all that philosophy and all that writing, he did after working 10 or 12 hours a day as a practicing physician all his life. He believed in the engaged life. And so I recommend the engaged life.
[If] you spend all your life thinking about some politician who wants it this way or that way — [or if] you’re sure [that] you know what’s right — you’re on the wrong track. You want to do something every day where you’re coping with the reality. You want to be more like Maimonides and less like Bernie Sanders.
I have been collecting some random bits of advice that I keep repeating to myself, do’s and don’ts of which I have been and will always be guilty.
Some of you have been exposed to one or more of these tidbits. Collecting these items and presenting them in one speech may be one of the less obnoxious among options of equal presumptuousness.
The advice we give others is the advice that we ourselves need. Since it is too late for me to learn these lessons, I will discharge my unfulfilled duty by dishing them out to you.
Rota’s insight is a variation of the famous saying, “x says more about the person saying it than it does about x.” As he notices it, this kind of self-unveilling is more pronounced when one is giving some sort of life advice to others.
But why is that?
I guess it’s because the advice one gives is usually drawn from one’s own life experiences. Generally speaking, if one chose something and have gone through the consequences (good or bad) of that choice, then it must feel viscerally true. To this person, that choice and its outcome become something worth preaching.
An interesting consequence of our boundness to our own experiences is that a keen observer may be able to gather lots of valuable insight about you just by asking for your advice.
]]>On the current state of corruption and institutional failure in Venezuela:
Lowenstein: What has happened to the oil wealth in Venezuela? Production in 2020 fell to roughly a half million barrels a day. Before Chávez, it was more than three million. Now, as you have written, gasoline shortages are a fact of life.
Naím: Petróleos de Venezuela [the state oil company] is a cage of thievery. It doesn’t exist [as it did]. They have run it into the ground. It doesn’t have the money, the people, the technical talent, the engineers. The company has lost the capacity to tap its own resources. […]
Venezuela will have a very hard time if it continues to be run by a cartel of criminals.
On the relationship between underdeveloped (commodity-based) economies and populism:
Lowenstein: Venezuela isn’t alone in turning to leftwing populism. Peru, Ecuador, Bolivia, Argentina — even Mexico — are moving or have moved leftward. Why this leftwing surge at the ballot box when established models such as Cuba haven’t succeeded?
Naím: The main defining variable is commodity prices. […] In countries where commodities are 50% or more of exports, give me the price and I’ll tell you what the political mood is. When prices are low the economic situation becomes dire and that opens the way to unemployment, inflation, budget cuts and cuts in social programs. You get a very foul mood in society.
Lowenstein: Why didn’t the previous parties succeed at reinvesting the oil wealth?
Naím: That is a very desirable goal. All governments have economic diversity and export diversity as a goal. Very few succeed. In that sense Venezuela is normal. Look at Chile. A great success — but it’s still [about] copper. In Russia, it’s still oil.
You can point to Norway, or the U.S. but these exceptions are countries that had a state, and state institutions, deeply grounded before the discovery of oil. Petrostates have a difficult relationship with democracy.
On the interplay between Chávez and Cuba:
Lowenstein: The 19th century essayist Thomas Lander called Venezuela “a nation of accomplices.” Was he right — was there a consistent flaw in the political culture that accommodated rule by caudillos?
Naím: You can say that about any country.
Lowenstein: Who were the accomplices to Chávez? Was it the Cubans, or was it previous generation of democratic leaders, whose mismanagement led to Chávez’s election?
Naím: The Cubans were not just accomplices. They were facilitators.
Lowenstein: But don’t the old establishment liberal parties — Democratic Action and the Social Christians, deserve some blame?
Naím: Of course. They mismanaged the power they had. They didn’t realize that the oil wealth had to be better invested and distributed. Yes, the political parties were a disgrace. The intelligentsia, the businesspeople, the professional middle class were also negligent or short-sighted. But the narrative that corruption and poverty was the reason for Chávez? If you look at United Nations statistics, Venezuela was corrupt but far less corrupt than Brazil, Mexico or Peru. We had inequality but Brazil was the world champion in inequality. We had poverty, but income per capita was one of the highest in Latin America.
Lowenstein: Are you saying that Chávez was a puppet? In the book, even the Cuban agent struggles to figure him out.
Naím: Chávez wasn’t a puppet. He surely invited the takeover, the infiltration of Cubans. Cubans have been running the intelligence services; they have had a huge role. [But] you cannot call Chávez completely a puppet. Fidel Castro and Chávez had a very strong personal bond.
You cannot say that of Maduro. He does not have the charisma, the knowledge, the smarts. He was trained in Havana, he there studied there. He was and is a Cuban operative.
Finally, he also makes interesting remarks about how legitimacy can be forged:
]]>Lowenstein: You write in the book of a ceremony to recast Simón Bolívar, known to Venezuelans as “the Liberator.” Bolívar, of course, was a descendant of Spanish aristocracy. In the book, Chávez, with Cuban assistance, reinvents Bolivar as a mestizo — to symbolically bolster Chávez’s claim to power.
Naím: I describe the exhumation of Bolívar. That happened on camera [in 2010] (a). There was a whole spectacle, quite surreal. You have Chávez and military escorts open a casket and take samples. After the cameras left something else happened. This I know from different sources. After the public event there was a private event, with Cubans, where it was decided that Bolivar had been assassinated by oligarchs. It shows a different picture of Bolivar — that he was [like Chávez] more mestizo than white. The genetic evidence is completely fake. The Cubans more or less anointed Chávez. It gave him the power of legitimacy.
]]>The new cameras are for the new generation of YouTube, Instagram and TikTok influencers. Ordinary people with extraordinary tools can do extraordinary work.
The latest iPhone 13 is, in my opinion, the most important iPhone ever. It creates the perception of what a phone should be and it sets up the trajectory for demand that did not yet exist. It’s facile to think that the utility of an OK, older phone is good enough. That assumes that we are satisfied with OK messaging and OK apps. With OK photos and OK video. With no wide angles, no nightmode and no macro photos. What the iPhone has shown however is that the demand for performance can be nudged up.
We did not ask for rack focus, post-production focus (!), night mode, macro photography and portrait bokeh. But once we have these features we begin, ever so slowly, to use them and then we start demanding them. Conversely it seems that what people mostly ask for — that is what the critics ask for — are extrapolations of existing features. The “faster horse” dilemma.
What makes the iPhone and perhaps Apple special is that it seems to deliver things that nobody asks for but then everybody wants while eschewing overshooting a performance dimension that a few demand but most won’t use.
The tragedy of overservice and disruption is that if you don’t shift the definition of performance eventually you run out of demand at the top of the performance curve. That opens you up to “good enough” competition from below. Instead you need to re-define the notion of performance: compete on a new basis, reset expectations. That the iPhone can find new dimensions of performance and hence demand is effectively a solution to the innovator’s dilemma.
Question: You’ve said that great companies are those that have an economic moat, and I understand that phrase to mean a sustainable competitive advantage. Do businesses begin their lives with sustainable competitive advantages, or must that be developed over a very long time? And then, what are the fundamental bases upon which you’ve seen companies successfully develop sustainable competitive advantages? Of those, which do you think is the most enduring and which is the least?
Buffett: Well, sometimes they can develop it very quickly. I would say that Microsoft, in terms of the operating system, that was a relatively quick development. But that was an industry that was exploding, and things were changing very fast.
On the other hand, if you go back to See’s Candies, which started in 1921, there was no way you could build a sustainable competitive advantage, at least that would be recognizable, in times measured shorter than decades. I mean, you opened up one shop at a time, and nobody’d heard of you originally, and then a few people did. And boxed chocolates were something that people may have bought once or twice a year for a holiday occasion or whatever. So, you weren’t going to embed yourself in the minds of Californians in one or two or five years just because you were turning out outstanding box of chocolates.
So it depends on the way the industry itself is developing.
Walmart has done an incredible job in quite a short period of time. But even they [took some time] — they took it in the small towns, and they progressed along, and refined their techniques as they went.
But I would say that there could be things in new industries.
I would say with NetJets, we have a sustainable competitive advantage. And that’s an industry that was only originated in 1986 when Rich Santulli got the idea, and it was in its total infancy for a good many years after that. But what he has built, and is building and fortifying, is that sustainable competitive advantage. But it depends very much on the industry you’re in.
And I mean, Coca-Cola. 1886, Jacobs Pharmacy, Atlanta, Georgia, you know. John Pemberton came up with a product. And did he have a sustainable competitive advantage that day? If he did, he blew it because he sold the place for 2,000 bucks to Asa Candler.
It took decades, thousands of competitors over that time. They were painting one barn at a time, and designing one Saturday Evening Post ad at a time, and all of that, and pebbles — you know. Around the world in World War II, General Eisenhower went to Mr. Woodruff and he said, “I want a Coke within the arm’s length of every American serviceman.” He said, “I want something to remind them of home.” And so he built a lot of bottling plants for Coke around the world (a). And that was a huge impetus.
But that was, what? 60 years or so after the product was invented.
So it takes a long time in certain kinds of products, but I could see certain areas of the world where a huge competitive advantage is built in a very short period of time.
I would say that probably, in terms of animated feature-length films, for example, Walt Disney did that. And after Snow White and a few more, it took him a while until he could cash in on it, but it became Disney and nobody else in that field for quite a while, and fairly quickly.
Charlie?
Munger: Yeah, there are a lot of different models that create a sustainable competitive advantage.
And there are also some models where you can lose it very fast. Just ask Arthur Andersen. That was a very good name in America not very long ago.
And I think it would be harder to lose the good name of Wrigley’s gum than the good name of Arthur Andersen.
I think there’s some perfectly remarkable competitive advantages that people have gotten over time. And the great trouble with the investment process is that they’re so damned obvious that the stocks sell at very high prices.
Buffett: Snickers has been the number one candy bar for probably 30 or 40 years now. How do you really knock it off?
I mean, we make candy, we would love to displace Snickers, but it’s hard to think of ways to knock them from the number one spot.
My guess is that they’ll be number one in 10 years from now in candy bars, and the list doesn’t change much in that field because —
If you think about the nature of how you make that choice as to what candy bar [you are going to buy and eat] —
If you were chewing Spearmint chewing gum five years ago, and you buy a pack of some chewing gum today, it’s likely to be Spearmint. I mean, there’s just things that you experiment a lot with, and there’re things that you don’t fool around with once you’re happy. You can understand that if you observe your own habits and people’s habits around you.
[And then] there’s other [aspect to it] — usually if something can gain competitive advantage very quickly, you have to worry about them losing it quickly, too. I mean, when an industry is in flux, there are a lot of people that think they’re the survivors, or the ones that are going to prosper, where it turns out otherwise.
In summary:
If things are changing very fast in an industry, it could be possible to develop an economic moat relatively quickly. Examples: Microsoft (with Windows), Walt Disney (in animated feature-length films), Walmart, NetJets
But, beware: what comes quickly, may go just as quickly. And even if the moat was built over decades, it could be destroyed very quickly. Example: Arthur Andersen
If a product needs to spread out and embed itself into the mind of millions of consumers, it may take several decades. Both the frequency of consumption and the product “stickiness” impact the “spreading out” outcome. Examples: See’s Candies, Coca-Cola, Snickers
Question: I’m still quite young, I don’t have a house yet and I’m thinking about buying a house someday soon. And in order to do that I’m going to have to put a down payment, which means I might have to sell my [BRK] shares. And I was wondering if you can provide some insight on when is the best time to buy a house, and how much down payment you should be putting down, in relation to interest rates and also in relation to available cash and the stock market.
Buffett: Well, Charlie’s going to give you an answer to that in a second. I’ll just relay one story, which was when I got married we did have about $10,000 starting off, and I told Susie — “Now, you know, there’s two choices, it’s up to you. We can either buy a house, which will use up all my capital and clean me out, and it’ll be like a carpenter who’s had his tools taken away for him. Or you can let me work on this and someday, who knows, maybe I’ll even buy a little bit larger house than would otherwise be the case.”
So she was very understanding on that point. And we waited until 1956. We got married in 1952.
And I decided to buy a house when the down payment was about 10% or so of my net worth, because I really felt I wanted to use the capital for other purposes.
But that was a way different environment in terms of what was available to buy. In effect, if you have the house you want to buy, you know, I definitely believe in just going out and probably getting the job done. But in effect, you’re probably making something in the area of a 7 or 8% [annual return] investment, implicitly, when you do it. So you know, you’ll have to figure out your own equation from that.
Charlie probably has better advice on that. He’s a big homeowner in both senses of the word.
]]>Munger: I think the time to buy a house is when you need one.
Buffett: And when do you need one?
Munger: Well, I have very old-fashioned ideas on that, too. The single people, I don’t care if they ever get a house.
Buffett: When do you need one if you’re married, Charlie? You need one when your wife wants one?!
Munger: Yeah, yes. I think you’ve got that exactly right.
Question: Hello, Mr. Buffett and Mr. Munger. I am 12 years old. My question is not about money. It’s about friendship. How do you remain friends and business partners for so long? And what advice do you have for young people like me in selecting true friends and future business partners? Thank you.
Munger: Well, that’s a wonderful question you’ve asked, because Warren and I both know some very successful businessmen who have not one true friend on earth. And rightly so.
Buffett: That’s true.
Munger: And that is no way to live a life. And if by asking that question, you’re asking: how do I get the right friends? You are really onto the right question.
And when you get with the right friends, if you’ve worked hard at becoming the right sort of fellow, I think you’ll recognize what you have and then all you have to do is hang on.
Buffett: The real question is: what do you like in other people? I mean, what do you want from a friend?
And if you’ll think about it, there are certain qualities that you admire in other people, that you find likeable, and that cause you to want to be around certain people.
And then look at those qualities and say to yourself, “Which of these is it physically or mentally impossible for me to have?” And the answer will be none.
I mean, it’s only reasonable that if certain things that attract you to other people that, if you possess those, they will attract other people to you.
And secondarily, if you find certain things repulsive in other people — whether they brag or they’re dishonest or whatever it may be — if that turns you off, it’s going to turn other people off if you possess those qualities.
And those are choices. You know, very few of those things are in your DNA. They are choices.
And they are also habits. I mean, if you have habits that attract people early on, you’ll have them later on. And if you have habits that repel people, you’re not going to cure it when you’re 60 or 70.
Buffett: It’s not a complicated equation. And, as I remember, Benjamin Franklin did something like that one time. Didn’t he list the qualities he admired, and then just set out to acquire them?
Munger: Absolutely. He went at it the way you’ve gone after acquiring money.
Buffett: They’re not mutually exclusive.
Munger: No [they are not].
Their advice in a nutshell:
Figure out the qualities that you like in other people
They are the kind of friends you want. You may do like Ben Franklin did and actually list out their qualities
Be the person that demonstrates the very same qualities that you admire in other people
By having those qualities, you will likely attract like-minded and like-behaved people to you — they are the friends you are looking for. Moreover, just like Munger once said, “The safest way to try to get what you want is to try to deserve what you want. It’s the golden rule”
Once you have the friends you like, simply hang on to them
Question: Hello, Mr. Buffett and Mr. Munger. I am 12 years old. My question is not about money. It’s about friendship. How do you remain friends and business partners for so long? And what advice do you have for young people like me in selecting true friends and future business partners? Thank you.
Buffett: Well, when Charlie and I met in 1959 we were introduced by the Davis family, and they predicted that within 30 minutes we would either not be able to stand each other or we would get along terrifically.
And that was a fairly insightful analysis, actually, by the Davises, because you had two personalities that both had some tendencies toward dominance in certain situations (sidenote: Buffett probably meant that both Munger and he tend to be intellectually dominant in conversations.) .
But we hit it off. We have disagreed, but we have never had an argument that I can remember at all in 43 years. And yet we both have strong opinions and they aren’t the same strong opinions at times.
But the truth is we’ve had an enormous amount of fun together, we continue to have an enormous amount of fun, and nothing will change that, basically. It may have worked better because he’s in California and I’m in Omaha, I don’t know.
In an interview with CNBC released on June 29th 2021 (a), Warren Buffett and Charlie Munger touched on the topic of their own friendship again. They shared more details on how they first met and why they instantly hit it off:
Buffett: There was a doctor couple, very prominent in Omaha, and his name was Eddie Davis, her name was Dorothy Davis. And it was Mrs. Davis that called me, actually. She did everything. She said, “We’ve heard that you manage money, and we’d be kind of interested in listening to your story about how you do it, and what we might do with you.”
So I went over and I talked to them. And I was all full of myself. You know, I couldn’t talk fast enough about stocks in those days. And Dorothy Davis, [who’s] very smart, listened to every word. The doctor was kind of over in the corner, submitting a yoyo or something, and really not paying much attention. And I got all through and the wife looked over at the doctor, [who] said, “I’m gonna give him $100,000.” And I was managing about $500,000 at the time, so it was a big deal.
In a very nice way, I said, “Dr. Davis, you really haven’t been paying much attention to what I’ve been saying and everything. I’d kinda like to know why you’re giving me this $100,000.” And Dr. Davis looked at me and he said, “Well, you remind me of Charlie Munger.” And I said, “Well, I don’t know who Charlie Munger is, but I like him.” And he gave me $100,000.
And then they told me about Charlie. [As a] young kid, how he would be over there asking them questions on medicine, and giving them lectures. I mean, they clearly loved him. And it sorta became their mission that sometime they wanted to get me and Charlie together. So, in 1959, Charlie’s dad died and he came back to Omaha. His mother lived there and the Davises really got us together.
So they arranged the dinner. And about five minutes into it, Charlie was sort of rolling on the floor laughing at his own jokes, which is exactly the same thing I did. So I thought, “This, I’m not gonna find another guy like this.” And we just hit it off.
Buffett: Both of our wives thought, “My god, another one.”
In Damn Right!: Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger, Janet Lowe wrote:
Two years after Buffett first heard Charlie’s name, the two men met. “In 1959, when Charlie’s dad died, he came back to help settle up. The Davises arranged a dinner. We hit it off immediately,” said Buffett.
The Davises that Warren now referred to were not the doctor [Edwin Davis] and his wife [Dorothy Davis], but rather the Davis children, who had been Charlie’s childhood playmates. Both Davis boys, Eddie and Neil, became doctors and by then the daughter, Willa Davis, was married to Omaha businessman Lee Seemann. It was Neil who arranged dinner at the old Omaha Club. The party included Willa and Lee Seemann, Joan and Neil Davis, Charlie and Warren. “It was electric in a really nice way,” recalled Willa.
Munger had heard other people mention Warren as well, but he did not have particularly high expectations about meeting him. “I knew everyone in the Buffett family except Warren,” said Charlie. Munger noticed a few things about the bespectacled young man right away. “He had a crew cut. Warren was working out of a sunporch at his house, and his dietary habits were toward Pepsi, salted nuts, and no vegetables.” Charlie, who considers himself fairly tolerant about such matters said, “Even I get surprised watching Warren eat breakfast.”
His minimal expectations of the meeting were unjustified. Munger, who is reserved in his judgments, was floored. “I would have to say that I recognized almost instantly what a remarkable person Warren is.”
Charlie began asking questions immediately about what Buffett did for a living and how he did it and was fascinated by what he heard. The following evening another mutual friend, Dick Holland, invited both to dinner. Warren, who was then 29, and Charlie, 35 years old, again fell into deep conversation. Charlie was so wrapped up in what he was saying that when he raised his glass to sip his drink, he held his other hand up to stop anyone else from interrupting the conversation.
The Kunhardt Film Foundation has released on YouTube the full interview that they did with Charlie Munger for the documentary Becoming Warren Buffett. Right at the beginning of it, Munger comments on their first encounter:
]]>Munger: When I first met Warren, I recognized immediately that he was a very intelligent person.
And, of course, he was interested in the subject that I was also interested in, which was the process of being a successful investor.
And we have a similar sense of humor, we had a high old time probably making ourselves obnoxious to the other people in the room.
We both came from Omaha. We both worked in his grandfather’s grocery store. So, we had a lot of common experience.