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Seeking Wisdom by Peter Bevelin

Alone Together

RATING: 9/10…READ: July 30, 2011

A Field-Guide To Life. Seeking Wisdom details the common misjudgments we make and how we can improve our thinking and mental systems with much insight from Warren Buffett and Charles Munger. A great book.

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The reproductive success of women doesn’t depend on how many man she has sex with but her ability to get access to resources (like food, shelter, and protection) for herself and her children.

1989, psychology professor David Buss published study of thousands of men and women from 37 cultures around the world showing rankings of qualities that are most important in choosing someone to date or marry:

-Women placed more emphasis on financial prospects

-Also ambitious and industrious men

-Men on physical attractiveness

Studies also show women less inclined to take risks. They are more influenced by the chance of loss. They are less competitive and status conscious.

Much of our psychology is the result of cultural influences:

-Life experiences / present environment / randomness


1. Mere Association: We automatically feel pleasure or pain when we connect a stimulus –a thing, situation or individual –with an experience we’ve had in the past or with values or preferences we are born with.

“Pavlov Dog Experiment”

Association OR Branding with a company or person (projecting an image bias)

Solution: Create a negative emotion to end certain behavior

2. Reward and Punishment: We do what is rewarding and avoid what we are punished for; We learn right from wrong from the consequences of our actions.

We like to have pleasurable experiences broken into segments but painful ones combined

It is better to encourage what is right than criticize what is wrong.

Don’t over learn from your own or others bad or good experiences. The same action under other conditions may cause different consequences.

Have systems that make it hard for people to get away with undesirable behavior.

Reward people after and not before their performance.

3. Self Interest and Incentives: People do what they perceive is in their best interest and are biased by incentives.

Consultants are dependant on repeat business therefore less incentive to get to the truth.

Buffett: We never look at projections, but we care very much about, and look very deeply at, track records.

Lead others by what amuses the, so that they may better discover the bent of their minds.

4. Self Serving Tendencies and Optimism: we see ourselves as unique and special and we have optimistic views of ourselves and our family. We overestimate the degree of control we have over events and underestimate chance.

Optimism is good but when it comes to important decisions, realism is better.

When we fail we blame external circumstances, but when we succeed we believe it was us.

Recognize your limits. How well do you know what you know? “It’s the strong swimmers who drown.”

Consider people’s actual accomplishments and past behavior over a long period of time versus first impressions.

By developing only a handful of strengths, we have an impoverished toolbox—only hammers. We need a full toolkit.

5. Self Deception and Denial: we deny and distort reality to feel more comfortable, especially when reality threatens our self interest.

6. Consistency: the more we have invested in our behavior the harder it is to change.

The opinion which we entertain of our own character depends entirely on our judgments concerning our past conduct.

Continuing to invest in something bad because you put a lot of time into it.

There is nothing wrong with changing a plan when the situation has changed.

When we can get people committed in advance, they tend to live up to their commitment.

When you are asked to perform a future action but are uncertain, ask yourself, would I do this if I had to do it tomorrow.

When you find yourself in a hole—stop digging.

7. Deprival Syndrome: We dislike losing the things we have more than we appreciate gaining the things we don’t have.

Its usually a mistake to try to make it back the way you lost it.

Ask why do I want this? For emotional or rational reasons?

If we want people to take a risk, we should make them feel behind(losing)

8. Status Quo and Do Nothing Syndrome: we prefer to keep things the way they are. We resist change and prefer effort minimization.

We want to feel good about the choices we make so we can justify our actions for others and ourselves.

We are more bothered by hard that comes from action than harm that comes from inaction.

Perhaps the most valuable result of all education is the ability to make yourself do the thing you have to do when it ought to be done whether you like it or not.

9. Impatience: we give more weight to the present than to the future. We seek pleasure today at a cost of what may be better found in the future.

We prefer an immediate reward to a delayed but maybe larger reward.

10. Envy and Jealousy: We evaluate our own situation by comparing what we have with what others have

The best way to avoid envy is to deserve the success you get.

11. Contrast Comparison: We judge stimuli by differences and changes and not absolute magnitudes. For example, temperature, loudness, brightness, etc. How we value things depend on what we compare them with.

The same thing may appear attractive when compared to less attractive things and unattractive when compared to more attractive things.

Evaluate people and objects by themselves and not by their contrast.

12. Anchoring: We are over-influenced by certain information acting as a reference “anchor” for future judgments.

We don’t price a thing according to its value but its relative price.

If we bought a stock for $50 with a present price of $40, we judge how good our decision was in reference to our purchase price.

Consider choices from a zero base level and remember what you want to achieve.

13. Vividness and Recency: The attention which we lend to an experience is proportional to its vivid or interesting character; and it is a notorious fact that what interests us most vividly at the time is, other things equal, what we remember best.

The more dramatic, salient, personal, entertaining, or emotional some information, event, or experience is, the more influence we are.

“A single death is a tragedy; a million deaths is a statistic.” [Joesph Stalin]

The media has its weakness, biases, and vulnerability to manipulation and deception. Consider what is relevant and the normal outcome in similar situations

Accurate information is better than dramatic information.

Trends may be wrong. Ask: Is it a permanent or temporary effect?

14. Omission and Abstract Blindness: We react more strongly to the concrete and specific than to the abstract. We tend to focus only on the present information rather than what information may potentially be missing.

Example, 1 lottery winner—we didn’t read about the 14 million losers

When we choose, we compare positive attributes but when we reject, we compare negative attributes

Compare missing information. Know what you want to achieve.

15. Reciprocation: We tend to repay in kind what others have done for us—good or bad.

Example: free trials / free samples

We make a concession to people who have first made a concession to us. Example: John is negotiating to buy a small business. The seller asks for a higher price than John is prepared to pay, so he declines. The seller than makes a concession and reduces the price.

The ultimate concession—infomercials slashing their prices’

“What you don’t want yourself, don’t do to others. Reward hostility with justice, and good deeds with good deeds.” [Confucius]

Example is better than law.

16. Liking and Social Acceptance: The deepest principle in human nature is the craving to be appreciated.

Studies show that we believe physically attractive people have a more desirable personality than average-looking or unattractive people.

“Talk to a man about himself and he will listen for hours.”

People believe we have the same personality as those we associate with.

If we perceive others dislike us, we tend to dislike them.

Asking a favor of someone is likely to increase that person’s liking for us.

“How much time he gains who does not look to see what his neighbor says or does or thinks. [Marcus Aurelius]

17. Social Proof: When people are free to do as the please, they usually imitate each other. We want what others want. We avoid what others avoid.

We trust testimonials from people that we see as similar to us.

Think “Ponzi Scheme”

We don’t want to be the ones that stand out in a crowd and risk embarrassment for acting in a non-emergency situation.

Warren Buffet: “We derive no comfort because important people, voal people, or great numbers of people agree with us. Nor do we derive comfort if they don’t.”

Children learn from their friends what is acceptable or not so make sure the right “peer group” surrounds them.

Make people responsible for their actions. Remember though, when all are accountable, no one is accountable

18. Authority: We tend to obey authority, especially when we are uncertain, supervised, or when people around us are doing the same. We are most easily influenced by credible authorities, those we see as both knowledgeable and trustworthy.

Example: we are more likely to trust celebrities for expertise

Evaluate the truth of a statement on the basis of its underlying facts, without regard to the authority’s personal qualities or social status.

Anyone can call themselves an expert. Separate between real and false experts.

19. Sensemaking: We have a need to understand and make sense of events. We refuse to accept the unknown.

Bias: glorifying past events or romancing certain figures in history

Charles Munger: “Around here I would say that if our predictions have been a little better than other people’s, it’s because we’ve tried to make fewer of them.”

Consider how other plausible outcomes might have happened. Don’t underestimate chance.

In hindsight, everything seems obvious. If we look forward, there are many possible outcomes.

20. Reason-Respecting: When people ask a favor we are more likely to comply if they give us a reason—even if we don’t understand the reason or it is wrong.

Often it isn’t the reason itself that is important, but the way the reason is phrased.

Ask why, ask why, and ask why again. The third why often gets to the real issue.

You cannot reason a person out of a position he did not reason himself into the first place.

Sometimes it is better to appeal to emotions than to reason since people are more moved by what they feel than by what they understand.

21. Believe First and Doubt Later: We start assuming that the product is good for us and look for evidence that confirms it. We find it easy to believe, but difficult to doubt.

Studies show that if students are told they are above average on a subject, they will do better.

Studies show that people—even professionals—are slightly better than chance at distinguishing truths from lies.

22. Memory Limitations: Our memory is selective. We remember certain things and distort or forget others.

We learn information better if it is tied to a vivid story.

We learn better in a positive mood.

Studies show that it is easy to get a witness to believe they saw something when they didn’t.

Keep records of important events.

23. Do-Something Syndrome: “Man finds nothing so intolerable as to be in a state of complete rest, without passions, without occupation, without diversion, without effort.”

We sometimes act because we can’t sit still. We act without a sensible reason. It seems easier to explain doing something than actively doing nothing.

“It is not enough to be busy: so are the ants. The question is: What are we busy about?” [Henry David Thoreau]

Don’t confuse activity with results. There is no reason to do a good job with something you shouldn’t do in the first place.

“There’s no use running if you’re on the wrong road” [Warren Buffett]

24. Say-Something Syndrome: “Wise men talk because they have something to say; fools, because they have to say something.” [Plato]

If you have nothing to say; say nothing.

25. Emotions: When we make a decision our feelings take over. We hear bad news first.

Sadness makes us willing to accept less money to sell something that we would pay for the same thing.

We automatically judge how good or bad stimulus is based on how we feel about it.

“John is buying a new sports car. He is all excited. But how will he feel one year from now?

When we have just gone through an emotional experience, we should hold off on important decisions.

26. Stress: Too much information, lack of predictability or control, too many choices, lack of sleep, social isolation, job status, crisis, catastrophes, fear, etc. cause stress.

Stress affects concentration and memory. Long-term stress exposure upset the brain’s chemical balance.  Stress may cause high blood pressure, heart disease, diabetes, back and stomach problems, headache, and depression.

Pavlov: behavior could be established or erased by exposing an animal to stress.

Stress is neither good nor bad in itself. It depends on the situation and our interpretation.

“Happiness and freedom begin with a clear understanding of one principle: Some things are within our control, and some things are not. It is only after you have faced up to this fundamental rule and learned to distinguish between what you can and can’t control that inner tranquility and outer effectiveness become possible.” [Epictetus]

27. Pain, Chemicals and Diseases: We become confused when we are in pain, under the influence of chemicals or have a physical or mental illness.

28. Multiple Tendencies: When you get two or three of these psychological principles operating together, then you really get irrationality on a tremendous scale.

It’s very, very important to create human systems that are hard to cheat. Otherwise you’re ruining your civilization because these big incentives will create incentives—caused biases and people will rationalize that bad behavior is OK.

In terms of director’s actually rebelling against the CEO, it tends to happen in one or two case: One is when they reduce the director’s perks—which most CEOs are wise enough not to do. The other is when the situation gets so bad that it threatens to disgrace the directors.

“No man is fit to hold public office who isn’t perfectly willing to leave it at any time.” [Elihu Root]

Most social acts have to be understood in their setting and lose meaning if isolated. No error in thinking about social facts is more serious than the failure to see their place and function.

We often see what we want or expect to see.

Irrational behavior in one context may cause good behavior in another.

Part of you must learn how to handle mistakes and new facts that change the odds. Life, in part, is like a poker game, wherein you have to learn to quit sometimes when holding a much-loved hand.

Two track analysis: (1) what are the factors that really govern the interests involved, rationally considered. (2) What are the subconscious influences where the brain at a subconscious level is automatically doing these things?

Take all the models from psychology and use them as a checklist.

“I think that even people who aren’t [expecting to] go near physics and engineering [in their planned profession] learn a thinking system in physics that is not learned so well anywhere else.

PART III: The Physics and Mathematics of Misjudgments

1. Systems Thinking: By solving one problem, we generate one and sometimes create an even worse one.

-Isn’t it more important to find out of the consequences are good rather than if the reasons are good? Ask: What are we trying to improve? What can be reasonably be expected to happen? Are the net effects positive or negative?

-Ask: What key factors influence the outcome of the system and how do these factors interact? What other thing may change as a consequence of some action? Given these conditions, what likely consequences (wanted and unwanted) will the proposed action have on the system, considering all the relevant factors that influence or are part of the system? Will the net result be what we want?

-A Lease winner tends to be the bidder who overestimates reserve potential

-Research shows that the more bidders there are competing for a limited object, each having the same information, and the more uncertain its value is, the more likely we are to overpay.

-Mark Twain said: “The art of prophecy is very difficult, especially with respect to the future.

-Predictions about the future are often just projections of past curves and present trends.

-Economics isn’t like physics. There are no reliable or precise formulas where we easily can fill in the values of various economic factors, and then have the work done.

-To convert a model into a quantitative formula is to destroy its usefulness as an instrument of thought.

-Albert Einstein wrote: “The right to search for truth…implies also a duty; one must not conceal any part of what one has recognized to be true.

2. Scale and Limits:

-Changes in size or time influences form, function and behavior. If something of a certain size is made bigger or smaller, it may not work the same way. Some things get better and others get worse. For example, changes in the size of an organism affect is strength, surface area, complexity, metabolism, longevity, and speed of movement.

-If we double the length of a similarly shaped object, surface area increased by 4 times and volume 8 times. Surface area increases at the square length and volume at the cube of length (to get areas we multiply two lengths together, and to get volumes we multiply three lengths)

-Volume always grows faster than surface area as we increase size, independent of an object’s shape.

-Small, slow changes operating over long periods can have great consequences.

-A small change may have no effect on a system until a critical threshold is reached. For example, a drug may be ineffective up until a certain threshold and then become effective, or it may become more and more effective, but then become harmful.

-At some point the disadvantages of business size may eat into the advantages. For example, increased costs and investments, per-unit cost increases, systems become too complicated, bureaucratic and inefficient, etc.

-As a colony grows in size, the propensity of the individual to claim a share of production “according to his needs” increases, while his eagerness to work “according to his ability” diminishes.

-It is estimated that about 5% of movies earn about 80 to 90% of profits in the movie industry [Pareto’s Principle]

-Warren Buffet says: “It is not necessary to do extraordinary things to get extraordinary results.” A few products or a few customers produce most of the profit or a few in the sales staff produce most of the sales.

3. Causes: In order to solve problems or achieve goals, we must first understand what causes the result we want to accomplish. Start with examining what factors make up the system and how they connect. Then, define the key factors that determine outcome.

-When bad things happen, we try to find causal explanations or something to blame. The more unexpected or negative we find an event, the more likely we are to look for explanations. We underestimate the influence of randomness.

-Take away the cause, and the effect ceases [Miguel De Cervantes, Don Quixote]

-When explaining behavior, think in terms of multiple causes.

-We tend to assume that when two things happen together, that one causes the other. That a change in one variable is strongly correlated or followed by a change in another doesn’t automatically mean that one causes the other. Some third factor may cause them both.

-Assume we detect a high correlation between money and happiness. But that doesn’t tell us if money causes happiness, if happiness causes money, of if some third factor causes them both.

-As Bertrand Russell says: “Obviousness is always the enemy of correctness.”

-When someone remarked to the French writer Voltaire, “Life is hard,” he retorted, “Compared to what?” We tend to ignore alternatives, and therefore we fail to make appropriate comparisons. Often we only consider information or evidence that is presented or available and don’t consider that information may be missing.

-Business performance is relative, not absolute. The performance of a business is always influenced by what its competitors do. Even if a company gets better in many areas, market share and profits may decline if the competition does things even better. And even if a company gets worse in many areas, market share and profits may increase if competition does things even worse.

-On one study people were asked to judge the effectiveness of a treatment based on the following data from an experiment:

Improvement                        No Improvement

Treatment                                    200 people                        75 people

No Treatment                                    50                                    15

Most subjects believed the treatment was effective. But it is rather ineffective. Why? We need to compare the outcome for the no treatment group with the outcome for the treatment group. 50 of 65 people (50+15) of about 77% improved without any treatment versus 200 of 275 (200+75) people or about 73% who improved with the treatment.

4. Numbers and Their Meaning: Something is only cheap or expensive in relation to something else. If an investor refers to a stock as “cheap,” what is it cheap in relation to?

-100,000 shares of stock priced at $1 have the same market valuation as 1,000 shares priced at $100. The relevant question is: What is the company worth in relation to its price?

-“TransCorp mad ea “huge” $1 billion in profits: Words like “big” or “small” have no meaning in themselves. A number has only size in relation to another number. $1 billion says nothing about economic performance unless we compare it with how much capital was needed to generate it. What if TransCorp needed $100 billion in equity and debt to run the business? That’s only a 1% return.

-Professor John Ioannidis show that the smaller the studies; the smaller the effect sizes; the hotter the field; the greater the interest; the larger the databases; and the greater the flexibility in analyses, the higher the chance that a research claim is false. True replication is the cornerstone of science, and assuming that biases are weeded out, the more researchers reproduce a finding, the better chance it has of being true.

-Even a small number of steady growth leads eventually to doubling and redoubling. For example, a country whose population grows by 2% a year, double in size in 35 years and redoubles in 70 years. A simple formula for doubling time is found by dividing 70 by the percent growth per year.

-1 penny compounded every day will lead to $1.3 million after 27 days.

-How much should we pay for the right of receiving $1000 a year from now? Or, how much do we need to invest today in order to have $1000 a year from now? It’s the same question. The answer depends on the interest rate. If the interest rate is 6%, then the answer is $943. If we invest $943 today at 6%, we have $1,000 a year from now. $943 is the present value of $1,000 a year from now. We have discounted or reduced $1,000 to its value today. The further out in time we receive the $1,000 or the higher the interest rate it, the less the percent value is.

5. Probabilities and Numbers of Possible Outcomes: We can either estimate the probability based on its relative frequency (proportion of times the event happened in similar situations in the past) or we can make an educated guess using past experience or whatever important and relevant information and evidence that is available.

A doctor says, “This is the first time I’ve seen this disease. I estimate there is a 50-50 chance that the patient will survive.”

—-This statement has only two possible outcomes. Either the patient dies or not. Does it really make any send to say “a 50-50 chance” if there are no past data or other evidence to base the probability on? Does it really tell us something? If there are no historical, comparable or representative data or other evidence to base an estimate on, the probability figure only measures the doctor’s belief in the outcome of the event.

-The more possible outcomes an event has (in number or time), the less likely a specific outcome is (for example only one outcome satisfies the wanted event: “roll a die once and observe a six”)

-We can reduce risk by increasing the number of wanted possible outcomes, reducing the number of unwanted possible outcomes, reducing the magnitude of consequences or avoiding certain situations.

-Gambler’s fallacy: this happens when we believe that when something has continued for a certain period of time, it goes back to its long-term average.

-In one experiment a social psychologist found that people were more reluctant to give up a lottery ticket they had chosen themselves, than one selected at random for them.

-You only have to get rich once.

-Whenever a really bright person who has a lot of money goes broke, it’s because of leverage…It’s almost impossible to go broke without borrowed money being brought in the equation.

6. Scenarios: The more independent steps that are involved in achieving a scenario, the more opportunities for failure and the less likely it is that the scenario will happen.

-Studies show that of every 10,000 to 30,000 drug candidates molecule entering discovery, only 250 make it to pre clinical evaluation; only 5 to 10 to clinical; and only one gets approved.

-A study of anesthesiologists found that human error was involved in 82% of preventable accidents. The remainder was due to equipment failure. Even if the probability that some technology works is 99.9%, human fallibility makes the system less reliable than technological ability alone.

-Most studies have shown that medical errors account for between 44,000 to 98,000 deaths in the U.S. every year and that medication errors are the leading eighth cause of death.

-The single most common cause of cognitive-based errors was the tendency to stop considering other possible explanations after reaching a diagnosis.

-Ancient Rome used incentives in the design and construction of safe bridges. The designer of the bridge had to stand under it after completion while chariots drove over the top. This put both the designer’s life and those who used the bridge at risk. This increased the probability that designers made sure the bridge held up.

7. Coincidences and Miracles: In the U.S. a country with about 280 million people, one in a million chance events happen 280 times a day.

-We want to find reasons for all kinds of events—random or not. We search for patterns even where none exist.

-Uncertainty, in the presence of vivid hopes and fears, is painful, but must be endured if we wish to live without the support of comforting fairy tales.

8. Reliability of Case Evidence: When we get new representative evidence, we must update the prior probability. Ask: What has happened in similar cases in the past? Are there any reasons this probability should be revised? Have the circumstances or the environment changed? The more uncertainty that surrounds a specific case, the more emphasis we must put on the prior probability.

9. Misrepresentative Evidence: People like to look for systems that have worked over the past 20 years or so. If you could make money based on what has worked the past 20 years, all of the richest people would be librarians.

-Often the past is a good guide to the future—but not always. Statistics are a record of the past, not a prediction of the future. We can’t automatically assume that the future will mirror the past.

-Ask: Why was past experience the way it was? What reason is there to suppose that the future will resemble the past? Has the environment changed? Are the conditions similar? Are the context and circumstances that caused the past still present?

-The same mistake that a baseball manager would were he to judge the future prospects of a 42-year-old center fielder on the basis of his lifetime batting average.

-There may also be business incentives at work. For example, a widening a market by creating a new condition, redefining a disease or exaggerating a minor one, thereby having more people labeled as having a disease.

4 out of 5 doctors recommended the drug: This statement doesn’t tell us anything if we don’t know how many doctors were observed. A small sample size has no predictive value. The smaller the sample is, the more statistical fluctuations and the more likely it is that we find chance events.

-Charlie Munger: “We’d rather by roughly right than precisely wrong.”

10 people have a total wealth of $10 million i.e. the average wealth per person is $1 million: What if one person has $10 million and nine nothing? How can the average income soar? Suppose ten middle-class people are riding on a bus. One gets off the buss and a billionaire gets on.

-John has been offered to invest in a private venture capital fund. The venture manager’s track record is an average rate of return of 25% over the last 5 years.

—-This doesn’t say much id we don’t look at how the underlying performance was produced. By looking closely at how his return was produced John found that the venture manager had done 10 deals. One deal had been a spectacular success and the rest failures. Had this one deal been due to luck?

Remember that some people leave out data when reporting performance.

Part IV: Guidelines to Better Thinking

1. Models of Reality: Is there anything I can do to make my whole life and my whole mental process work better? And I would say that developing the habit of mastering the multiple models which underlie reality is the best thing you can do…it’s just so much fun—and it works so well.

-One idea from biology that agrees with reality is that “people on everage act out of self-interest.”

-If you get a certain kind of process going in chemistry, it speeds up on its own. So you get this marvelous boost in what you’re trying to do that runs on and on. Now, the laes of physics are such that it doesn’t run on forever. But it runs on for a goodly while. So you get a huge boost. You accomplish A—and all of a sudden, you’re getting A + B + C for awhile.

-A model should be easy to use. If it is complicated, we don’t use it. It is useful on nearly a daily basis. If it is not used, we forget it. And what use is knowledge if we don’t use it?

-Have a kit full of tools…go through them in your mind checklist style…you can never make any explanation that can be made in more fundamental way in any other way than the most fundamental way.

-When you’re using physics, say you’re using physics. When you’re using biology, you say you’re using biology.

-We can use the Feynman “one sentence explanation” when dealing with big ideas. “What sentence contains the most information in the fewest words?” An example of a one-sentence idea from psychology is: “We get what we reward for.” A sentence from physics is: “Energy is neither created nor destroyed—only changed from one form into another.”

-Just as iron rust from disuse, and stagnant water putrefies, or when cold turns to ice, so our intellect wastes unless it is kept in use. –Leonardo da Vinci

2. Meaning: Knowledge is only valuable if it’s useful and something is only useful if we understand what it means.

-“Never express yourself more clearly, than you are able to think.” When describing something, tell it as it is and use words that people understand, and in terms of ideas with which they are familiar. Albert Einstein said: “If you can’t explain it simply, you don’t understand it well enough.”

-The key question we should ask when investing money in economic assets is: What is the expected future cash we can take out and when does it appear? How else can we know what an asset may be worth and what kind of return we can expect at a given price? In the end, what you have to decide is whether you’re going to value a business at $400 million, $600 million or $800 million –and then compare that with the price.

-Earnings are only a means to an end, and the means should not be mistaken for the end. Therefore we must say that a stock derives its value from its dividends, not its earnings, In short a stock is worth only what you can get out of it.

-No matter whether a company makes telecom equipment, cars, or candy, it’s still the same question: How much cash do we get and when? The name attached to the cash doesn’t matter.

-Why pay more for a telecom business than a brick business? Money doesn’t know where it comes from. There’s no sense in paying more for a glamorous business if you’re getting the same amount of money, but paying more for it. It’s the same money that you can get from a brick company at a lower cost. The question is what are the economic characteristics of the bank, the Internet company or the brick company. That’s going to tell you how much cash they generate over long periods in the future.

-First, we try to stick to business we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change, we’re not smart enough to predict future cash flows.

-We never sit down, run the numbers out and discount them back to the net present value…the decision should be obvious.

-If we think that we simply don’t know what’s going to happen in the future, that doesn’t mean it’s risky for everyone. It means we don’t know—that it’s risk for us. It may not be risky for someone else who understands the business. However, in that case, we just give up.

-Energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.

3. Simplification: We haven’t succeeded because we have some great complicated systems or magic formulas we apply or anything of the sort. What we have is just simplicity itself. Charles Munger adds: If something is too hard, we move on to something else.

-It’s amazing how people even today use a computer to do something you can do with a pencil and pen in less time [Richard Feynman] (No Ordinary Genius)

-Be problem-oriented. Not method-oriented. Use whatever works. Why? Because the result is what matters, not the method we use to arrive at it.

-Deal with situations in life by knowing what to avoid. Reducing mistakes by learning what areas, situations and people to avoid is often a better use of time than seeking out new ways of succeeding.

-There are two questions you must ask yourself as you look at the decision you’ll make. A) Is it knowable? B) If it is not knowable, as you know there are all kinds of things that are important but not knowable, we forget about those. And it it’s unimportant, whether it’s knowable or not, it won’t make any difference.

-The formulation of a problem is often more essential than its solution, which may be merely a matter of mathematical or experimental skill [Albert Einstein]

4. Rules and Filters: Ask: What are the most critical (and knowable) factors that will cause what I want to achieve or avoid?

-Try to use as few criteria as necessary to make your judgment. Then rank them in order of their importance and use them as filters. Set decision thresholds in a way that minimizes the likelihood of false alarms and misses (in investing, choosing a bad investment or missing a good investment). Consider the consequences of being wrong.

-Buffet’s 4 Criteria Investing Filter:

—Can I understand it? If it passes this filter,

—Does it look like it has some kind of sustainable competitive advantage? If it passes this filter,

—Is the management composed of able and honest people? If it passes this filter,

—Is the price right? If it passes this filter, then we write a check

-Some issues to think about when designing checklists are:

—Different issues need different checklists

—A checklist must include each critical item necessary for “safety” and avoiding “accidents” so we don’t need to rely on memory for items to be checked.

—Readily usable and easy to use.

—Agree with reality

5. Goals: Goals should be:

-Clearly defined. Don’t say: “I want to have a better life.” Be concrete. For example: “I want a new Volvo.”

-Focused on results

-Realistic and logical – what can and can’t be achieved? Low goals may produce low performance and unrealistic goals may cause people to cheat.


-Tailored to our individual needs

-Subject to change. Ask: Given our current objective, what is the best course of action to take?

6. Alternatives: If you’ve got two suitors who are really eager to have you and one is way the hell better than the other, you do not have to spend much time with the other. And that’s the way we filter out buying opportunities.

-Every minute we choose to spend on one thing is a minute unavailable to spend on other things.

7. Consequences: The key thing in economics, whenever someone makes an assertion to you, is to always ask, “And then what?” Actually, it’s not such a bad idea to ask it about everything. But you should always ask, “And then what?”

-We can’t get something for nothing: Take the issue on alternative energy sources. Some relevant headlines when thinking about alternatives: Energy used versus usable energy produced (considering the entire production process)? Infrastructure requirements? Scalable? Transport and storage? Costs (considering subsidies)? Who pays? Environmental benefits and costs? Sustainability? Consequences over time? Degree of difficulty in properly evaluating all the factors involved? Consequences of being wrong?

8. Quantification: When we translate something into numbers we can make comparisons. How can we evaluate if a decision is intelligent or not if we can’t measure it against a relevant and important yardstick?

-We need to understand what is behind the numbers. Return on beginning capital equity is the most appropriate measure of single-year managerial performance. Informed use of that yardstick, however, requires an understanding of many factors, including accounting policies, historical carrying values of assets, financial leverage, and industry conditions.

-Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return –even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.

9. Evidence: There are in fact two things: science and opinion; the former begets knowledge, the latter ignorance. [Hippocrates]

-The scientific process involves the following steps:

—Problem or Observation: Why a certain problem happens.

—Guess why: make a hypothesis for why it occurs

—Predict consequences: work out all logical consequences of our guess and see what would be implied if our guess was right.

—Test: “If I do this, what will happen?” repeat experiment, trial and error, etc.

-Darwin realized that for an observation to be of any use, it must be tested for or against a theory, hypothesis or model (if we don’t “guess why”, there can be no experiments since a test has nothing to guide it).

-Occam’s Razor principle attributed to the 14th Century logician William of Occam: “Entities should not be multiplied unnecessarily.” If we face two possible explanations which make the same predictions, the one based on the least number of unproven assumptions is preferable, until more evidence comes along. Occam doesn’t rule out other explanations.

-To paraphrase Albert Einstein: “Theories should be as simple as possible, but no simpler.”

-“No number of experiments can prove me right; a single experiment can prove me wrong.” [Albert Einstein]

-Disprove ideas. Charles Darwin always looked at the possibility that he was wrong.

-Since a lot of evidence agrees with my explanations, I must be right: Not necessarily, the same evidence may agree with other explanations. Look for evidence that disproves your explanation.

10. Backward Thinking: A lot of success in life and success in business comes from knowing what you really want to avoid—like early death and a bad marriage. [Charles Munger]

-Avoid what causes the opposite of what you want to achieve.

-Wise men profit more from fools than fools from wise men; for the wise men shun the mistakes of the fools, but fools do not imitate the successes of the wise. [Marcus Porcius Cato]

11. Risk: A life without adventure is likely to be unsatisfying, but a life in which adventure is allowed to take whatever from it will, is sure to be short. [Bertrand Russell]

-Munger: “I had a relative by marriage who died in his late 80s. And I don’t think he ever had a loss. He only did about eight things in his lifetime. He started with a small poke, and if something wasn’t a near cinch, he didn’t do it. He lived well and died rich. I think it’s possible for a great many people to live a life like that where there isn’t much risk of disaster and where they’re virtually sure to get ahead a reasonable amount. It takes a lot of judgment, a lot of discipline and an absence of hyperactivity. By this method, I think most intelligent people can take a lot of risk out of life.

-Whoever undertakes to set himself up as a judge of truth and knowledge is shipwrecked by the laughter of the gods. We can’t predict what is going to happen in life. Never underestimate the chance or rare events.

12. Attitudes: “Be happy while you’re living, for you are a long time dead.”

-George Burns: “You can either do what you love or love what you do. I don’t see there’s any other choice.”

-Confucius said: “To know that we know that we know, and that we do not know, what we do not know; that is true knowledge.”

-Buffett: You have to stick within what I call your circle of competence. You have to know what you understand and what you don’t understand. It’s not terribly important how big the circle is. But it’s terribly important that you know where the perimeter is.

-Ask: What is my nature? What motivates me? What is my tolerance for pain and risk? What has given me happiness and unhappiness in the past? What things and people am I comfortable with? What are my talents and skills? Do I know the difference between what I want and what I’m good at? Where do I have an edge over others? What are my limitations?

-Warren Buffett’s front-page test: “Would I be willing to see my action immediately described by an informed and critical reporter on the front page of my local paper, there to be read by my spouse, children and friends?”

-The only way to be loved is to be lovable. You always get back more than you give away. If you don’t give any you won’t get any. Lao Tsu said: “Respond intelligently even to unintelligent treatment.” Be nice to people and if they are not nice to you—don’t be nasty—just avoid them in the future.

-Whenever you think that some situation or some person is ruining your life, it is actually you who are ruining your life…Feeling like a victim is a perfectly disastrous way to go through life. If you just take the attitude that however bad it is in any way, it’s always your fault and you just fix it as the best you can—the so-called “iron prescription” – I think that really works.

Appendix I – Charles Munger Commencement Speech:

“Invert, always invert.” It is in the nature of things, as Jacobi knew, that many hard problems are best solved only when they are addressed backward.

Wisdom from Charles T. Munger and Warren E. Buffett:

Appealing to interest is likely to work better as a matter of human persuasion than appeal to anything else. That, again, is a powerful psychological principle with deep biological roots.

“John this situation could ruin your life. You could lose your wealth. You could lose your reputation…CEOs don’t like the idea of being ruined, disgraced and fired.

On why managers don’t make rational decisions:

(1) If governed by Newton’s First Law of Motion, an institution will resist any change its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-or-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

On the Kind of People to do business with:

(1) Apply themselves with an enthusiasm and energy that would make Ben Franklin and Horatio Alger look like dropouts. (2) define with extraordinary realism their area of special competence and act decisively on all matters within it; (3) ignore even the most enticing propositions falling outside of that area of special competence; and (4) unfailingly behave in a high-grade manner with everyone they deal with.

We find it meaningful when an owner care about whom he sells to. We like to do business with someone who loves his company, not just the money that a sale will bring him.

On picking the right character traits:

Just pick out the person you admire the most and sit down and write the reasons why you admire him and they try and figure out why you can’t have the same qualities. After all, they’re not like the ability to throw a football 60 yards or run the 100 in 10 seconds flat or something like that. They’re qualities of personality, character, and temperament that can be emulated.

And you can apply the reverse of it following Charlie’s theory: You can find the people you don’t like and say, “What don’t I like about these people?

There is no reason to look only for living models.

On Some reasons on why bad lending happens: 

The more powerful and useful is any model, the more error it tends to produce through overconfident misuse. This brings to mind Ben Graham paradoxical observation that good ideas cause more investment mischief than bad ideas.

On the value of math:

If you own a farm, what the farm produces is all you’re going to get from the farm. If it produces $50 an acre of net profit, you’ll get $50 an acre of net profit. And there’s nothing about it that transforms that in some miraculous form. If you owned all of the Fortune 500 – if you owned 100% of it – you’d be making $334 billion. And if you paid $10.5 trillion for that, well, that’s not a great return on investment

-Then you might say “can that $334 billion double in five years?” Well, it can’t double in five years with GDP growing at 4% a year or some number like that.

On the Advantages of Scale:

Just doing something complicated in more and more volume enables human beings, who are trying to improve and are motivated by the incentives of capitalism, to do it more and more efficiently. The very nature of things is that you get a whole lot of volume through your joint; you get better at processing that volume. That’s an enormous advantage. And it has a lot to do with which business succeed and fail…

-Another advantage of scale comes from psychology…We are all influenced – subconsciously and to some extent consciously – by what we see others do and approve. Therefore, if everybody’s buying something we think it’s better. We don’t like to be the one guy who’s out of step.

The Disadvantages of Scale:

Where our competitors beat us. And the way they beat us was by going to narrower specialization.

The great defect of scale of course, which makes the game interesting – so that the big people don’t always win –is that as you get big, you get the bureaucracy. And with the bureaucracy comes the territoriality – which is again grounded in human nature.

On how to get world wisdom:

You need the best 100 or so models from microeconomics, physiology, psychology particularly, elementary mathematics, hard science and engineering [and so on]. You don’t have to be a huge expert in any of those fields. All you’ve got to do is take the really big ideas and learn them really well.

You have to learn the models so that they become part of your everyday repertoire.

On what something really means:

By its nature, the U.S. is running a substantial merchandise trade deficit. If you buy more from the rest of the world than you’re selling them — which is what happened by definition when you’re running a trade deficit – you have to balance the books. They have to get something  — some capital asset – in exchange: They may get a government bond. They get a piece of U.S. business. But they have to get something.

3 timeless ideas for investing:

1. that you should look at stocks as part ownership of a business

2. that you should look at market fluctuations in terms of his “Mr. Market” example and make them your friend rather than your enemy by essentially profiting from folly rather participating in it, and finally,

3. the three most important words in investing are “margin of safety” — …always building a 15,000 pound bridge if you’re going to be driving 10,000 pound truck across it…

On how to evaluate a business:

To flesh out this principle, you must answer only three questions:

-How certain are you that there are indeed birds in the bush?

-When will they emerge and how many will there be?

-What is the risk-free interest rate (which we consider to be the yield on long-term U.S. bonds)?

-If you can answer these three questions you will know the maximum value of the bush – and the maximum number of birds you now possess that should be offered for it. And, of yourself, don’t literally think birds. Think dollars.

On Commodity business:

Business in industries with both substantial over-capacity and a “commodity” product (undifferentiated in any customer-important way be factors such as performance, appearance, service, support, etc.) are prime candidates for profit troubles.

Hence the constant struggle of every vendor to establish and emphasize special qualities of product or service. This works with candy bars (customers buy by brand name, not by asking for a “two-ounce candy bar”) but doesn’t work with sugar (how often do you hear, “I’ll have a cup of coffee with cream and C & H sugar, please”).

On Paying cash out or keeping it in the business:

First, does it make more sense to pay it out to the shareholders than to keep it within the company?

Should we repurchase stock?

If you have the capital and you think you can create more than a dollar, how do you create the most value with the least risk? And that gets to business risk…I can determine it by looking at the business, the competitive environment in which it operates and so on.

On how to avoid problems:

If I need a team of lawyers and accountants, it isn’t going to be a good deal…We’ve never had an extended negotiation with anybody about anything.

If something is difficult to figure…We’d rather multiply by 3 than by pie.

On the real risk of investing:

1. The certainty with which the long-term economic characteristics of the business can be evaluated;

2. The certainty with which management can be evaluated, both to its ability to realize the full potential of the business and to wisely employ its cash flows

3. The certainty with which management can e counted on to channel the rewards from the business to the shareholders rather than to itself;

4. The purchase price of the business

5. The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing power return is reduced from his gross return.