The following came from a 1994 article by Charles Munger, best known as one of the lead Berkshire Hathaway investors with Warren Buffett.
As a warning, its very long and talks about a lot of topics from role of math and psychology, business management, stock picking, etc but its very informative.
I've picked out a few more juicy paragraphs from it but if you have time, make sure to read it. I've broken it up into several smaller chunks that I found interesting and will post them out over a few days.
Source: (Courtesy: The Big Picture)
Charles Munger, USC Business School, 1994
A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business
See Part 1 - Value Investing
See Part 2 - Fewer But Bigger Bets
See Part 3 - Efficient Market Hypothesis & Race Tracking Betting Model
See Part 4 - Advantages & Disadvantages of Scale
See Part 5 - Bureaucracy & Yes Men
See Part 6 - Efficiencies & Profitability Differences from Competition
See Part 7 - Negative Effects of Technology on Business Profits
See Part 8 - Focusing on Your Competitive Edge & Follies of Investment Management
See Part 9 - Sector Rotation & Yearly tax avoidance
See Part 2 - Fewer But Bigger Bets
See Part 3 - Efficient Market Hypothesis & Race Tracking Betting Model
See Part 4 - Advantages & Disadvantages of Scale
See Part 5 - Bureaucracy & Yes Men
See Part 6 - Efficiencies & Profitability Differences from Competition
See Part 7 - Negative Effects of Technology on Business Profits
See Part 8 - Focusing on Your Competitive Edge & Follies of Investment Management
See Part 9 - Sector Rotation & Yearly tax avoidance
- Focusing on your competitive edge
Again, that is a very, very powerful idea. Every person is going to have a circle of competence. And it’s going to be very hard to advance that circle. If I had to make my living as a musician…. I can’t even think of a level low enough to describe where I would be sorted out to if music were the measuring standard of the civilization.
So you have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.
If you want to be the best tennis player in the world, you may start out trying and soon find out that it’s hopeless—that other people blow right by you. However, if you want to become the best plumbing contractor in Bemidji, that is probably doable by two-thirds of you. It takes a will. It takes the intelligence. But after a while, you’d gradually know all about the plumbing business in Bemidji and master the art. That is an attainable objective, given enough discipline. And people who could never win a chess tournament or stand in center court in a respectable tennis tournament can rise quite high in life by slowly developing a circle of competence—which results partly from what they were born with and partly from what they slowly develop through work.
So some edges can be acquired. And the game of life to some extent for most of us is trying to be something like a good plumbing contractor in Bemidji. Very few of us are chosen to win the world’s chess tournaments. Some of you may find opportunities “surfing” along in the new high-tech fields—the Intels, the Microsofts and so on. The fact that we don’t think we’re very good at it and have pretty well stayed out of it doesn’t mean that it’s irrational for you to do it.
So you have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.
If you want to be the best tennis player in the world, you may start out trying and soon find out that it’s hopeless—that other people blow right by you. However, if you want to become the best plumbing contractor in Bemidji, that is probably doable by two-thirds of you. It takes a will. It takes the intelligence. But after a while, you’d gradually know all about the plumbing business in Bemidji and master the art. That is an attainable objective, given enough discipline. And people who could never win a chess tournament or stand in center court in a respectable tennis tournament can rise quite high in life by slowly developing a circle of competence—which results partly from what they were born with and partly from what they slowly develop through work.
So some edges can be acquired. And the game of life to some extent for most of us is trying to be something like a good plumbing contractor in Bemidji. Very few of us are chosen to win the world’s chess tournaments. Some of you may find opportunities “surfing” along in the new high-tech fields—the Intels, the Microsofts and so on. The fact that we don’t think we’re very good at it and have pretty well stayed out of it doesn’t mean that it’s irrational for you to do it.
- Investors vs Investment management
I think the reason why we got into such idiocy in investment management is best illustrated by a story that I tell about the guy who sold fishing tackle. I asked him, “My God, they’re purple and green. Do fish really take these lures?” And he said, “Mister, I don’t sell to fish.”
Investment managers are in the position of that fishing tackle salesman. They’re like the guy who was selling salt to the guy who already had too much salt. And as long as the guy will buy salt, why they’ll sell salt. But that isn’t what ordinarily works for the buyer of investment advice.
If you invested Berkshire Hathaway-style, it would be hard to get paid as an investment manager as well as they’re currently paid—because you’d be holding a block of Wal-Mart and a block of Coca-Cola and a block of something else. You’d just sit there. And the client would be getting rich. And, after a while, the client would think, “Why am I paying this guy half a percent a year on my wonderful passive holdings?”
So what makes sense for the investor is different from what makes sense for the manager. And, as usual in human affairs, what determines the behavior are incentives for the decision maker.
Investment managers are in the position of that fishing tackle salesman. They’re like the guy who was selling salt to the guy who already had too much salt. And as long as the guy will buy salt, why they’ll sell salt. But that isn’t what ordinarily works for the buyer of investment advice.
If you invested Berkshire Hathaway-style, it would be hard to get paid as an investment manager as well as they’re currently paid—because you’d be holding a block of Wal-Mart and a block of Coca-Cola and a block of something else. You’d just sit there. And the client would be getting rich. And, after a while, the client would think, “Why am I paying this guy half a percent a year on my wonderful passive holdings?”
So what makes sense for the investor is different from what makes sense for the manager. And, as usual in human affairs, what determines the behavior are incentives for the decision maker.
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