MI361: Poor Charlie's Almanack w/ Shawn O'Malley

0:00You're listening to TIP. The idea of being a multidisciplinary thinker in some ways is really about being well-rounded enough to avoid the pitfalls of people who spend their whole lives narrowly focused on one thing, the type of person with a hammer who thinks every problem looks like a nail.

0:20Hey guys, in today's episode, I had the chance to sit down once again with my friend and colleague Sean O'Malley, who's chief editor of our newsletter, We Study Markets, to talk about his main takeaways from doing a deep dive into poor Charlie's Almanac. You'll learn how Ben Franklin inspired Munger, how Buffett and Munger developed their relationship, what the key character traits were that made Munger a great investor, why it's important to be a multidisciplinary and thinker, what elementary worldly wisdom is and how to develop it, what the psychology of human misjudgment is and how to avoid it to lead a better life and a whole lot more.

0:52Buffett described Munger as his closest partner and right-hand man and credited him with being the architect of Berkshire Hathaway's business philosophy. He was vice chairman of the company and sadly passed away at the age of 99 in November of 2023. One of my favorite quotes of Munger's is, in my whole life, I've known no wise people who didn't read all the time. None. Zero. You'd be amazed at how much Warren reads and how much I read. My children laugh at me. They think I'm a book with a couple of legs sticking out. Munger's goal was try to be a little smarter each day than when he woke up. And just like capital, knowledge and wisdom compounds over time.

1:28With that in mind, let's dive into today's episode with Sean O'Malley and learn about the wit and wisdom of Charlie Munger.

1:39Celebrating 10 years, you are listening to Millennial Investing by the Investors Podcast Network. Since 2014, we interviewed successful entrepreneurs, business leaders, and investors to help educate and inspire the millennial generation. Now for your host, Patrick Donley.

2:06Hey, everybody. Welcome to the Millennial Investing Podcast. I'm your host today, Patrick Donley. And joining me in the studio once again is my friend and colleague, Sean O'Malley. Sean, welcome to the show. Great to be back. Happy to have you back. We are getting into our final episode, which is, this has been a lot of fun. We've covered the essays of Warren Buffett. We've covered Benjamin Graham and the Intelligent Investor. We did the Outsiders last week. We're going to cover what I would say is like the third key figure of this kind of legendary value investing trifecta, which is Charlie Munger.

2:39And my first question I wanted to get into is talking about Benjamin Franklin. Franklin was this huge inspiration for Munger and his life. And many see Munger as kind of having carried the torch of Franklin's legacy, who's famous, obviously, for many things. But the book's title, Poor Charlie's Almanac, is inspired by Ben Franklin's annual publication that he put out called Poor Richard's Almanac. So I wanted to start just talking a little bit about Ben Franklin and how he ties into the Charlie Munger story. Charlie is synonymous with Warren Buffett and Berkshire Hathaway, which sort of implicitly connects him to Ben Graham, who, as we know, is considered the father of value investing.

3:19But when you look at Charlie's life individually, you see that he's so much more than Warren Buffett's partner or even a value investor. He was an incredibly clear thinker across a number of domains from physics to psychology to law and even meteorology. So Charlie packs an intellectual punch in a way that very much distinguishes him from his longtime partner, Warren Buffett, who tends to stray less far from economics and finance. You might even say that similar to how Bing Graham shaped Buffett's views on investing, the writings of Benjamin Franklin had a similarly profound impact on Munger. Charlie famously loved to read biographies and he saw this as a way to make friends with the imminent dead.

4:05So I don't think it's as much of a stretch as it may seem to say that Franklin was sort of like a mentor to Munger, despite there obviously being a 200-year gap in their lifetimes. And if you're not familiar with Ben Franklin's life, that would probably sound pretty strange, but Franklin is one of history's great multidisciplinary thinkers. He was a philosopher, politician, writer, and prolific inventor. We could probably spend an hour just going through all of his accomplishments in detail. What's relevant is that for 25 years, starting in 1732, he wrote an annual publication called Poor Richard's Almanac using the pseudonym Poor Richard.

4:42And it would have had a ton of useful information for people at the time, but it's best remembered today for the life advice that it offered. For two centuries, Franklin had sort of the last word on how to live a virtuous life until Charlie came along and really pushed forward a lot of that advice to new generations of people and and ask even more of them in some ways. What makes them similar is that they're both self-taught. Neither were happy to defer to experts in other subject matters. They wanted to be proficient in every noteworthy intellectual domain. They were both pull yourself up by your bootstraps kind of guys.

5:17And much of this book is Munger teaching people how he did that, how he built up a collection of mental models and frameworks from a lifetime of ravenous reading, and how he used that toward making better decisions in business and in life. Speaking of Munger's mentors, Warren wasn't the first member of the Buffett family that Munger knew well. I wanted to hear a little bit about the origin story of Buffett and Munger and their relationship. Yeah, it's funny. As you said, Munger's first contact with the Buffetts was with Warren's grandfather. Charlie was a few years older than Warren and worked at Warren's grandfather's grocery store as a teenager.

5:55So the two grew up around each other, but didn't really crossed paths until a few years later. And during this time, like he did with his whole life, really, Charlie read every book he could get his hands on. For Christmas, his gifts would be a handful of books. And sometimes by the end of the night, he would have already finished several of those books. And at 19, he enlists in the Army Air Corps during World War II and studies meteorology and thermodynamics. From there, with some help from a family friend, he gets into Harvard Law despite not having a bachelor's degree and finishes near the top of his class.

6:30After that, he moves to Southern California where he begins practicing law until after a few years, he realizes that it's just not stimulating enough for him and that he can't really earn the kind of wealth he envisions for himself working as a lawyer, especially at that time where I don't think it was as profitable to work in law. So on the side, he picks up investing in real estate and stocks and crafts his exit plan from the law firm. And then at a dinner party in Omaha, that's sort of where the stars align. Charlie remembers Warren from his days working in the grocery store. And Warren remembers Charlie because when Warren was raising funds for his own investment partnership, someone mentioned that they'd happily invest with him because he reminded them so much of Charlie Munger.

7:14And as the story goes, the two just hit it off talking about very obscure stock picks and they sort of dominate the dinner party with their conversation. But obviously, they keep in touch after that for many years and they frequently send each other long letters or would talk on the phone for hours. And during this period, the two were both running their own separate investment funds. And everyone probably knows that Warren Buffett did very well, but Munger also held his own as a stock picker. In his partnership's first 11 years, he earned 20 % per year and then bounce back from a bear market in 1974 to deliver 19.8 % compounded annual returns over those 14 years before he decided to follow Warren's lead and close up his investment fund.

7:58And that's around the time when Warren invites Charlie to join him in running Berkshire. We all know the story after that, but what's interesting to me is how Munger never wanted the credit for Berkshire's success. When asked to provide some comments for the book, Munger really tries to understate his role. I have a quote. I'm just going to read it verbatim. He says, I think there's some mythology in this idea that I've been a great enlightener of Warren. He hasn't needed much enlightenment. I frankly think I get more credit than I deserve. It is true that Warren had a touch of brain block while working under Ben Graham and making a ton of money.

8:34It's hard to switch from something that's worked so well. But if Charlie had never lived, the Buffett record would still be pretty much what it is. I think part of what makes Charlie and Warren so appealing to people is just their natural chemistry that they have. It's just fun to watch the two of them riff with each other at a shareholder meeting. Warren supplied this folksy optimism, and Charlie was just the sidekick with this super dry humor. What else would you say makes Munger so special as a person? What would you say made him tick? Warren is probably as qualified as anyone to paint a picture as to who Charlie Munger was.

9:12And I'll just relay what he writes in the book. He calls Charlie a grandmaster of preparation, patience, discipline, and objectivity. And so being a great investor in a way is a natural byproduct of the carefully organized and focused approach to life that Charlie had. He had something like 100 mental models he kept in his head to explain human behavior and biases. and he became extraordinarily efficient at working through all those models for understanding the world. Buffett gives him probably the best praise any investor could give to another by saying that no man in the world could analyze a deal faster than Charlie.

9:50He could run his mental models and find any valid weaknesses in an idea in supposedly about 60 seconds. Beyond Buffett though, his family in the book tells the story of a man who had this wonderful way of knowing what really mattered in life and communicating that to others in short stories, which actually in a way is also another example of his brilliance. Munger is the type of guy who might spend a weekend plowing through textbooks to become an expert on some topic, but he recognizes you can't just dump that information on people. They're obviously not going to retain it in the same way. So, he leans into storytelling as a more digestible way to pass on that wisdom and he'd tell these stories or even just expressions that would contain a world of wisdom in them.

10:34At his core, it really connects back to his belief that you should simplify an idea as much as possible, but no simpler. One of his best sayings is to avoid going through life like a one-legged man in an ass-kicking contest. Another one of those memorable expressions is a simple framework for investing, which he calls sit on your ass investing, where you make a few high conviction decisions in your lifetime as an investor and let time and compounding, do the rest. His comments on inverted thinking also always stand out to people. He loved to say, all I want to know is where I'm going to die, so I'll never go there.

11:08It's sort of a tongue-in-cheek thing. But at the same time, he actually uses that same inverted logic elsewhere. Instead of trying to imagine what the perfect company looks like, it's easier to think about everything you don't want to see from a company you invest in and then rule them out on that basis. And in a more profound way, you might imagine the types of friends and family relationships you'd want to have on your deathbed. And think about how you can lead a life that will get you to that end result. Munger credits many of the good choices he made to simply focusing on what not to do. His usual examples include avoiding laziness, not feeling like a victim, rejecting intense ideology, and trying to never work for people that you don't like or respect.

11:50With a background in law and meteorology, Charlie comes into learning about investing without any of the same biases that somebody educated in classical economics or business might have. And he decides that none of the mainstream approaches to thinking about investing really capture it well. So he decides to painstakingly build his own philosophy on investing and pulls from a bunch of disciplines. He uses ideas like evolution for biology, breaking point in physics, the necessity of redundancies and backups for engineering, power of compounding from mathematics, and all these key insights from other intellectual domains sort of form a spider web of overlapping and complementary ideas for him as an investor.

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15:11To begin getting smarter about investing, just visit theinvestorspodcast.com slash get started with stocks. That's theinvestorspodcast.com slash get started with stocks. And for a limited time, you can use code stocks15 for a 15 % discount at checkout. All right, back to the show. So Buffett called Charlie the abominable no man in their relationship. Do you see Charlie as primarily playing that role as devil's advocate at Berkshire? I think a trusted devil's advocate is a great thing to have. We should all be so lucky to have a Charlie Munger in our lives. A friend who is almost like an extended version of herself with just enough differences and perspective to tell you when you're wrong.

15:58And by telling Warren when he was wrong, he was also helping shape Berkshire. As we've talked about in our last few episodes together, Buffett pivoted his approach to investing in cigar butt stocks to more enduring and high quality businesses. And Charlie deserves the credit for that. I also think another thing worth mentioning is that by jointly running the show at Berkshire, they kept each other grounded. If it's just one person at the top of Berkshire, especially after all the success that the company has had, it would be pretty easy to imagine that you would slowly drift from your values and that humility would sort of fade away and you really start to believe the hype about yourself.

16:36But together, I think they kept those impulses in check. It's a lot easier to commit to a life of frugality and virtue when your closest partner is doing it alongside with you. So, Charlie definitely took pleasure in being a cold dose of rationality for Buffett's optimism. In a 2007 speech, he said, it didn't make me unhappy to anticipate trouble all the time and be ready to perform adequately if trouble came. The timing here is pretty remarkable, right? Over the next two years, him and Warren would capitalize in a very big way from the trouble caused by the great financial crisis. Being a pessimist does have its costs though.

17:16At the Berkshire shareholder meeting five years ago, Charlie lamented the fact that they had an opportunity to invest in Google early on and completely missed it. So having a friend like Charlie will help you dodge a lot of bullets. And the price you pay is that occasionally you miss out on some big winners like Google, which is a steep opportunity cost, but you're not going to get wiped out either. When it comes to investing across a lifetime, what really matters is not getting wiped out. And you need a good bit of skepticism about any decision you make to avoid betting at all on something really exciting, but also really risky.

17:48I can imagine how many bullets Charlie probably helped Warren dodge. Up until his death last year, he was still bringing his signature skepticism to all of today's most popular buzzwords from crypto to AI and meme stocks. I don't think Berkshire would have been rushing to invest in AI without Charlie, but it's refreshing to hear someone show a little doubt about the next big thing. He actually says something along the lines of good old-fashioned intelligence still works just fine. So he doesn't see the need to go around building artificial intelligence. Maybe that'll age terribly, but there are also going to be a ton of people who lose everything chasing the AI hype.

18:24And as a Berkshire shareholder, you can rest assured that you won't be at risk of having that happen to you. Munger tells us that if we want to be smarter, we have to just keep asking why, why, why. And so in that spirit, why is it necessary to be a multidisciplinary thinker? Why is it so important to pull ideas from very different fields into investing? I think that to some extent, this is because economics and finance are soft sciences, which begs the question of, okay, what actually is a soft science? We all loosely know what that means. But the distinction is that there are no universal constants in economics.

18:59There is no law of gravity. You could say that laws of supply and demand are the closest thing we have to that. But even supply and demand are plagued with exceptions. In theory, demand for a good is supposed to go down as the price rises, except if it's a luxury good, where in that case, a higher price creates exclusivity that people crave. So economics is more of a study of human nature than it is a study of objective laws of the universe. And humans are complicated and paradoxical. So there's boundaries to what we can know with any real certainty. And one of the biggest problems among economists and on Wall Street is the belief that we can model every relevant variable to an investment or an economic system.

19:42In these models, they treat the so-called risk-free rate like a law of physics. Everything from corporate borrowing rates to stock valuations are connected to it. Yet there isn't really a universal definition of what the risk-free rate actually is. Some people will tell you to look at the three-month US treasury bond yield. Others will use 10-year treasury bonds as a reference point, depending on the context of the valuation that they're trying to do. But the point is that this is subjective, not objective. And even worse, I think is that the whole thing is a misnomer. I don't want to be accused of spreading fear about the sky falling.

20:18But if your fundamental assumption in economics and finance is that there's no credit risk from investing in US government debt, then I think you've made a big mistake. Ask your Uber driver or anyone on the street what they think of that idea. I don't think any regular person would feel like that makes any sense. It's really a classic case of smart people being too smart for their own good. On the one hand, a business school professor will lecture about all the uncertainties of business and the shortcomings of financial markets. And then they'll conclude that these Excel models are the best we can do still.

20:50But I would be surprised if Charlie Munger ever built a spreadsheet of any meaningful complexity in his life. And you certainly don't hear him talking about risk-free rates. Instead, he looked outside of the status quo of the investment world for more durable insights. One of them being from psychology and the importance of remembering that above all, you are the easiest person to fool. Our subconscious is constantly trying to fool us. And if you don't have a mastery of basic psychological principles, you're going to be helpless to resist those biases. Or if you don't have an appreciation for how physics and biology and chemistry combined together to shape the world around us, you might delude yourself into believing that you can build a 50-tab Excel model that would track every imaginable economic variable for valuing a company.

21:37The idea of being a multidisciplinary thinker in some ways is really about being well-rounded enough to avoid the pitfalls of people who spend their whole lives narrowly focused on one thing, the type of person with a hammer who thinks every problem looks like a nail. Charlie uses the term elementary worldly wisdom to describe the multidisciplinary thinking that you just described. The point being that we need some general knowledge about the world to be great stock pickers. You can't really know anything if you just jam your brain full of isolated facts, but you need to have theories about the world to connect those bits of information together in more usable ways.

22:15That's a takeaway at least from one of his more famous talks in the book, which is appropriately called A Lesson on Elementary Worldly Wisdom. Is there anything else about Charlie's ideas on worldly wisdom that you would want our audience to know about? He does a great job showing off the mental models he uses for understanding the world. And one of them ties into the benefits of scale for businesses. We've all heard about economies of scale and manufacturing, but scale has other benefits too. Large brands have an informational advantage with potential customers. If you're traveling in some obscure corner of the world and you're craving a refreshing drink, you'll probably pay a bit extra for Coca-Cola over the local brand.

22:58And that's because you know what to expect. You know it's going to be of decent quality. With the local soda, you have no idea whether it's any good. Brands spend tons of money hammering this into your subconscious so that in a split second, your brain decides on Coca-Cola over the local choice. There's also an element of social proof here. We love to take mental shortcuts to reduce the processing power our brain uses. And the best way to do that is to just look around and see what others are doing. Even if you've never had a Coca-Cola before, you've seen countless people drinking it. So if you're faced with the choice between Coca-Cola and some no-name brand, you're still probably going to drink Coca-Cola because you know other people think it's good.

23:40At the same time, brands get so entrenched, it's easy to imagine that with economies of scale and brand recognition and social proof and a bunch of other factors working together, it must be impossible to dislodge the biggest companies. But we know that's also not true. If it were, a man from Bentonville, Arkansas would never have scaled a single small town retail store into the empire that is Walmart today. A more recent example people will be familiar with is what Netflix did to Blockbuster, right? So if your mental model is that the biggest companies will always stay big, that's obviously wrong too.

24:17Scale gives advantages, but it doesn't guarantee anything long-term. I wanted to go a little deeper on how Munger thought about competition. There's a really interesting section in his talk on worldly wisdom where Munger takes a stab at explaining why some industries are so much more profitable than others. What takeaways did you have from that part of the book? Mature industries tend to consolidate down to the five or six biggest and most dominant names, but there are huge disparities across industries and the returns they deliver. One example being the airlines where a few companies control the industry and the industry itself has completely revolutionized the world.