Surround the CEO with confused, unmotivated subordinates. Give key customers reasons to be angry. Late and wrong deliveries, delays, and arrogance will help. Let the customers associate the business with misery and make sure that this feeling gets reinforced at every contact with the company."
Thinking backwards, we can determine what actions must be avoided. As Charles Munger says, "If you were hired by the World Bank to help India, it would be very helpful to determine the three best ways to increase man-years of misery in India - and, then, turn around and avoid those ways."
Instead of asking how we can achieve a goal, we ask the opposite question: What don't I want to achieve (non-goal)? What causes the non-goal? How can I avoid that? What do I now want to achieve? How can I do that? For example, instead of searching for how John and Mary can improve their marriage, they ask: "What qualities will destroy our marriage?" One quality is dishonesty. Now they
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reinvert the question back and ask: "How can we improve our marriage?" Be honest. (See also Charles Munger's brilliant speech on prescriptions for guaranteed misery in Appendix One).
Charles Munger provides an enlightening example on how dumb systems cause dumb behavior:
Let's say you have a desire to do public service. As a natural part of your planning, you think in reverse and ask, "What can I do to ruin our civilization?" That's easy. If what you want to do is to ruin your civilization, just go to the legislature and pass laws that create systems wherein people can easily cheat. It will work perfectly. Take the workers' compensation system in California. Stress is real And its misery can be real. So you want
to compensate people for their stress in the workplace. It seems like a noble thing to do. But the trouble with such a compensation practice is that it's practically impossible to delete huge cheating. And once you reward cheating, you get crooked lawyers, crooked doctors, crooked unions, etc. participating in referral schemes. You get a total miasma of disastrous behavior. And the behavior makes all the people doing it worse as they do it. So you were trying to help your civilization. But what you did was create enormous damage, net. So it's much better to let some things go uncompensated - to let life be hard - than
to create systems that are easy to cheat.
"Don't think about the color red!"
If someone told you not to think of the color red, you might automatically think of that color. Why? Because in order to know what not to think about, your brain must first think about it. When John is on a golf course trying to hit over a water hazard in front of the green, he doesn't say to himself, "I don't want to hit the ball in the water," but instead "I want to hit the ball on the green." So when we tell people what to avoid, we should end with what we want them to achieve.
Study errors.
Marcus Porcius Cato wrote: "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."
To reduce mistakes, we should study failures with severe consequences. Both in business and in life. We should look at their causes over time and see if they are unchanged.
Often we learn more from understanding why something doesn't work than from why it does. Studies also show that dramatic error-story training is an
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effective method of learning. Errors are salient and memorable. Studying errors encourage effortful thinking, and improves our capacity to deal with change and new or unusual situations. Ask: Why did that happen? Why do certain businesses lose money or fail? Why do smart people engage in foolish behavior? Why do certain accidents happen? What was the mistake that caused bad performance? What circumstances were present? What's the lesson?
When we know this, we should ask: What people or businesses are doing things that history has proven causes failure? How can we best avoid what we don't want to happen? How can we create the best conditions to avoid mistakes? How can we prevent causes that can't be eliminated? How can we limit the consequences of what we want to avoid? How can we limit the probability of what we want to avoid?
We can organize the study of errors, by using a table like the one below.
What to avoid
What were the mistakes?
Cause Antidote
Why did those happen? What are the major risk factors?
How do specific errors evolve? What factors contribute?
Stupidity/Irrationality
Big idea that helps explain and predict?
What is rational? How can I create the best conditions to make good decisions? What can be eliminated or prevented?
Turn the negative into an advantage.
In 1796, British physician Edward Jenner discovered vaccination. He noticed that milkmaids who had contracted a mild and usually non-lethal form of the pox virus - cowpox - seemed to be immune to the lethal form of the virus, smallpox. He then took samples of a milkmaid's lesions and inoculated a young boy with cowpox. The boy built up antibodies in his immune system that prevented him from getting smallpox and subsequently survived the epidemic.
Begin with the end in mind
In the 4th Century the Greek mathematician Pappus of Alexandria wrote: "Let us start with what is being seeked and assume that we already found it." Assume we've achieved our goal, then ask: What was the purpose? Was this what I wanted? If so, from which earlier position do I get there? What is needed to achieve this? Then work backward to the beginning. By working backwards we can easier see
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how and if something may work. An example of this is retrospective disease studies. Researchers study the disease then work backward to see what prior conditions are associated with it.
"We need discipline in schools. "
What would be the consequences if this statement were false? Turn a statement backwards and show that the opposite is worse. What are the consequences? Unbelievable or negative? Suppose there was no discipline in schools, would there be more behavior we don't want?
When we believe we have arrived at the right judgment, we should consider what could cause the opposite of our prediction -what we don't want to happen. Suppose we make a personality judgment and conclude that the individual is of good character and we want to enter a relationship. Ask: What can ruin this relationship? What causes me to misjudge character?
Other uses of backward thinking are: Study evidence that implies the opposite of what is normal and ask "why." Use "negative" rules - tell people what they can't do. Practice zero base thinking - start with a clean sheet of paper and ask: If we weren't already doing what we do, how can we best achieve our goal?
Next chapter is about risk or the possibility of loss. If we put our head in the lion's mouth, we shouldn't be surprised if it's bitten off.
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- ELEVEN -
RISK
Alife without adventure is likely to be unsatisfying, but a life in which adventure is allowed to take whatever form it will is sure to be short.
Bertrand Russell (from Authority and the Individual)
"Why do you want to buy this stock?What must happen for the investment to succeed? What is the downside?"
Reflect on what can go wrong. Ask: What may cause this to turn into a catastrophe? What is the potential downside? What should I worry about? What is the likelihood and magnitude of a possible loss? What's the worst thing chat could happen? What can I do to prevent it? What will I do if it happens?
We need to look at the downside when we invest. According to Forbes
Magazine, Charles Munger's way of reasoning is:
The simple fact is that you can't tell whether an idea is likely to work unless you consider all the possible negatives... Okay, it's a good company. But is the price low enough? Is the management made up of people Munger and Buffett are comfortable with? If it is cheap enough to buy, is it cheap for the wrong reason or the right reason? As Munger puts it: "What's the flip side, what can go wrong that I haven't seen?"
Being wrong causes
both an actual loss and an opportunity cost. When investing, we can either lose our capital - we invest 10 and get back 5 - or we get an inadequate return - for example 3% versus 6% from a bond. What does Warren Buffett say about business risk?
When we look at businesses, we try to look at businesses that are good businesses today and think about what can go wrong. We think of business risk in terms of what can happen five, 10 or 15 years from now that will destroy, modify or reduce the economic strengths we believe currently exist in the business. And for some businesses, that's impossible to figure - at least it's impossible for us to figure - and we don't even think about it. If we can think of very much that can go wrong, we just forget it.
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Warren Buffett says that "the best way to minimize risk is to think". He also tells us how Berkshire reduces risk:
In stocks, we expect every commitment to work out well because we concentrate on conservatively financed businesses with strong competitive strengths, run by able and honest people. If we buy into these companies at sensible prices, losses should be rare. Indeed, during the 38 years we have run the company's affairs, gains from the equities we manage at Berkshire (that is, excluding those managed at General Re and GEICO) have exceeded losses by a ratio of about 100 to one.
Do we need to take a lot of risks to get ahead in life? Charles Munger tells a story:
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 oflife.
A fool and his money are soon parted
What traits are necessary to be an outstanding long-term investor? Warren Buffett gives us some clues in Berkshire Hathaway's 2006 Chairman's letter, where he mentions Berkshire's intention of hiring someone to succeed him as Berkshire's chief investment officer when the need arises:
Picking the right person(s) will not be an easy task. It's not hard, of course, to find smart people, among them individuals who have impressive investment records. But there is far more to successful long-term investing than brains and performance that has recently been good.
Over time, markets will do extraordinarily, even bizarre things. A single, big mistake
could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions.
Temperament is also important. Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success.
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The consequences of being wrong
If we can't tolerate a possible consequence, remote though it may be, we steer clear of planting its seeds.
- Warren Buffett
Experience tells me that the foture will be similar to the past.
It may or may not. We don't know the future. What if the consequences of being wrong are terrible and can cause us great harm? If the decision is important, we should largely ignore what has happened in the past and focus on the consequences of being wrong.
Why do we insure our houses? We do it because the consequences of being wrong
- a fire - is devastating, and the cost of insurance is relatively minor in comparison. For example, the cost of a $1.000 premium decreases my happiness very little, while the potential loss of $300,000 would lead to considerable misery. Ask: What could go wrong? What can I do to prevent harm or to deal with it if it happens?
john wants to buy another ice cream store.
The key variable he's betting on is that "Unit volume will increase." What are the consequences ifhe is wrong?
The worse the consequence of being wrong, the less inclined we must be to
take a specific action or the more evidence we need in favor of something.
Ask: What is the cost of being wrong versus the benefit of being right compared to other investment opportunities? Cost: John may lose money, reputation, and experience mental stress. It will also take his focus away from other business. Benefit: Possibility to make more money over a period of time. Alternative: More time to concentrate on the present business or other opportunities.
Or stated another way: Ifl do this because I bet that unit volume will increase but I'm wrong (volume remains the same or decreases due to less demand and more competition or unfavorable environment) what are the consequences? Can I handle them? Are they reversible? IfI don't do this because I bet that unit volume will go down or stay the same, but I'm wrong, what are the consequences? In which alternative do I lose less?
Margin of safety
We try to arrange [our affairs] so that no matter what happens, we'll never have to 'go back to go. "
Charles Munger
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Albert Einstein said: "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 of rare events.
To protect us from all the unknowns that lie ahead we can either avoid certain situations, make decisions that work out for a wide range of outcomes, have backups or a huge margin of safety. For example, when investing money the following can guide us: know the underlying business value, don't use leverage, enter situations where the management is able and honest, and invest with a huge margin of safety.
How much margin of safety do we need? Warren Buffett answers:
If you understand a business - if you can see its future perfectly- then, obviously, you need very little in the way of margin of safety. Conversely, the more things that can happen, the more uncertainty there is, the more vulnerable the business is or the greater the possibility of change, the larger margin of safety you require...
If you're driving a 9,800 pound truck across a bridge that says it holds 10,000 pounds and the bridge is only about six inches above the ground, then you may feel OK. However, if the bridge is over the Grand Canyon, then you may want a little larger margin of safety. And, therefore, you may only drive a 4,000 pound truck across. So it depends on the nature of the underlying risk.
What else is important? We have a better chance of avoiding misjudgment and improving our lives if we have the right attitude and follow certain values.
In writer Janet Lowe's wonderful biography of Charles Munger, Damn Right!, we can learn some of Charles Munger's views on values and behavior from his stepson, Hal Borthwick:
Charlie drummed in the notion that a person should always "Do the best that you can do. Never tell a lie. If you say you're going to do it, get it done. Nobody gives a shit about an excuse. Leave for the meeting early. Don't be late, but if you are late, don't bother giving people excuses. Just apologize... Return your calls quickly. The other thing is the five second no. You've got to make your mind up. You don't leave people hanging."
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- TWELVE -
ATTITUDES
Be happy while you're living, for you are a long time dead.
Scottish proverb
Life is long if we know how to use it
The Roman philosopher Lucius Annaeus Seneca tells us in his Moral Essays that it's not that we have so little time but that we waste much of it:
Why do we complain of Nature? She has shown herself kindly; life, if you know how to use it, is long. But one man is possessed by an avarice that is insatiable, another by a toilsome devotion to tasks that are useless; one man is besotted with wine, another is paralyzed by sloth;
one man is exhausted by an ambition that always hangs upon the decision of others, another, driven on by the greed of the trader, is led over all lands and all seas by the hope of gain... many are kept busy either in the pursuit of other men's fortune or in complaining of their own; many, following no fixed aim, shifting and inconstant and dissatisfied, are plunged by their fickleness into plans that are ever new; some have no fixed principle bywhich to direct their course, but Fate takes them unawares while they loll and yawn - so surely does it happen that I cannot doubt the truth of that utterance which the greatest of poets delivered with all the seeming of an oracle: "The part of life we really live is small." For all the rest of existence is not life, but merely time.
He continues: "You live as if you were destined to live forever, no thought of your frailty ever enters your head, of how much time has already gone by you take no heed.":
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