Decade of Investing
The most rich data about how humans make decisions and the widest selection of strategies to predict the future in a complex adaptive system are the financial markets. Starting from the tulip mania to the recent housing bubble, there have been several people who have contributed to making the market more efficient. The spectrum of people who have been successful has ranged from Jim Simons to Warren Buffett and the methods they have used have been replicated by other investors. Their methods have been independently verified to work and are not unique talents. An understanding of how the system works should be consistent in explaining the success of both strategies even though they exploit different inefficiencies. I recently completed my first decade of investing and thought of reflecting on the new things that I learnt or were reinforced due to investing.
Earn your freedom
Spend less than you make; always be saving something. Put it into a tax-deferred account. Over time, it will begin to amount to something. This is such a no-brainer. — Charlie Munger
I had a considerable passion to get rich. Not because I wanted Ferraris — I wanted the independence. — Charlie Munger
Most investment managers are in a game where the clients expect them to know a lot about a lot of things. We didn’t have any clients who could fire us at Berkshire Hathaway. — Charlie Munger
There is a constant debate weather it is nature or nurture that plays a more vital role in the outcomes wherever the two interact. If you would like to become a wheat farmer, would you settle near a river with fertile soil or the desert. Similarly to practice independent decision making , the necessary structure that supports the pursuit should be in place otherwise even with great skill the goal cannot be achieved. The requirements are education, time to study and money that can be invested and not getting margin calls or supervisors/investors that are not aligned. When these aspects are missing, the first thing to do is to create them.
Michelangelo is known to have painted the Sistine Chapel but he was a sculptor and not a painter. He had never painted with the fresco technique which uses a mix of sand and lime that is applied to the wall and color applied quickly while the wall is still wet. He called his friends to learn fresco and even after that painting on a ceiling was very demanding physically. It took him 54 months to paint the whole ceiling and Pope Julius who hired him would not let him leave.
To earn your freedom, you have to do what is needed and sometimes there are hard choices with sacrifices.
In business we often find that the winning system goes almost ridiculously far in maximizing and or minimizing one or a few variables — like the discount warehouses of Costco. — Charlie Munger
Just as in an ecosystem, people who narrowly specialize can get terribly good at occupying some little niche. Just as animals flourish in niches, similarly, people who specialize in the business world — and get very good because they specialize — frequently find good economics that they wouldn’t get any other way. — Charlie Munger
The economy and financial markets are a complex adaptive system and the different agents are interacting with each other and it is difficult to have a mathematical formula to define the system and make future conclusions that are precise. Complex systems can be managed and start from simple rules. Our interaction with the system is as a complex whole and to understand it the simpler rules need to be discovered. The strategy to achieve superior returns is then generated from an understanding of the simple rules.
Purity is defining what you are going to do and what you are not going to do and keeping the focus on purity of the idea. Many people will get feedback from others or make compromises to satisfy ancillary needs or demands. Keeping the purity of the path you want to follow while making something and maintaining harmony with the ecosystem in which it exists is important. As your investment thesis evolves, it needs constant work to improve it and it is like sharpening a knife and not about creating something that can work as a knife, sword and axe. When updates and changes are made, it is to purify the strategy more and adapt it better to it’s environment.
When developing an idea, improve it with diversity but don’t destroy it by committee.
And I also think that one should recognize reality even when one doesn’t like it. Also, I think one should cheerfully endure paradox that one can’t remove by good thinking. — Charlie Munger
The way to win is to work, work, work, work and hope to have a few insights…. And you’re probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It’s just that simple. — Charlie Munger
The returns from investments follow a pareto distribution and when you go for extreme good returns, you are also signing up to look like a fool.There is security in the herd and average returns. It takes courage to stand behind ideas and investments which are not popular and the investments that give extreme results are always non-consensus. Having a margin of safety is the right way to reduce the risk.
Courage is needed to go from 1->10->100->1000->10K->100K->1M->100M->1B->100B. All jumps have risk and courage is needed to keep taking the risks to grow bigger.
Edge of chaos
Pascal said in essence, “The mind of man at one and the same time is both the glory and the shame of the universe.” And that’s exactly right. It has this enormous power. However, it also has these standard misfunctions that often cause it to reach wrong conclusions. -Charlie Munger
I’m afraid that’s the way it is. If there are twenty factors and they interact some, you’ll just have to learn to handle it — because that’s the way the world is. But you won’t find it that hard if you go at it Darwin-like, step by step with curious persistence. You’ll be amazed at how good you can get. — Charlie Munger
This is the place where all value is generated and what differentiates the extreme results from the good results. This is where engineers and scientists make leaps to create innovations. This is where novelty and creativity lives and is always beyond the mathematical tools and towards art. As technology develops, this is the envelope that is being pushed. When the first human walked on moon, it is this boundary that we were pushing to reduce the uncertainty. It is this domain where we keep moving the frontiers as more of art becomes science. It is this domain that brings order to the universe where we saw randomness before.
This is exactly the place where artificial intelligence is today and Apple 1 was in 1975.
It is this place where mispriced bets in the market exist and can be captured with patience and a prepared mind.
It is here that people have different perspectives and where artists, entrepreneurs, investors, scientists and sportsmen start looking more alike in their core. This is where babies are everyday and the human brain has the capacity to learn and move the envelope forward. What we need to do is keep moving and not stop.
This is where Warren Buffett and Charlie Munger calculate the odds for an investment and a formula to calculate the odds does not exist. This is the domain in which Efficient Market Theory is being used to create a model and behavioural economics can punch holes in the theory but cannot provide a new model to replace the rational agents. We will use the tools that increase order over chaos till we get better tools.
The events in this domain are the ones which we are good at rationalizing looking backwards and difficult to make the next prediction.
We all want a formula here to be as successful as Buffett and it doesn’t exist because as more chaos turns into order, the envelope for the next idea is pushed forward. We will be able to make more progress in predictions here by understanding Complex Adaptive Systems and using artificial intelligence tools. The pace of innovation gets faster and half life of new ideas keeps reducing.
When we learn a new skill like coding, investing, driving, swimming or painting, we quickly learn what has already been structured and it requires a bigger commitment to punch through the edge.
I rarely ever think about big themes; our business is a bit more like bird spotting; you don’t look at big flock, you try to pick out each one. You might find odd looking, interesting complected bird in flock that otherwise looks mundane, rather than try to make observation on large flock in any particular area. Can point to late entries into crowded market and then went on to prosper. You want to make sure bird you are picking out can fly for a long time. There is lot to be said for investing in ugly ducklings. — Michael Moritz
Bird spotting works better in identifying opportunities than pattern matching.
It is here that happy accidents happen more often than planned innovation.
The opportunities always exist and can be located by skill or luck or both. Investors have to stay in this domain and develop an understanding to have multi-decade track records. Usually people are able to capitalize on 1–2 opportunities in a 10 year period and then new players exploit other opportunities. To stay here and capitalize on gains for 4–5 decades needs a framework that can detect good opportunities. Even among those who are successful in finding a winning bet, very few can do it repeatedly and the challenge is to keep taking risks and learning at the same pace as a young man. Buffett moved from cigar butts to insurance to premium companies to operator of businesses. GE and 3M have also constantly renewed themselves to be relevant. Steve Jobs was able to go from the Apple 1 to Mac to Next to iPod to iPhone to iPad and that’s the recipe to build a large company. These people are rare.
It is here that the successful ones say “Follow your heart” because the compass for navigation keeps spinning.
It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities. — Charlie Munger
If you took our top fifteen decisions out, we’d have a pretty average record. It wasn’t hyperactivity, but a hell of a lot of patience. You stuck to your principles and when opportunities came along you pounced on them with rigor. — Charlie Munger
The world is setup so that only outcomes and end products are evaluated and rewarded. However a lot of thinking and trial and error is required to learn and prepare to be able to create something and deliver. Patience is needed while external feedback cannot judge you and you cannot see the end yourself. An investment manager cannot be compensated for thinking about ideas but only in return for a profit from an investment. The system is setup correctly and the lion eats if it kills a goat and not just for chasing goats all day. Patience is needed while working towards the goal even though that effort will never be recognized. Keeping patience and learning becomes fun only if a state of “Flow” is experienced in the activity.
1st decade financial performance: Compounded at 12% per annum vs 8% for S&P500
Image from — More Than You Know, Michael Mauboussin
Poor Charlie’s Almanac, The Wit and Wisdom of Charles T. Munger, Edited by Peter Kaufman