Oct 14, 2009|
The mental habits for investment success
Investing is primarily a mental exercise. One can have the best source of resources - money, people and information - but investment success depends mostly on the ability to think. This ability to think is not an isolated exercise of will power; rather it is a habit that takes years of careful cultivation. Among the practicing investors today, there are few who have spend as much time and energy on the topic as Charlie Munger, the Vice Chairman of Berkshire Hathaway and partner of the legendary investor, Warren Buffett. Mr. Munger has very definite views on
the right mental habits required for a successful investor. Following are some of the most important ones:
Munger on knowledge
- Multidisciplinary thinking: Accumulate mental models from multiple disciplines such as mathematics (compound interest, permutations & combinations, decision trees), accounting, psychology, statistics (bell curve), engineering (back up system, break point), physics (critical mass), microeconomics (free markets as ecosystems, monopolies, economies of scale, competitive destruction) etc. Learning from wide sources.
- Simplicity: Concentrate on the simple, obvious things first instead of chasing the esoteric. Try not to be stupid instead of trying to be very intelligent.
- Latticework: Tie the models in a latticework by repeatedly asking the question- why, why, why?
- Checklists: Use checklists with priority given to important points. Give special emphasis on consequences of consequences.
- Vicarious learning: Don't just learn from your own mistakes. Learn from the experience of others. Build upon the best work of the previous generations.
- Eminent dead: Relate concepts to the lives and personalities of the people who developed them.
- Attribute: Always attribute to the original source and prefer their most fundamental explanation. That helps make a good mental filing cabinet.
- Fluency in practice: Gain knowledge to a practice-based fluency if you intend to use it later.
- First things first: Allocate more time to the more important things so that fluency is increased in important areas and disuse eats away only less important things.
- Revise: Revisit knowledge in order to prevent atrophy from disuse.
- Seek the bad news: Seek evidence that contradicts your cherished notions. Test and destroy your best loved ideas.
- Read: Be a voracious reader. Regularly read newspapers and business periodicals.
Munger on thinking
- Patient preparation: Search and wait for a few, clearly recognizable opportunities. Prepare for them by cultivating a curious mind that loves diagnosis involving multiple variables. When the time comes, act promptly and in a large scale.
- Own conclusions: Reach out for your own conclusions instead of cramming others' work. It will help you remember better.
- Apply: Make the effort to tie theories to the real world.
- No-brainers: Simplify problems by deciding big ‘no-brainer' questions first.
- Offence and defense: Know when to concentrate mostly on what you want to happen and when to concentrate mostly on avoiding what you don't want to happen.
- Invert: Complex problems can often be solved by the process of inversion. Think sometimes in forward, sometimes in reverse.
- Lollapalooza effect: Look out for the effect of combination of factors.
- Numerical fluency: Develop numerical fluency.
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