In Memoriam: Charlie Munger

Dear investors,

Last week, news of the death of Charlie Munger, Warren Buffett's partner at Berkshire Hathaway, who would have turned 100 in a month, spread throughout the financial market within minutes. The fame stems not only from Berkshire's size, now valued at around US$800 billion, but also from the fact that Warren Buffett and Charlie Munger inspired a legion of investors attracted not only by Berkshire's success but also by the philosophy of life they followed and preached.

While Buffett fits more into the stereotype of a businessman, diplomatic in his statements, Munger was more transparent and direct, not only in making his founding values clear, but also in openly criticizing anything that went against them.

This mixture of honesty and intellectual generosity meant that Munger, despite not being so adept at public manifestations, left a vast legacy of knowledge in the recordings of the annual meetings of Berkshire Hathaway and the Daily Journal (the latter led by him), in a series of articles and interviews.

In this letter, we will revisit some of Munger's lessons that, over time, have had the greatest impact on shaping both our investment philosophy and our own life ideals. For those interested in learning more about Charlie Munger's life and philosophy, we recommend reading the book Poor Charlie's Almanack.

The sources of human errors

Munger said that, early in life, he was struck by the fact that so many obvious mistakes were made by people, even those who were intelligent and should have been able to recognize the irrationality of their actions. This led him to seek to understand what motivated such failures and what he should do to avoid falling victim to the same fate. Throughout his life, he became a "collector of stupidity," his simple way of referring to the anecdotes about irrational actions that came to his attention.

The topic is less trivial than it might seem. In the 1970s, the first academic studies on what became known as cognitive biases emerged, conducted by Amos Tversky and Daniel Kahneman. Concurrent with the emergence of this academic field, now reasonably well-known among investors, Munger had developed his own system for identifying cognitive biases. Several of his principles are condensed into a lecture given at Harvard University, entitled "The Psychology of Human Misjudgment."

This knowledge has two uses. The first is to use the cognitive bias map to interpret the probabilities of how people might act when faced with investment and business decisions. The second is to understand which biases you yourself are subject to and learn to avoid them, to improve the quality of your own decisions. In our experience, biases affect each person differently, depending on their personality. Therefore, an initial stage of self-analysis is necessary to understand in what types of situations specific biases may influence you, and eternal self-discipline to prevent potential errors. The ideal to strive for is to be purely rational in each and every decision.

“People are trying to be smart. All I'm trying to do is not be stupid, but it's harder than most people think.” – Charlie Munger

Mental models

Avoiding mistakes is already a good first step, but Munger argued that it is possible to greatly expand our cognitive capacity through the cultivation of a series of mental models that serve as a toolbox for interpreting the reality of the world.

The concept of mental models is inevitably abstract: they are archetypal ideas that function as shortcuts to facilitate the understanding of certain situations, as if they were pre-processed deductive chains that can be quickly retrieved to compose more complex lines of reasoning. For example, in economics, the notion that large-scale industrial operations tend to have lower unit costs is a mental model that can be immediately retrieved without having to go through the entire line of reasoning that deduces why this effect occurs.

The main point of Munger's philosophy is that having a few mental models is not enough. Reality is complex, and multiple angles of analysis are often necessary to understand, for example, how a business might develop over time. Furthermore, reality does not respect the divisions between areas of knowledge created by academics, so it is common for the mental models required to understand a business to be related not only to economic theories, but also to several other fields (psychology, politics, physics, chemistry, biology, etc.). Therefore, an investor must be willing to study whatever is necessary to understand their object of analysis, regardless of the academic field in which the knowledge of interest lies.

The risk of being too specialized is losing your perspective. With his characteristic humor, Munger illustrated this risk by saying that "to the man with only a hammer, everything looks like nails."

"What you need is a network of mental models in your head. And with this system, things gradually fall into place in a way that expands cognition." – Charlie Munger

Circle of competence

Since knowing everything is a utopian ideal, despite the willingness to overcome any artificial barriers created between academic departments, it's important to be realistic about your own ability to analyze a given case. That is, always start by assessing whether your current knowledge is sufficient to analyze a specific investment thesis. This boundary of your own knowledge's reach is what Buffett and Munger called the circle of competence.

For investors, the first recommendation is to never step outside your circle of expertise. Rather than trying to develop opinions on anything, it's safer to select only those investment opportunities that you have a deep understanding of and form more assertive opinions about. The remaining opportunities, which are outside your circle of expertise, should be avoided due to the risk of misinterpretation caused by your own lack of knowledge about the specifics of the case.

Defining your own circle of competence is an exercise in humility, but not conformity. The boundaries of your knowledge are not fixed and can be continually expanded as you dedicate more and more time to studying new topics. Munger said that Buffett's secret to success is that he never stopped learning new things. Even after becoming extremely wealthy and at a very advanced age, he continued studying and learning.

“Being aware of what you don't know is more useful than being brilliant.” – Charlie Munger

Slow debugging

Munger once criticized the modern trend toward increasingly shorter attention spans. Going in the exact opposite direction, he attributed much of his success to his ability to maintain focus on a subject of interest for long periods, as long as necessary to deeply understand and fully absorb each new piece of knowledge.

Despite the apparent lack of agility this approach can bring, investing the time necessary to fully master new concepts allows you to react more quickly to situations that continually arise. Buffett once said, "Charlie can analyze any business faster and more accurately than anyone else. He sees any potential weakness in sixty seconds." This account illustrates the result of a life dedicated to the patient and constant refinement of countless mental models.

Munger also said, "Consider a simple idea seriously," emphasizing that simplicity is sometimes the result of long, hard work understanding the world's deep truths and condensing them into a memorable format. People often overlook the impact of simple concepts, judging them too trivial to explain high-impact situations, but it's common for widely known factors to be the most decisive variables in business scenarios.

The philosophy of value investing itself is quite simple: look for predictable and resilient businesses, wait until you have the opportunity to buy them cheaply, and have the patience to wait for the investment to yield results. However, even with this simple and widely proven successful method, much of the investing public continues to search for new miraculous investment methods.

“I didn't succeed in life because I was smart. I succeeded because I had long attention spans.” – Charlie Munger

Independent thinking

Seeking to personally understand the principles and logic behind each opinion, rather than simply accepting that the most popular view is correct, is a general concept valid for any field, but especially important in the field of investments. Inevitably, the greatest investment opportunities will be related to cases in which an investor is simultaneously correct and contrary to the general market opinion. This inevitability stems from the fact that, if the market were of the same opinion, the price of the analyzed asset would already reflect expectations and would no longer offer exceptional returns. Therefore, an investor aspiring to above-average returns must be willing to maintain their convictions in disagreement with the majority of their peers.

It's worth noting here that going against the market, pure and simple, is not a recommended strategy. In most cases, the analyst and investor community is correct, and, by default, always acting in the opposite direction tends to produce poor results. The goal should be to identify the few situations you understand better than the average and act with conviction when the market is contrary to your own well-founded view.

“Everyone is wrong except Charlie.” – Charlie Munger

Discipline and patience

Finally, we emphasize that none of the lessons summarized here are tricks or shortcuts that make investing easier. Despite the simplicity of the recommendations, their implementation requires constant effort over long periods. This is another mental model that can be easily incorporated: true human excellence is achieved through decades of dedication to self-development, not through magical methods that allow for quick results. Developing vast knowledge depends on thousands of hours invested in accumulating information in memory, and human intelligence requires a certain amount of methodological refinement to be used to its full potential.

Therefore, the best investors will naturally be those who adopt good methods and dedicate their lives to studies and constant self-development.

"To get what you want, you have to earn it. The world isn't a crazy enough place yet to reward a bunch of undeserving people." – Charlie Munger

We are deeply grateful to Charlie Munger for his shared knowledge and example of life. May his memory and philosophy live on for generations of investors to come.