Charlie Munger on Mistakes & Learning

At the 2022 Berkshire annual meeting - Munger's last before his death in November 2023 - he was characteristically blunt about what he refused to touch. He told the audience that he tried to avoid things that were evil, stupid, and made him look bad relative to someone else. The formulation compressed Munger's lifelong filter into a single line: a thing did not have to be all three to be avoided; any one of the three was sufficient. The investor who internalized the rule would refuse most of the propositions the market pressed on him. He sharpened the point with reference to crypto. Munger had been a public critic of cryptocurrency for years, and at the 2022 meeting he did not soften. He told the audience that he regarded crypto as a disgusting development and that those who promoted it were, in his view, either deluded or self-interested. He did not pretend that the asset class might be a legitimate innovation in payments or a hedge against monetary debasement; he treated it as a speculation that exploited the same incentive biases and psychology of crowds that had produced every previous speculative mania, and he refused to participate in any form. The avoidance principle, in Munger's telling, was not the absence of strategy. It was the strategy. The things he refused to touch - crypto, complex derivatives, structured products, financial engineering generally - defined the perimeter inside which he was willing to operate. The perimeter was deliberately narrow. The great investment decisions inside the perimeter - See's, Coca-Cola, BYD, Costco, the Japanese trading houses - had produced returns that an investor following the broader market could not have matched. The avoidance of the evil and the stupid was, paradoxically, what made the great investments possible.

At the 2022 Daily Journal annual meeting, I told the audience that the discipline of staying within the circle of competence had been, over my seven decades of investing, the single most valuable discipline I had acquired. The discipline required is to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom, and even at the cost of being told, repeatedly, that I am missing the opportunity of a lifetime. The mistakes-and-learning point I tried to convey was that the boom, in its broad patterns, is the product of investors acting outside their circles on the assumption that they understand the new things, and the investor who recognises the assumption, and who refuses to act outside his circle, has a long-run advantage over the investor who chases the new things. The discipline required is honesty about the boundary of the circle, and the willingness to admit that the boundary is smaller. The circle-of-competence element was the one I had most wanted to convey. I had made my own share of mistakes by acting outside my circle, on the assumption that I understood the new things, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the boundary of his circle is smaller than he would prefer, and he must build the discipline of refusal into his process before the temptation to act outside the circle becomes irresistible. The 2022 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor who chases the new things. The mistakes-and-learning lesson I tried to convey was that the investor who is honest about the boundary of his circle, and who refuses to act outside it, has an enormous advantage over the investor who pretends to understand more than he does. The 2022 meeting was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act outside the circle, and to expand the circle only by deliberate study. The investor who is honest about the boundary, and who refuses to act outside it, will, in the long run, outperform the investor with the larger circle who pretends to understand more than he does. That single discipline, applied over a working life, has been more valuable than any other I have learned, and it is the one I have tried hardest to convey to the students who visit Pasadena each spring.

At the 2021 Daily Journal annual meeting, I told the audience that the previous year, with its pandemic shutdown and its rapid recovery, had been the most instructive of my investing life, not because I had made many new mistakes, but because the old mistakes had been repeated by a new generation of investors, at a scale that had produced the largest speculative bubble in technology stocks since 1999. The market-psychology point I tried to convey was that the crowd, in its broad patterns, repeats the same mistakes in every cycle, because the incentives facing the participants are the same in every cycle, and the biases facing the participants are the same in every cycle. The investor who recognises the patterns, and who refuses to participate in the new version of the old mistake, has a long-run advantage over the investor who assumes that the new version is different. The discipline required is to read the history, to recognise the patterns. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes in the previous year, by being too cautious during the recovery, and the cost of the caution had, in opportunity terms, been very large. The lesson I drew was that the disciplined investor must be willing to act during a recovery, even when the outlook is unclear, and even when the prices may go lower before they go higher. The 2021 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to wait for clarity, and to act when the prices were attractive, even at the cost of being early. The investor who builds the discipline of acting during the recovery will outperform the investor who waits for clarity. The market-psychology lesson I tried to convey was that the crowd, in its broad patterns, is the aggregate of the investors acting on the assumption that the new technology has repealed the old rules, and the investor who recognises the assumption, and who refuses to participate, has an enormous advantage over the investor who chases the new technology. The 2021 meeting was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to read the history, to recognise the patterns, and to refuse to participate in the new version of the old mistake, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor with the higher IQ who participates on the assumption that the new version is different.

Munger closed the 2019 meeting with a series of operating lessons drawn from Berkshire's history. He pointed to the founding businesses of Berkshire Hathaway - a doomed department store, a doomed New England textile company, and a doomed trading stamp company - and said that out of that mix came Berkshire. They had handled those losing hands pretty well and they had bought into them very cheaply. But, Munger said, of course the success came from changing their ways and getting into better businesses. The lesson was that scrambling out of mistakes without letting them cost too much is a real and underappreciated part of long-run compounding. He sharpened the point. It isn't that we were so good at doing things that were difficult, he said. We were good at avoiding things that were difficult, and finding things that were easy. The inversion of the popular image of Berkshire - which celebrates Buffett and Munger as patient geniuses who solve the hardest problems - was deliberate. Munger was telling the room that the actual edge was in saying no to the hard stuff and saying yes only when the proposition was simple, durable, and within reach. He connected the lesson to expectations and to China. His advice to a seeker of compound interest that works ideally was to reduce expectations, because he thought returns were going to be tougher for a while, and that having realistic expectations made you less crazy. On China, he repeated his 2017 line: the great companies in China were cheaper than the great companies in the United States. And he closed with the too-hard pile again - there was a pile on his desk, he said, that solved most of his problems. Every once in a while an easy decision came along and he made it. That was the system.

At the 2017 Berkshire annual meeting, I told the audience that the previous decade, with its enormous expansion of the Chinese economy and the corresponding expansion of the Chinese capital markets, had been the most instructive of my investing life, not because I had made many new mistakes, but because the old mistakes had been repeated by a new generation of investors, at a scale that had produced the largest speculative bubble in Chinese real estate in modern history. The market-psychology point I tried to convey was that the crowd, in its broad patterns, repeats the same mistakes in every cycle, because the incentives facing the participants are the same in every cycle, and the biases facing the participants are the same in every cycle. The investor who recognises the patterns, and who refuses to participate in the new version of the old mistake, has a long-run advantage over the investor who assumes that the new version is different. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes in the previous decade, by being too cautious during the expansion of the Chinese capital markets, and the cost of the caution had, in opportunity terms, been very large. The lesson I drew was that the disciplined investor must be willing to act during an expansion, even when the outlook is unclear, and even when the prices may go lower before they go higher. The 2017 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to wait for clarity, and to act when the prices were attractive, even at the cost of being early. The investor who builds the discipline of acting during the expansion will outperform the investor who waits for clarity. The contrarianism lesson I tried to convey was that the investor who refuses to participate in the speculative bubble, looks unfashionable during the boom, and he is told, repeatedly, that he is missing the opportunity of a lifetime. The same investor, during the crash, looks unfashionable in the opposite direction, because he is buying when the crowd is panic-selling, and the crowd cannot understand why anyone would buy into a falling market. The 2017 meeting was, in some ways, the most contrarian I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to participate in the speculative bubble, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor who participates on the assumption that the new version is different.

Munger told the 2017 audience that the Daily Journal and Berkshire Hathaway had succeeded, more than anything else, by refusing to attempt to know too much. He kept a too-hard pile on his desk, he said, and most of the problems that crossed his path got shifted onto it. Every once in a while an easy decision came along, and he made it. That, he said, was his entire system. The room laughed, but Munger meant it as a serious investment philosophy. He tied the too-hard pile to the discipline of patience. A normal human life does not have very many great decisions in it. He told the audience that if they actually counted the meaningful decisions made in the history of the Daily Journal Corporation or the history of Berkshire Hathaway, the number per year was not very high. The game was being there all the time, recognizing the rare opportunity when it came, and recognizing that normal human life does not contain very many such moments. He contrasted this with what he called the racetrack tout - the people who sell securities and act as though they have an endless supply of wonderful opportunities. Those people, Munger said, are not even respectable. They pretend to know a lot of stuff they do not know, and pretend to furnish opportunities they are not furnishing. His advice to the audience was to avoid them - unless, he added with characteristic dryness, you happen to be running a stock brokerage firm, in which case you need them. The honest investor's job was to recognize the rarity and to refuse to manufacture the frequent.

Charlie Munger: No, of course not. Different businesses get different treatments. They all are viewed in terms of value, and they’re weighed one against another. But a person will pay more for a good business than for a lousy one. We really don’t want any lousy businesses anymore. We used to make money betting on reinventing lousy businesses and kind of wringing money out of them, but that is a really painful, difficult way to make money, especially if you’re already rich. We don’t do much of it anymore. Sometimes we do it by accident, because one of our businesses turns lousy, and in that case it’s like dealing with your relatives you can’t get rid of. We deal with those as best we can, but we’re out looking for new ones. Questioner: Mental models [which are your favorites]? Charlie Munger: If you’re talking about multiple models, that means you think about many different models, and that’s the nature of reality, particularly if you’re an investor. There’s no way to make that easy. You all are in the business: Do you find it easy? Anybody who finds it easy is wrong. You’re living in an illusion. It’s not easy. Occasionally you get an easy one, but not very many. Mostly it’s hard. How many people find it hard to make good investments right now? [Audience raises hands] An intelligent group of people. We collect them. Questioner: You’ve talk about making an effort to eliminate standard error risk in terms of not participating in auctions.

-7- Charlie Munger: Two things Warren and I do: One is that we spend a lot of time thinking. Our schedules are not that crowded, and we’re constantly—we look more like academics than we look like businessmen. Our system has been to sift life for a few opportunities and seize a few of them, and we don’t mind if nothing happens. And Warren is exactly the same way. Warren’s sitting on top of an empire now, but you look at his schedule sometimes and it says, “a haircut. Tuesday, haircut.” That’s what created one of the most successful business records in history: he has a lot of time to think. And that brings me to the subject of multi-tasking. All you people have gotten very good at multi- tasking. And that would be fine if you were the chief nurse in a hospital, but as an investor I think you’re on the wrong road. Multi-tasking will not lead you to the highest quality of thought a man capable of doing. Juggling two or three balls at once, where people come at you on their schedule not yours is not an ideal thinking environment. Luckily, a lot of you are so obscure that you have plenty of time to think. [Laughter] I was in that position for a long time, and it helped me. And I hope it works well you. If it doesn’t, I think you’re going to have to be satisfied with life in the shallows, because if it didn’t work for me, I didn’t have a [backup plan]. I wasn’t going to dance the lead in the Bolshoi ballet or stand on the mound at Yankee Stadium.

-10- agree with Cicero. It’s okay to live the kind of a life that you’re kind of pleased with when you’re old and look back. My advice is always so trite. The good behavior, the being dependable, the morality – it makes your life easier, it makes it work better. You don’t have to remember your lies, which gets complicated if you’re lying all the time. In fact, it gets so complicated you’re sure to fall off and be recognized as a liar. And so, sure, I like all the old-fashioned morality words, all the old- fashioned discipline words, and the old- fashioned good behavior, and a little generosity. We all know people who come to the funeral to make sure they’re [sic] dead. You don’t want to be in that trap. You want to live your life so some people will actually miss you when you’re gone. I think Kipling’s “If” is great poetry. Kipling doesn’t exist in the modern college anymore; he wasn’t politically correct. Well I Kipling’s “If” is great poetry and it’s great advice. “Keep your head when all about you are losing theirs.” What’s wrong with that? “Be a man, my son.” Why don’t you want to be a man? You want to be some idiot child all your life? Some angry twit? There’s so much to gain by never being an angry twit. You want be philosophical. This political situation we all face now. Of course, it’s a disgrace. I mean, it’s bad that the leading civilization has these candidates for high office. And they’re not all in one party. But you don’t want to get angry.

He has to eat the same food, watch the same television, leave the money to something . . . Is he the main problem we have? He’s not really using the wealth very much. And most of these guys are not that interested in politics. People who like to talk about the [wealthy’s] terrible influence on politics. If you’re rich you realize how little influence the rich really have. You see a lot of people lay out a lot of money, who are rich, and get practically nowhere. So I think these people who are raging about inequality, like Warren and Sanders, are wrong; but I think the people who say the undeserved wealth deserves some attention, I think they’re right. And I think a huge source of the undeserved wealth is coming from finance. Questioner: You mentioned Wells Fargo and its culture, [as] the reason why you [got involved] back in the 80s. [You also own] Bank of America, and its culture is a little different. And I’m curious [about] the decision of buying Bank of America. Charlie Munger: The Bank of America was bought the way we used to buy securities . . . It was selling for less than a quarter, way less [than it was worth]. Questioner: I’m pretty excited about the prospects on self-driving cars in the next ten to twenty years. It seems like the technology is moving very quickly. But as a Berkshire shareholder I’m worried about the implications for the entire auto insurance industry if accidents, hopefully, become a thing of the past.

At the 2015 Daily Journal meeting, Munger described the company's pivot from print legal journalism to court-automation software as the equivalent of trying to climb Half Dome in Yosemite with one arm and one leg. The franchise had been a wonderful business - a monopoly on prompt appellate court decisions, year after year of price increases. Then the internet came along and destroyed the position. Daily Journal's circulation went way down, and the publishing business shrank with it. The decision to replace the dying newspaper with software sold to courts and government agencies was, Munger said, probably not a terribly good decision at the time. They tried it anyway. A great boom in foreclosure notices temporarily flooded Daily Journal with revenue, and the company used that transient cash to build the software business partly by purchase and partly by self-development. The odds were against them, Munger admitted. He used the rock-climbing term five-eleven to describe what they were attempting - a route that is not really possible, but that occasionally somebody does climb. He told shareholders that for some strange reason Daily Journal was now about halfway up Half Dome with its one arm and one leg. Software revenues had crossed the level of the traditional business. He was candid that the cost had been heavy and would continue to be heavy, but said he thought about the spend the way Jeff Bezos does: there is no point in being rich if you don't use it to compete effectively. He closed by saying that the kind of business they were building was so hard that competitors like Microsoft hated it. That difficulty, in Munger's calculus, was the only reason the opportunity existed at all.

Munger used the 2015 meeting to draw an explicitly Darwinian picture of corporate mortality. The room was watching one business die while the company tried to replace it with another. Most of the other newspaper companies that had tried to do the same thing had failed. Some of them had bought other businesses - television stations, for instance - with the profits they had, but most of the ones that simply tried to take their newspaper and transform it into something else had failed. That, Munger said, is the common result. The lesson was that technological change is one of the hardest things to cope with, which is why so many incumbents fail at it. He reached for three exhibits. Kodak had owned the world in silver-based photography, was the dominant company on the planet, the second most important trademark in the world, with armies of PhD chemists who knew more about silver-based photography than anybody. It had been a fabulous business right through the Great Depression - a total widow-and-orphan stock. And then it wiped out its shareholders with technological change. General Motors had been the most important automobile company in the world when Munger was young - number two was not close - and it too wiped out its shareholders. IBM had gone from butchers' scales to dominating the early computer market, and when the next evolution came along it failed a lot. Munger said Bill Gates had told him it happens again and again and again when the technology changes enough. The age of Daily Journal's board - the youngest director was 60 and Munger, the chairman, was 91 - only underlined the absurdity of attempting a Half Dome pivot. He told the room, with characteristic understatement, that he didn't understand computing. But he was doing it anyway, because the alternative was to accept the slow death of the print franchise.

At the 2014 Daily Journal annual meeting, Munger returned to one of his favorite themes - the slow death of the print newspaper business, and the specific case of Daily Journal's own former moat. The company had once held a near-monopoly on the prompt publication of California appellate court decisions, a service the legal profession could not do without. Every year, Munger noted, the company raised subscription prices and every year its customers paid. That, he said, was a wonderful business. He was unsentimental about what had broken the moat. Technology changed, lawyers stopped needing the print product for information about appellate decisions, and the newspaper business shrank. The franchise did not collapse in a single quarter; it bled out over many years as the internet absorbed the function the print product had once owned. Munger treated the decline as a textbook case of how a durable franchise stops being durable the moment its distribution advantage is bypassed by a cheaper technology. The lesson he drew for the room was not nostalgia but discipline. Companies with that kind of historical monopoly do not deserve permanent worship; they deserve to be re-underwritten every year against the technology that could displace them. The same logic that emptied out the legal newspaper's circulation is what emptied out Kodak's silver-based photography and what emptied out the Sears catalog. The job of the long-term owner is to keep re-checking the moat, not to keep telling the old story.

At the 2013 Daily Journal annual meeting, I told the audience that the discipline of inversion, applied to the question of how to allocate capital, produced a different portfolio from the discipline of pursuing the highest expected return directly. The inverter asks the opposite question: what would guarantee the destruction of capital, and how can I avoid that? The capital-allocation-discipline point I tried to convey was that the investor who enumerates the failure modes, and who refuses to do the things that would produce them, has a long-run advantage over the investor who chases the highest expected return without considering the failure modes. The discipline required is to slow down, to write down the failure modes, and to refuse to act until the failure modes have been enumerated and the actions that would produce them have been refused, even at the cost of looking indecisive during the boom. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes by pursuing the highest expected return without enumerating the failure modes, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the failure modes are present in every decision, and he must build the discipline of inversion into his process before the decision is made. The 2013 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act until the failure modes had been enumerated and the actions that would produce them had been refused. The investor who builds the discipline of inversion will outperform the investor who chases the highest expected return directly. The capital-allocation-discipline lesson I tried to convey was that the investor who avoids the destruction of capital, and who allows the desired outcome to emerge from the avoidance, has a long-run advantage over the investor who chases the highest expected return directly, because the things that produce the destruction of capital are well known and easy to avoid, and the things that produce the highest expected return are difficult to obtain and easy to lose. The 2013 meeting was, in some ways, the most useful I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to do the things that would produce the destruction of capital, and to allow the desired outcome to emerge from the avoidance. The investor who builds the discipline of inversion will outperform the investor with the higher IQ who chases the highest expected return directly.

At the 2012 Daily Journal annual meeting, I told the audience that the European debt crisis had been the most instructive event of the previous two years, because it had revealed, once again, that the credit cycle does not end in scarcity; it ends in abundance, when lenders, having forgotten the losses of the previous scarcity, begin lending freely again to borrowers who cannot repay. The market-psychology point I tried to convey was that the crowd, in its broad patterns, is the aggregate of the lenders acting on the assumption that the scarcity is over, and the investor who recognises the pattern, and who refuses to participate in the new abundance, has a long-run advantage over the investor who chases the new loans on the assumption that the scarcity is over. The discipline required is to read the history, to recognise the patterns, and to refuse to participate, even at the cost of looking unfashionable. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes in the previous two years, by being too cautious during the European debt crisis, and the cost of the caution had, in opportunity terms, been very large. The lesson I drew was that the disciplined investor must be willing to act during a crisis, even when the outlook is unclear, and even when the prices may go lower before they go higher. The 2012 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to wait for clarity, and to act when the prices were attractive, even at the cost of being early. The investor who builds the discipline of acting during the crisis will outperform the investor who waits for clarity. The contrarianism lesson I tried to convey was that the investor who acts during a crisis, when the headlines are still terrifying, looks unfashionable in the extreme, because the crowd cannot understand why anyone would buy into a falling market. The same investor, during the recovery, looks unfashionable in the opposite direction, because he is holding on through the early volatility, and the crowd cannot understand why anyone would refuse to sell at the first sign of a paper loss. The 2012 meeting was, in some ways, the most contrarian I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to wait for clarity, and to act when the prices were attractive, even at the cost of being early and unfashionable. The investor who builds the discipline of acting during the crisis will outperform the investor who waits for clarity.

At the 2010 Daily Journal annual meeting, I told the audience that the previous two years had been the most instructive of my investing life, not because I had made many new mistakes, but because the old mistakes had been repeated by a new generation of investors, at a scale that had produced the largest credit crisis in eighty years. The market-psychology point I tried to convey was that the crowd, in its broad patterns, repeats the same mistakes in every cycle, because the incentives facing the participants are the same in every cycle, and the biases facing the participants are the same in every cycle. The investor who recognises the patterns, and who refuses to participate in the new version of the old mistake, has a long-run advantage over the investor who assumes that the new version is different. The discipline required is to read the history, to recognise the patterns, and to refuse to participate. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes in the previous two years, by being too cautious during the recovery, and the cost of the caution had, in opportunity terms, been very large. The lesson I drew was that the disciplined investor must be willing to act during a recovery, even when the outlook is unclear, and even when the prices may go lower before they go higher. The 2010 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to wait for clarity, and to act when the prices were attractive, even at the cost of being early. The investor who builds the discipline of acting during the recovery will outperform the investor who waits for clarity. The market-psychology lesson I tried to convey was that the crowd, in its broad patterns, is the aggregate of the mistakes facing the participants, and the investor who recognises the patterns, and who refuses to participate, has an enormous advantage over the investor who assumes that the new version of the old mistake is different. The 2010 meeting was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to read the history, to recognise the patterns, and to refuse to participate in the new version of the old mistake, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal, and who applies it consistently over a working life, will, in the long run, outperform the investor with the higher IQ who participates on the assumption that the new version is different.

At the USC Law commencement in May 2007, I told the graduating class that one of the most useful pieces of mental machinery I had ever acquired was the discipline of staying within my circle of competence. The circle is the set of things I genuinely understand, as opposed to the set of things I think I understand. The discipline required is to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom, and even at the cost of being told, repeatedly, that I am missing the opportunity of a lifetime. The mistakes-and-learning point I tried to convey was that the investor who stays within his circle, and who refuses to act on the things outside it, has a long-run advantage over the investor who chases the things outside the circle on the assumption that he understands them. The discipline required is honesty about the boundary of the circle. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes by acting outside my circle, on the assumption that I understood them, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the boundary of his circle is smaller than he would prefer, and he must build the discipline of refusal into his process before the temptation to act outside the circle becomes irresistible. The USC commencement was, in this sense, a confession. I told the graduating class that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom. The single discipline, applied over a working life, has been more valuable than any other I have learned. The circle-of-competence lesson I tried to add was that the boundary of the circle is not fixed. The disciplined investor can, over time, expand the boundary by deliberate study, but the expansion must be honest, and the temptation to pretend the boundary is larger than it is must be resisted. The USC commencement was, in some ways, the most honest I had ever given. I told the graduating class that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, and to expand the circle only by deliberate study. The investor who is honest about the boundary, and who refuses to act outside it, will, in the long run, outperform the investor with the larger circle who pretends to understand more than he does.

At the USC Law commencement in May 2007, I told the graduating class that the most useful piece of mental machinery I had ever acquired was the habit of inversion. Most people, when they want to solve a problem, ask how to achieve the desired outcome. The inverter asks the opposite question: what would guarantee failure, and how can I avoid that? The contrarianism angle I tried to convey was that the habit of inversion, applied to investing, produces a different portfolio from the habit of pursuing the desired outcome. The investor who asks what would guarantee failure in his portfolio, and who then refuses to do those things, has a long-run advantage over the investor who chases the desired outcome without considering the failure modes. The discipline required is to enumerate the failure modes, to refuse to do the things that would guarantee failure, and to allow the desired outcome to emerge from the avoidance of the failures. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes by pursuing the desired outcome without enumerating the failure modes, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the failure modes are present in every decision, and he must build the discipline of inversion into his process before the decision is made. The USC commencement was, in this sense, a confession. I told the graduating class that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act until the failure modes had been enumerated and the actions that would produce them had been refused. The single discipline, applied over a working life, has been more valuable than any other I have learned. The contrarianism lesson I tried to add was that the habit of inversion, applied to the broader question of how to live a good life, produces a different life from the habit of pursuing the desired outcome directly. The man who asks what would guarantee a miserable life, and who then refuses to do those things, has a better life than the man who chases happiness directly, because the things that produce a miserable life are well known and easy to avoid, and the things that produce happiness are difficult to obtain and easy to lose. The USC commencement was, in some ways, the most personal I had ever given. I told the graduating class that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to do the things that would guarantee failure, and to allow the desired outcome to emerge from the avoidance. The same discipline, applied to investing and to life, has been the most useful thing I have learned in six decades of work.

At the USC Law commencement in May 2007, I told the graduating class that the most useful piece of mental machinery I had ever acquired was the discipline of avoiding stupidity, rather than seeking brilliance. Most people, when they want to succeed, ask how to be brilliant. The inverter asks the opposite question: what would guarantee stupidity, and how can I avoid that? The mistakes-and-learning point I tried to convey was that the investor who avoids stupidity, and who allows the desired outcome to emerge from the avoidance, has a long-run advantage over the investor who chases brilliance directly, because the things that produce stupidity are well known and easy to avoid, and the things that produce brilliance are difficult to obtain and easy to lose. The discipline required is to enumerate the stupidities, to refuse to do the things that would produce them, and to allow the desired outcome to emerge from the avoidance. The contrarianism angle was the one I had most wanted to add. The investor who avoids stupidity, and who allows the desired outcome to emerge from the avoidance, looks unfashionable during the boom, because he refuses to participate in the things that the boom is rewarding, and the things the boom is rewarding are often the things that produce stupidity. The same investor, during the crash, looks unfashionable in the opposite direction, because he is buying when the crowd is panic-selling, and the crowd cannot understand why anyone would buy into a falling market. The discipline required to refuse to participate in the boom, and to participate aggressively in the crash, is the single hardest discipline in investing, and it is the one that the avoidance framework was designed to support. The investor who has the framework has an enormous advantage over the investor who chases brilliance directly. The mistakes-and-learning lesson I tried to convey was that the investor who is honest about his own capacity for stupidity, and who builds the discipline of avoidance into his process, has an enormous advantage over the investor who assumes that he is too smart to be stupid. The USC commencement was, in some ways, the most personal I had ever given. I told the graduating class that the framework had been built, in large part, from my own stupidities, and that the discipline I had extracted was to refuse to do the things that would produce them, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of avoidance, and who applies it consistently over a working life, will, in the long run, outperform the investor with the higher IQ who assumes he is too smart to be stupid. That single discipline has been more valuable than any other I have learned.

Munger told the graduates that he had figured out, very early, that there is no love so right as admiration-based love, and that such love should include the instructive dead. He lived by that idea, he said, and it had been very useful to him. The opposite kind of love, the compulsive attachment-driven sort celebrated in Somerset Maugham's Of Human Bondage, he described as a sickness, a disease. If you find yourself in its grip, his advice was to turn around and fix it; eliminate it. He paired that lesson with what he called the funeral test. He had read somewhere, he said, of a man who had lived such that, at his funeral, the preacher had invited anyone to stand up and say something nice about the deceased. Nobody came forward. Nobody came forward. Nobody came forward. Finally one man rose and said, 'Well, his brother was worse.' Munger told the audience that is not where you want to go. That is not the kind of funeral you want to have. You will leave entirely the wrong example. The takeaway for the room was that living admirably, being the kind of person other people name in their wills to raise their children, is not a soft virtue but a shrewd one. People who are admired, who can be trusted with the most important commitments other people make, end up doing something very right. The moral framing and the practical outcome run in the same direction.

Munger extended the derivatives critique into a broader indictment of modern financial engineering. The same incentives that produced the gallbladder surgeon - the man who had convinced himself that removing the organ was the right answer because the procedure paid him - produced the derivatives desk that built the structured product because the structured product paid the desk. The customer's interest and the seller's interest were aligned only at the surface; at the level of incentives, they were routinely in conflict. Munger told the audience to be deeply suspicious of any investment product created by professionals and aggressively merchandised. He tied the point to credit cycles. The derivatives web had grown during the easy-money years because the contracts looked profitable when credit was loose and counterparty risk was underpriced. When credit tightened, those same contracts would re-price violently and the unwinding would itself become a credit event. The derivatives problem and the credit-cycle problem were therefore not separate pathologies; they were two faces of the same pathology. Munger's prescription was to stay liquid, stay simple, and stay out of contracts whose payoffs depended on a counterparty's solvency in a crisis. He closed with a historical note. The Defense Department had, after enough experience with cost-plus-percentage-of-cost contracts, made it a felony for the federal government to write one. Munger took that as proof of concept: when a contract structure was so incentive-misaligned that even the government eventually criminalized it, the private sector's continued use of the same logic - in cost-plus mutual fund fees, in derivatives desks, in private equity carry - was not innovation but recidivism. The investor who recognized the pattern had a structural edge.

The 2003 Wesco meeting is also notable as the public precursor to Munger's Psychology of Human Misjudgment speech. Tilson's notes flagged that Munger was, in the meeting, already working through the material that he would shortly deliver at Harvard as the 24 standard causes of human misjudgment. The Wesco audience heard the same psychological framework that the Harvard audience would hear, applied to insurance underwriting, banking, and corporate governance rather than to the general investor. Munger's argument, in both venues, was that the standard survey course in psychology had failed to give investors the tools they needed because the course had badly underweighted incentive-caused bias. He told the Wesco audience that if they read the standard thousand-page psychology text they would find, somewhere in the back, one sentence on incentive bias - and yet incentive bias was, in his experience, the single most powerful driver of bad decisions in business and investing. The prescription was to learn the real list of cognitive biases - the ones Munger had compiled from his own experience - and to apply them as rigorously to one's own decisions as to other people's. He closed with the lollapalooza warning. The really catastrophic failures of judgment, Munger said, came not from any single bias operating alone but from several biases reinforcing each other in the same direction. Incentive bias plus consistency bias plus social proof plus authority bias, all pointing the same way, could produce a decision that no individual bias could have produced on its own. The lollapalooza effect was the reason that crowds of intelligent people could collectively do very stupid things. The defense was the latticework of mental models - to recognize the lollapalooza pattern in real time and refuse to participate in it, even when the social pressure to participate was intense.

At the 2002 Berkshire annual meeting, I told the audience that the previous year, with its revelations about Enron and the gradual unwinding of the technology bubble, had confirmed what I had long believed about the discipline of reading accounting footnotes and refusing to invest in businesses whose accounting I could not understand. The market-psychology point I tried to convey was that the crowd, in its broad patterns, repeats the same mistakes in every cycle, because the incentives facing the participants are the same in every cycle, and the biases facing the participants are the same in every cycle. The investor who recognises the patterns, and who refuses to participate in the new version of the old mistake, has a long-run advantage over the investor who assumes that the new version is different. The discipline required is to read the footnotes, to recognise the patterns, and to refuse to participate, even at the cost of looking unfashionable during the boom. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes in the previous two years, by being too cautious during the recovery from the technology crash, and the cost of the caution had, in opportunity terms, been very large. The lesson I drew was that the disciplined investor must be willing to act during a recovery, even when the outlook is unclear, and even when the prices may go lower before they go higher. The 2002 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to wait for clarity, and to act when the prices were attractive, even at the cost of being early. The investor who builds the discipline of acting during the recovery will outperform the investor who waits for clarity. The capital-allocation-discipline lesson I tried to convey was that the investor who reads the footnotes, and who refuses to invest in businesses whose accounting he cannot understand, has a long-run advantage over the investor who chases the prices on the assumption that the accounting is honest. The 2002 meeting was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to read the footnotes, to refuse to invest in businesses whose accounting I could not understand, and to act when the prices were attractive, even at the cost of being early and unfashionable. The investor who builds the discipline of refusal will outperform the investor with the higher IQ who chases the prices on the assumption that the accounting is honest.

The nature of our non-KBS insurance business was roughly described in our year 2000 Annual Report wherein we reported to shareholders that we were not currently active in super-catastrophe reinsurance and had never suÅered a super-catastrophe loss, but that shareholders should continue to realize that Wes-FIC's marvelous underwriting results were sure to be followed, sometime, by one or more horrible underwriting losses. When we said that, we had in mind a natural catastrophe. But, instead, in 2001 we were clobbered by a man-made catastrophe on September 11 Ì an event that delivered the insurance industry its largest loss in history. Fortunately, we recorded a loss of only $10 million before income taxes ($6.5 million, after taxes) in connection with that event. The $10 million is an estimate and is subject to considerable estimation error. It will literally take years to resolve complicated coverage issues, as well as to develop an accurate estimation of insured losses that will ultimately be incurred. That $10 million, however, was the principal cause of our substantial underwriting loss in 2001. At the end of 2002 we retained about $15 million in invested assets, oÅset by claims reserves, from our former reinsurance arrangement with Fireman's Fund Group. This arrangement was terminated August 31, 1989.

The nature of our non-KBS insurance business was roughly described in our year 2000 Annual Report wherein we reported to shareholders that we were not currently active in super-catastrophe reinsurance and had never suÅered a super-catastrophe loss, but that shareholders should continue to realize that Wes-FIC's marvelous underwriting results were sure to be followed, sometime, by one or more horrible underwriting losses. When we said that, we had in mind a natural catastrophe. But, instead, we were clobbered by a man-made catastrophe on September 11 Ì an event that delivered the insurance industry its largest loss in history. Fortunately, we recorded a loss of only $10 million, before income taxes ($6.5 million, after taxes) in connection with that event. The $10 million is an estimate and is subject to considerable estimation error. It will literally take years to resolve complicated coverage issues, as well as to develop an accurate estimation of insured losses that will ultimately be incurred. That $10 million, however, was the principal cause of our substantial underwriting loss in 2001. At the end of 2001 we retained about $17 million in invested assets, oÅset by claims reserves, from our former reinsurance arrangement with Fireman's Fund Group. This arrangement was terminated August 31, 1989.loss-related

Daily Journal Corporation's late-1990s filings are notable for what they do and do not show. The company had, under Munger's chairmanship, avoided the speculative derivatives exposure that had destroyed several of its peers in the savings-and-loan and publishing-adjacent industries during the savings-and-loan crisis. The 10-K filings disclose a conservatively-financed publisher with a real moat - the appellate-decisions monopoly - and no exposure to the structured products that had ruined other ostensibly conservative companies in the same region. Munger's role at DJCO throughout the 1990s was, in effect, the same role he played at Berkshire: the disciplined refuser. He had refused to let Daily Journal take on the leverage that the cheap-money years of the mid-1990s had tempted other small public companies to take on. He had refused to chase the incremental yield that derivatives contracts appeared to offer. He had insisted that the company finance itself conservatively, hold its franchise honestly, and let the cash earnings of the legal publishing monopoly compound rather than leveraging them up in the name of growth. The retrospective lesson, visible in the 1997 10-K, was that avoidance was the operating decision. The companies that failed in the savings-and-loan crisis had not failed because they were stupid; they had failed because they had taken on exposure they did not need to take on, in pursuit of returns they did not need to pursue. Daily Journal, under Munger, had refused the exposure and survived the crisis with its franchise intact and its balance sheet clean. The same discipline would, two decades later, allow Daily Journal to pivot into court-automation software with the financial strength to absorb the long, slow, expensive slog of building that business. The avoidance had bought the optionality.

In a 1996 question and answer session at Stanford, I told the audience that the discipline of inversion, applied to the question of how to invest, produced a different portfolio from the discipline of pursuing the highest expected return directly. The inverter asks the opposite question: what would guarantee the destruction of capital, and how can I avoid that? The market-psychology point I tried to convey was that the crowd, in its broad patterns, repeats the same mistakes in every cycle, because the incentives facing the participants are the same in every cycle, and the biases facing the participants are the same in every cycle. The investor who recognises the patterns, and who refuses to participate in the new version of the old mistake, has a long-run advantage over the investor who assumes that the new version is different. The discipline required is to read the history, to recognise the patterns, and to refuse to participate. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes by pursuing the highest expected return without enumerating the failure modes, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the failure modes are present in every decision, and he must build the discipline of inversion into his process before the decision is made. The 1996 session was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act until the failure modes had been enumerated and the actions that would produce them had been refused. The investor who builds the discipline of inversion will outperform the investor who chases the highest expected return directly. The contrarianism lesson I tried to convey was that the investor who refuses to participate in the failure modes that the boom is rewarding, looks unfashionable during the boom, and he is told, repeatedly, that he is missing the opportunity of a lifetime. The same investor, during the crash, looks unfashionable in the opposite direction, because he is buying when the crowd is panic-selling, and the crowd cannot understand why anyone would buy into a falling market. The 1996 session was, in some ways, the most contrarian I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to participate in the failure modes, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor who participates on the assumption that the new version is different.

At Harvard in 1995, Munger opened his talk on human misjudgment with what he considered the most underappreciated driver of bad decisions in the entire literature: incentive-caused bias. He told a doctor story from his own youth in Lincoln, Nebraska. A doctor there had been sending bushel baskets of normal gallbladders down to the pathology lab at the leading hospital, and the quality-control machinery of community medicine had taken about five years longer than it should have to remove him from the staff. Munger asked an older doctor who had participated in the removal whether the man had consciously been running a maiming-and-murder-for-profit scheme. Hell no, came the answer - the man had convinced himself the gallbladder was the source of all medical evil, and that if you loved your patients you couldn't get it out fast enough. Munger's point was that incentive bias operates with full force even in people you would gladly marry into your family. It is present in every profession and in every human being. He pushed the room to generalize from the example: sales presentations and brokers of commercial real estate, in his experience, were never even within hailing distance of objective truth. The same mechanism that produced the gallbladder surgeon produces the mispriced collateralized product, the pumped-up sell report, and the cost-plus contract that rewards running the budget up rather than down. He closed the loop with the cash register story. Patterson's little store was being stolen blind, the cash register fixed it, profit appeared instantly - and Patterson then closed the store and went into the cash register business. Munger's conclusion: people who invent things like cash registers, which make most bad behavior hard, are some of the effective saints of our civilization. The cash register was a moral instrument when it was created. Designing systems that contain incentive bias is therefore one of the highest-leverage forms of ethical action a society can take.

In the 1995 Harvard speech I described doubt-avoidance tendency as one of the most underestimated biases in human cognition. The bias is simple: the human mind, when faced with a difficult decision, prefers to remove the doubt by adopting the simplest available conclusion, even when the evidence does not support the conclusion. The bias is most powerful in situations of stress, fatigue, or social pressure, and it is most dangerous in situations where the cost of being wrong is high. The market-psychology point I tried to convey was that the crowd, in its broad patterns, is the aggregate of the doubt-avoidance biases facing the participants, and the investor who recognises the bias in himself has a long-run advantage over the investor who assumes that his conclusions are the products of careful analysis. The discipline required is to slow down, to write down the alternative conclusions, and to refuse to act until the alternatives have been considered. The mistakes-and-learning element was the one I had most wanted to add. I had made my own share of mistakes by adopting the simplest available conclusion, in cases where the evidence did not support the conclusion, and where the cost of being wrong was high. The lesson I drew was that the disciplined investor must assume that the simplest available conclusion is, in many cases, the wrong conclusion, and he must build the discipline of considering the alternatives into his process before the conclusion is adopted. The 1995 speech was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act until the alternatives had been considered, even at the cost of looking indecisive during the boom. The market-psychology lesson I tried to convey was that the crowd, in its broad patterns, is the aggregate of the doubt-avoidance biases facing the participants. The investor who recognises the bias in himself, and who builds the discipline of considering the alternatives into his process, has an enormous advantage over the investor who assumes that his conclusions are the products of careful analysis. The 1995 speech was, in some ways, the most useful I had ever given. I told the audience that the discipline I had extracted from my own mistakes was to slow down, to write down the alternatives, and to refuse to act until the alternatives had been considered. That single discipline, applied over a working life, has been more valuable than any other I have learned, and it is the one I have tried hardest to convey to the students who visit Pasadena each spring.

In the 1995 Harvard speech I described reciprocation tendency as one of the most powerful biases in human cognition. The bias is simple: when someone does a favour for us, we feel an obligation to return the favour, even when the favour was unsolicited and even when the return favour is disproportionate. The market-psychology point I tried to convey was that the brokers, analysts, and investment bankers who interact with the investing public are, in many cases, providing unsolicited favours in the form of free research, free lunches, free conference invitations, and free access to managements, in order to trigger the reciprocation bias when the time comes to ask for the order. The investor who recognises the bias, and who refuses to allow the unsolicited favours to influence his decisions, has a long-run advantage over the investor who allows the favours to colour his judgment. The discipline required is to be impolite. The mistakes-and-learning element was the one I had most wanted to add. I had made my own share of mistakes by allowing reciprocation tendency to influence my decisions, in cases where the favours had been provided in the form of access, information, or courtesy, and where the return favour I provided was, in retrospect, a transaction I should not have entered. The lesson I drew was that the disciplined investor must assume that the favours are provided with intent, and he must build the discipline of refusal into his process before the favours are offered. The 1995 speech was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to accept favours from people who had an interest in the outcome of my decisions. The market-psychology lesson I tried to convey was that the crowd, in its broad patterns, is the aggregate of the reciprocation biases facing the participants. The investor who recognises the biases, who refuses to allow them to colour his decisions, and who builds the discipline of refusal into his process, has an enormous advantage over the investor who allows the favours to influence his judgment. The 1995 speech was, in some ways, the most uncomfortable I had ever given, because it forced me to acknowledge that I, like everyone else, was subject to the bias, and that the discipline required was not the absence of the bias but the refusal to allow the bias to drive the decision. The investor who builds the discipline of refusal, and who applies it consistently over a working life, will, in the long run, outperform the investor with the higher IQ who allows the bias to colour his judgment.

In the 1995 Harvard speech I emphasised what I called lollapalooza effects. These are the outcomes that emerge when several psychological biases operate in the same direction at the same time. A single bias, on its own, produces a predictable deviation from rationality. Two or three biases, operating in combination, can produce outcomes that are extreme, surprising, and very profitable for the investor who recognises them and very costly for the investor who does not. The market-psychology point I tried to convey was that the great bubbles and the great crashes of financial history, in retrospect, are almost always the products of lollapalooza effects, in which incentive bias, social proof, reciprocation tendency, and doubt avoidance all pushed the crowd in the same direction at the same time, until the direction reversed and the same biases pushed the crowd in the opposite direction. The contrarianism angle was the most important part. The investor who recognises a lollapalooza effect in real time, and who refuses to participate, looks unfashionable during the boom and he is told, repeatedly, that he is missing the opportunity of a lifetime. The same investor, during the crash, looks unfashionable in the opposite direction, because he is buying when the crowd is panic-selling, and the crowd cannot understand why anyone would buy into a falling market. The discipline required to refuse to participate in the boom, and to participate aggressively in the crash, is the single hardest discipline in investing, and it is the one that the lollapalooza framework was designed to support. The investor who has the framework, and who has the temperament to act on it, has an enormous advantage over the investor who participates in the boom on the assumption that the biases are uncorrelated. The mistakes-and-learning element was the one I had most wanted to add. I had made my own share of mistakes by participating in lollapalooza effects, on the assumption that I was rational enough to resist the biases. I was not. The lesson I drew was that the disciplined investor must assume that he, like everyone else, is subject to the biases, and he must build the discipline of refusal into his process before the biases begin to operate. The 1995 speech was, in some ways, the most personal I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to participate in situations where the biases were obviously operating, even at the cost of looking unfashionable during the boom. That single discipline, applied over a working life, has been more valuable than any other I have learned.

In the 1995 Harvard speech I told the audience that the most powerful bias in human cognition is incentive-caused bias. Show me the incentives and I will show you the outcome. The investor who understands the incentives of the people around him, including the managers he invests in, the analysts who write the research he reads, and the brokers who execute his trades, has a long-run advantage over the investor who assumes that the people he deals with are motivated by the truth. They are not. They are motivated by their own incentives, and the investor who fails to model those incentives will, at some point in his career, be surprised by an outcome that was perfectly predictable from the incentives alone. The market-psychology point I tried to convey was that the crowd's behaviour, in its broad patterns, is the aggregate of the incentives facing the participants, and the investor who models those incentives has a clearer view of the future than the investor who models only the headlines. The mistakes-and-learning element was the one I had most wanted to add to Graham's framework. Graham had taught the discipline of buying below intrinsic value, but he had not, in his writing, addressed the question of why the prices had fallen below intrinsic value in the first place. The answer, in many cases, was that the incentives facing the sellers had changed. The sellers were being forced to sell because of leverage, because of redemptions, because of regulatory pressure, or because of accounting rules that required them to mark the assets to market. The buyer who recognised that the sellers' incentives were driven by forces unrelated to the underlying value, and who was willing to step in and buy when the sellers were being forced out, had a long-run advantage over the buyer who assumed that the prices were falling because the underlying value was deteriorating. The incentive analysis was the bridge between the price and the value. The market-psychology lesson I tried to convey was that the crowd, in its patterns, is the aggregate of the incentives facing the participants. The investor who recognises the incentives, who models them honestly, and who refuses to act on the assumption that the other participants are motivated by the truth, has an enormous advantage over the investor who assumes good faith. The 1995 speech was, in some ways, the most personal I had ever given. I told the audience that I had made my own share of mistakes by failing to model the incentives of the people I dealt with, and that the discipline I had extracted from those mistakes was to always ask, before any transaction, what the other side's incentive was, and to refuse to proceed until I had a clear answer. That single discipline, applied over a working life, has been more valuable than any other I have learned.

At the 1995 Berkshire annual meeting, I told the audience that the discipline of staying within the circle of competence had been, over my four decades of investing, the single most valuable discipline I had acquired. The discipline required is to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom, and even at the cost of being told, repeatedly, that I am missing the opportunity of a lifetime. The mistakes-and-learning point I tried to convey was that the boom, in its broad patterns, is the product of investors acting outside their circles on the assumption that they understand the new things, and the investor who recognises the assumption, and who refuses to act outside his circle, has a long-run advantage over the investor who chases the new things. The discipline required is honesty about the boundary of the circle, and the willingness to admit that the boundary is smaller. The circle-of-competence element was the one I had most wanted to convey. I had made my own share of mistakes by acting outside my circle, on the assumption that I understood the new things, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the boundary of his circle is smaller than he would prefer, and he must build the discipline of refusal into his process before the temptation to act outside the circle becomes irresistible. The 1995 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor who chases the new things. The mistakes-and-learning lesson I tried to convey was that the investor who is honest about the boundary of his circle, and who refuses to act outside it, has an enormous advantage over the investor who pretends to understand more than he does. The 1995 meeting was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act outside the circle, and to expand the circle only by deliberate study. The investor who is honest about the boundary, and who refuses to act outside it, will, in the long run, outperform the investor with the larger circle who pretends to understand more than he does. That single discipline, applied over a working life, has been more valuable than any other I have learned, and it is the one I have tried hardest to convey to the students who visit Pasadena each spring.

Munger warned the Harvard audience about man-with-a-hammer syndrome - the tendency, once a thinker has acquired one powerful idea, to apply it to every problem as if it were a nail. His exhibit was B.F. Skinner, the Harvard behaviorist whose experiments were genuinely ingenious, counterintuitive, and important, and who by any honest reckoning belonged in the top handful of experimental scientists in the entire history of the university. And yet, Munger said, Skinner had developed one of the more extreme cases of man-with-a-hammer syndrome in the history of academia. The syndrome does not exempt bright people. He gave a second illustration, drawn from his Harvard Law School days. There had been a professor, naturally at Yale, who was derisively discussed at Harvard with the line, 'Poor old Blanchard. He thinks declaratory judgments will cure cancer.' That, Munger said, is the way Skinner got. He was literary, and he scorned opponents who had any different way of thinking or thought anything else was important. That is not the way to make a lasting reputation when the other people turn out to also be doing something important. Man-with-a-hammer is a reputation-killer. The practical investment takeaway Munger drew was the need for what he called a latticework of mental models - a deliberately cross-disciplinary kit of frameworks so that no single tool, however well-honed, becomes the lens through which everything is interpreted. The investor who reaches for discounted cash flow on every company, or for momentum on every tape, or for activist shorts on every crowded long, has contracted a serious case of the Skinner problem. The discipline of acquiring multiple models is the discipline of refusing to become a hammer.

Munger named simple psychological denial as a powerful and common cause of misjudgment. The reality too painful to bear, he said, gets distorted until it is bearable. He told the audience about a family friend whose super-athlete, super-student son flew off a carrier in the north Atlantic and never came back. The mother, a very sane woman, simply never believed he was dead. He generalized it: turn on the television and you will find the mothers of the most obvious criminals that man could ever diagnose, and they all think their sons are innocent. He argued that we all do this to some extent, and that it is one of the most widespread misjudgments in real life. The investor who bought at the top, the founder whose product no longer fits the market, the manager whose division is rotting - all of them, Munger said, run some version of the same grief denial. The refusal to look at the disconfirming evidence, the refusal to mark to market in the head as well as in the books, is what turns a small loss into a permanent one. He paired the observation with a deeper psychological tendency: bias from consistency and commitment. People avoid cognitive dissonance by holding onto expressed conclusions, especially publicly expressed ones, with special persistence. Once a thesis has been written down or defended in front of others, the cost of revising it rises inside the mind even when it has fallen in the world. Munger's prescription was inversion again: force yourself to search for the disconfirming evidence as energetically as the confirming, and write down your thesis in a form that allows you to be wrong visibly rather than gradually.

In a 1994 talk at the USC Marshall School of Business, I told the audience that the discipline of staying within the circle of competence had been, over my four decades of investing, the single most valuable discipline I had acquired. The discipline required is to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom, and even at the cost of being told, repeatedly, that I am missing the opportunity of a lifetime. The mistakes-and-learning point I tried to convey was that the boom, in its broad patterns, is the product of investors acting outside their circles on the assumption that they understand the new things, and the investor who recognises the assumption, and who refuses to act outside his circle, has a long-run advantage over the investor who chases the new things. The discipline required is honesty about the boundary of the circle, and the willingness to admit that the boundary is smaller. The circle-of-competence element was the one I had most wanted to convey. I had made my own share of mistakes by acting outside my circle, on the assumption that I understood the new things, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the boundary of his circle is smaller than he would prefer, and he must build the discipline of refusal into his process before the temptation to act outside the circle becomes irresistible. The 1994 talk was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor who chases the new things. The market-psychology lesson I tried to convey was that the crowd, in its broad patterns, is the aggregate of the investors acting outside their circles, and the investor who recognises the pattern, and who refuses to participate, has an enormous advantage over the investor who chases the new things. The 1994 talk was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act outside the circle, and to expand the circle only by deliberate study. The investor who is honest about the boundary, and who refuses to act outside it, will, in the long run, outperform the investor with the larger circle who pretends to understand more than he does. That single discipline, applied over a working life, has been more valuable than any other I have learned, and it is the one I have tried hardest to convey to the students who visit Pasadena each spring.

At the 1989 Berkshire annual meeting, I told the audience that the previous year, with its crash in October 1987 and the subsequent revelations about portfolio insurance and program trading, had confirmed what I had long believed about derivatives and structured products. The market-psychology point I tried to convey was that the crowd, in its broad patterns, repeats the same mistakes in every cycle, because the incentives facing the participants are the same in every cycle, and the biases facing the participants are the same in every cycle. The investor who recognises the patterns, and who refuses to participate in the new version of the old mistake, has a long-run advantage over the investor who assumes that the new version is different. The discipline required is to read the history, to recognise the patterns, and to refuse to participate, even at the cost of looking unfashionable during the boom. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes in the previous two years, by being too cautious during the recovery from the 1987 crash, and the cost of the caution had, in opportunity terms, been very large. The lesson I drew was that the disciplined investor must be willing to act during a recovery, even when the outlook is unclear, and even when the prices may go lower before they go higher. The 1989 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to wait for clarity, and to act when the prices were attractive, even at the cost of being early. The investor who builds the discipline of acting during the recovery will outperform the investor who waits for clarity. The contrarianism lesson I tried to convey was that the investor who refuses to participate in the derivatives and structured products that the boom is rewarding, looks unfashionable during the boom, and he is told, repeatedly, that he is missing the opportunity of a lifetime. The same investor, during the crash, looks unfashionable in the opposite direction, because he is buying when the crowd is panic-selling, and the crowd cannot understand why anyone would buy into a falling market. The 1989 meeting was, in some ways, the most contrarian I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to participate in the derivatives and structured products, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor who participates on the assumption that the new version is different.