The following is Part 3 of portfolio management highlighted extracted from a gem of a Munger speech given at USC nearly a decade ago. It’s long, but contains insights collected over many years by one of the greatest investment minds in this century. Caustically humorous (purely Munger), it is absolutely worth 20 minutes of your day between browsing ESPN and TMZ. Psychology
“…the nature of human psychology is such that you'll torture reality so that it fits your models, or at least you'll think it does…‘To the man with only a hammer, every problem looks like a nail.’”
“…the great useful model, after compound interest, is the elementary math of permutations and combinations…people can't naturally and automatically do this. If you understand elementary psychology, the reason they can't is really quite simple: The basic neural network of the brain is there through broad genetic and cultural evolution. And it's not Fermat/Pascal. It uses a very crude, shortcut-type of approximation. It's got elements of Fermat/Pascal in it. However, it's not good.
So you have to learn in a very usable way this very elementary math and use it routinely in life—just the way if you want to become a golfer, you can't use the natural swing that broad evolution gave you. You have to learn—to have a certain grip and swing in a different way to realize your full potential as a golfer.
If you don't get this elementary, but mildly unnatural, mathematics of elementary probability into your repertoire, then you go through a long life like a one-legged man in an asskicking contest. You're giving a huge advantage to everybody else.
One of the advantages of a fellow like Buffett, whom I've worked with all these years, is that he automatically thinks in terms of decision trees and the elementary math of permutations and combinations...”
“There's not a person in this room viewing the work of a very ordinary professional magician who doesn't see a lot of things happening that aren't happening and not see a lot of things happening that are happening. And the reason why is that the perceptual apparatus of man has shortcuts in it.
The brain cannot have unlimited circuitry. So someone who knows how to take advantage of those shortcuts and cause the brain to miscalculate in certain ways can cause you to see things that aren't there…your brain has a shortage of circuitry and so forth—and it's taking all kinds of little automatic shortcuts… just as a man working with a tool has to know its limitations, a man working with his cognitive apparatus has to know its limitations.”
“We are all influenced—subconsciously and to some extent consciously—by what we see others do and approve. Therefore, if everybody's buying something, we think it's better. We don't like to be the one guy who's out of step. Again, some of this is at a subconscious level and some of it isn't. Sometimes, we consciously and rationally think, "Gee, I don't know much about this. They know more than I do. Therefore, why shouldn't I follow them?"
Team Management, Psychology
“…this knowledge, by the way, can be used to control and motivate other people...”
“Personally, I've gotten so that I now use a kind of two-track analysis. First, what are the factors that really govern the interests involved, rationally considered? And second, what are the subconscious influences where the brain at a subconscious level is automatically doing these things—which by and large are useful, but which often misfunction.
One approach is rationality—the way you'd work out a bridge problem: by evaluating the real interests, the real probabilities and so forth. And the other is to evaluate the psychological factors that cause subconscious conclusions—many of which are wrong.”
“If people tell you what you really don't want to hear what's unpleasant—there's an almost automatic reaction of antipathy. You have to train yourself out of it. It isn't foredestined that you have to be this way. But you will tend to be this way if you don't think about it.
Television was dominated by one network—CBS in its early days. And Paley was a god. But he didn't like to hear what he didn't like to hear. And people soon learned that. So they told Paley only what he liked to hear. Therefore, he was soon living in a little cocoon of unreality and everything else was corrupt…You get a lot of dysfunction in a big fat, powerful place where no one will bring unwelcome reality to the boss.”
“Carl Braun…His rule for all the Braun Company's communications was called the five W's—you had to tell who was going to do what, where, when and why. And if you wrote a letter or directive in the Braun Company telling somebody to do something, and you didn't tell him why, you could get fired. In fact, you would get fired if you did it twice.
You might ask why that is so important? Well, again that's a rule of psychology. Just as you think better if you array knowledge on a bunch of models that are basically answers to the question, why, why, why, if you always tell people why, they'll understand it better, they'll consider it more important, and they'll be more likely to comply. Even if they don't understand your reason, they'll be more likely to comply.
So there's an iron rule that just as you want to start getting worldly wisdom by asking why, why, why, in communicating with other people about everything, you want to include why, why, why. Even if it's obvious, it's wise to stick in the why.”
“The great defect of scale, of course, which makes the game interesting—so that the big people don't always win—is that as you get big, you get the bureaucracy. And with the bureaucracy comes the territoriality—which is again grounded in human nature.
And the incentives are perverse. For example, if you worked for AT&T in my day, it was a great bureaucracy. Who in the hell was really thinking about the shareholder or anything else? And in a bureaucracy, you think the work is done when it goes out of your in-basket into somebody else's in-basket. But, of course, it isn't. It's not done until AT&T delivers what it's supposed to deliver. So you get big, fat, dumb, unmotivated bureaucracies.
They also tend to become somewhat corrupt. In other words, if I've got a department and you've got a department and we kind of share power running this thing, there's sort of an unwritten rule: ‘If you won't bother me, I won't bother you and we're both happy.’ So you get layers of management and associated costs that nobody needs. Then, while people are justifying all these layers, it takes forever to get anything done. They're too slow to make decisions and nimbler people run circles around them.
The constant curse of scale is that it leads to big, dumb bureaucracy—which, of course, reaches its highest and worst form in government where the incentives are really awful. That doesn't mean we don't need governments—because we do. But it's a terrible problem to get big bureaucracies to behave. So people go to stratagems. They create little decentralized units and fancy motivation and training programs…But bureaucracy is terrible.... And as things get very powerful and very big, you can get some really dysfunctional behavior.”