Think Like a Freak: Buffett and Munger Edition

I heard there were a few book recommendations in Omaha this year.  Unfortunately, Think Like a Freak was not one of them.  It should have been.

Think Like a Freak is the third book in the Freakeonomics series from Steven Levitt and Stephen Dubner, one a journalist and the other a Professor of Economics at the University of Chicago.  The other two books are equally great and if you are planning a beach vacation this year, I would recommend bringing all three.

Think Like a Freak is a book about improving your thinking.  One of the overarching themes of the book is the focus on incentives in a variety of circumstances.  Some of the examples may seem obviously once the read through a few of these behavioral finance books, but the continued focus on how incentives can lead you to understand people’s behavior is a true gem.

The problem with describing this book is the learning from this book, and others like it, comes as the authors walk you through the examples and the thought process that helps you understand the incentives in each example.  These incentives rarely create the optimal outcome, but history has certainly taught us that incentives tend to drive more behavior than any other mental model out there.

Below are a smattering of thoughts and ideas from Think Like a Freak.  The quotes are directly from the book, and although the ideas below may seem exhaustive, I have only scratched the surface with what I am sharing.

Incentives Matter:

“Incentives are the cornerstone of modern life.  And understanding them–or, often, deciphering them–is the key to understanding a problem, and how it might be solved.  Knowing what to measure, and how to measure it, can make a complicated world less so.  There is nothing like the sheer power of numbers to scrub away layers of confusion and contradiction, especially with emotional, hot-button topics.  The conventional wisdom is often wrong.  And a blithe acceptance of it can lead to sloppy, wasteful, or even dangerous outcomes.”  

Buffett learned early on that incentives matter (probably much earlier than this example), but the details of his investment in Sanborn Maps illustrate this idea clearly.  The story of the members of the Board smoking expensive cigars on Sanborn’s dime are a comical and clear example of how incentives matters.

I guarantee I have never heard a CEO or Co-CEO talk more about incentives than Buffet and Munger.  Munger gave an entire talk called the “Psychology of Human Misjudgment.”  You can watch it here.

On Thinking:

“Another barrier to thinking like a Freak is that most people are too busy to rethink the way they think–or to even spend much time thinning at all.  When was the last time you sat for an hour of pure unadulterated thinking?  The absurdly talented George Bernard Shaw–a world-class writer and a founder of the London School of Economics–noted this thought deficit many years ago.  “Few people think more than two or three times a year,” Shaw reportedly said.  “I have made an international reputation for myself by thinking once or twice a week.”

I have heard Buffett go on and on about how most of his day is just spent reading and thinking, no meetings, few phone calls and obviously no endless traveling to every individual subsidiary.  How many new CEOs get on their first conference call proclaiming how they have made it their first priority to visit every one of their 1,000s of field offices.  I always cringe at the wasteful travel expenses this useless proclamation must entail, and more importantly the lost “thinking time.”

The Three Hardest Words in the English Language:

“It has long been said that the three hardest words  to say in the English language are I love you.  We heartily disagree!  For most people it is much harder to say I don’t know.   That’s a shame, for until you can admit what you don’t yet know, it’s virtually impossible to learn what you need to.”

“In most cases, the cost of saying “I don’t know is higher than the cost of being wrong–at least for the individual.”

“Every time we pretend to know something we are doing the same: protecting our own reputation rather than promoting the collective good.  None of us want to look stupid, or at least overmatched, by admitting we don’t know an answer.  The incentives to fake it are simply too strong.”

Buffet and Munger are some of the only people I have ever publicly hear say they don’t understand something.  It is a breath of fresh air.  I especially enjoyed Munger’s recent comment, “What the hell do I know about Ukraine.”

On the Future: 

In other words, it can be hard to ever really “know” what caused or solved a given problem–and that’s for event that have already happened.  Just think how much harder it is to predict what will work in the future.  “Prediction,” as Niels Bohr liked to say, “is very difficult, especially if it’s about the future.”

Munger and Buffett’s investment philosophy seems firmly rooted in not being able to predict the future.  I can hear Munger proclaiming, “God invented economists to make astrologers look good.” 

On Learning:

“The key to learning is feedback.  It is nearly impossible to learning anything without it.”

“Experimentation of this sort (freakeonomics style) is regrettably rare in the corporate and nonprofit worlds, government, and elsewhere.  Why?  One reason is tradition.  In our experience, many institutions are used to making decisions based on some murky blend of gut instinct, moral compass, and whatever previous decision maker did…and the third reason for the general reluctance toward experimentation: it requires someone to say “I don’t know.”

The authors discuss the champion Japanese hot dog “eater.”  I will let you read the details of this story, but reading it made me reflect on how “contrarian” Buffett and Munger’s strategy of concentration and what risk meant to them must have been when the Efficient Markets Theory became investing gospel.  I attended law school in the early 2000s and the my corporate securities Professor proudly proclaimed that risk was defined as the variation in a security’s price from a specific market index over a given period of time.  Oddly, I was literally reading Buffett’s annual letters in class that day and Buffett’s definition of risk couldn’t have been more different.

The story of ulcers is another amazing example of the Buffet/Munger’s oft repeated Upton Sinclair quote “It is difficult to get a man to understand something when his salary depends upon him not understanding it.”

Thinking Small:

“Maybe the two of us [the authors] are biased.  Maybe we believe in the power of thinking small only because we are so bad at thinking big.  In any case, we’ve come to the conclusion that it’s much better to ask small questions than big ones.”

“Here’s another cardinal rule of thinking like a child: don’t be afraid of the obvious.”

I love Buffett’s idea of a “hard pile.”  Lots of investors think they have to understand the difficult stuff in order to make money.  Buffett flips this idea on its head and sticks to the simple and small stuff in order to make sure he adequately understands what he is doing.

Enjoying Life:

“You may have noticed a common thread in some of the stories we’ve told–about solving ulcers, eating hot dogs, and blind-tasting wine: the people involved seem to be having a good time as they learn.  Freaks like to have fun.  This is another good reason to think like a child.”

Buffett and Munger are both way past retirement age.  Why do they keep doing it…because they love it.

Speaking with others who don’t agree:

“In discussions with people you don’t agree with: The first step is to appreciate that your opponent’s opinion is likely based less on fact and logic than ideology and herd thinking.  If you are to suggest this to his face, he would of course deny it.  He is operating from the set of biases he cannot even see.  As Kahneman has written, “We can be blind to the obvious, and we are also blind to our blindness.”

“Also, keep the insults to yourself.”

I have also admired this part of Buffet when he says, “You can always tell someone off tomorrow.”  How Buffett has handled the recent Coke compensation package has caused a small bit of controversy, but Buffett has handled it in his own way and I wouldn’t expect anything else.

Quitting and Failing

“The key is failing fast and failing cheap.”

As recent as this past meeting, Buffet mentioned how they have been able to scramble out of their mistakes (think early retail investments) quickly, so as to avoid large losses.

“A premortem tries to find out what might go wrong before it’s too late.”

Can you imagine Buffett sitting alone in his office trying to think up all the crazy ways that an investment might go south.  I imagine Munger might have some colorful ideas also, if Buffett ever decides to pick up the phone.  A premortem might be in order in the future if Berkshire ever decides to invest in a heavy-levered natural gas play.

And in closing:

“If there is one mantra a Freak lives by, it is this: People respond to incentives.”

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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