Wesco Financials Charlie Munger

A Lesson on Elementary, Worldly Wisdom As It Relates to Investment Management & usiness!"

MAY 5, 1995
The theory of modern education is that you need a general education before you specialize. And I think to some extent,
before you are going to be a great stock picker, you need some general education.
A particularly astute student of human natureparticularly insofar as it relates to business and investing. Belo is his
lecture at the !niversity of "outhern #alifornia in $%%&.
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Charlie Munger+
To be a great stock picker, you need some general education
The talk is sort of along the lines that some behaviorist psychologists call 'randma(s ruleafter the isdom of 'randma
hen she said that you have to eat the carrots before you get the dessert.
The carrot part of this talk is about the general sub)ect of orldly isdom of 'randma hen she said that you have to seat
the carrots before you get the dessert.
The carrot part of this talk is about the general sub)ect of orldly isdom, hich is a pretty good ay to start. After all,
the theory of modern education is that you need a general education before you specialize. And I think to some extent, before you
are going to be a great stock picker, you need some general education.
"o, emphasizing hat I sometimes aggishly call remedial orldly isdom, I am going to start by altzing you through a
fe basic notions.
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*hat is elementary, orldly isdom+ *ell, the first rule is that you can(t really kno anything if you )ust remember
isolated facts and )ust try to bang them back. If the facts don(t hang together on a latticework of theory, you don(t have them in usable
form.
,ou have got to have models in your head. And you have got to array your experienceboth vicarious and directon this
latticeork of models. ,ou may have noticed students ho )ust try to remember and pound back hat is remembered. *ell, they fail
in school and fail in life. ,ou have got to hang experience on a latticeork of models in your head.
Absent enough models, your brain ill torture reality
*hat are the models+ *ell, the first rule is that you have got to have multiple modelsbecause if you have )ust one or
to that you are using, the nature of human psychology is such that you ill torture reality so that it fits your models, or at least you
ill think that it does. ,ou become the e-uivalent of a chiropractor ho, of course, is the great boob in medicine.
It is like the old saying, .To the man ith only a hammer, every problem looks like a nail./ And of course, that is the ay
the chiropractor goes about practicing medicine. But that is a disastrous ay to think and operate in the orld. "o you have got to
have multiple models.
And the models have to come from multiple disciplinesbecause all the isdom is not to be found in one little academic
department. That is hy poetry professors, by and large, are so unise in a orldly sense. 'o you have got to have multi.le models
across an array o/ disci.lines.
0ortunately, it isn(t all that tough
,ou may say, .1y 'od, this is already getting ay too tough./ But fortunately, it is not that toughbecause 23 to %3
important models ill carry about %34 of the freight in making you a orldly5ise person. And, of those, only a mere handful really
carries very heavy freight.
"o let us briefly revie hat kind of models and techni-ues constitute this basic knoledge that everybody has to have
before they proceed to being really good at a narro0 art li1e stoc1 .ic1ing!
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The great useful model is permutations 6 combinations.
*orldly *isdom by #harlie 1unger $%%75$%%2 $
0irst there is mathematics. 8bviously, you have got to be able to handle numbers and -uantitiesbasic arithmetic.
And the great useful model, after compound interest, is the elementary math of permutations and combinations. And that
as taught in my day in the sophomore year in high school. I suppose by no in great private schools, it is probably don to the
eighth grade or so.
It is very simple algebra. And it as all orked out in the course of about one year in correspondence beteen 9ascal and
0ermat. They orked it out casually in a series of letters.
,our brain isn(t designed to figure it out spontaneously.
It is not hard to learn. *hat is hard is to get so you use it routinely almost every day of your life. The 0ermat:9ascal
system is dramatically consonant ith the ay that the orld orks. And it(s fundamental truth. "o you simply have to have the
techni-ue.
1any educational institutionsalthough not nearly enoughhave realized this. At ;arvard Business "chool, the great
-uantitative thing that bonds the first year class together is hat they call decision5tree theory. All they do is take high school algebra
and apply it to real life problems. And the students love it. They are amazed to find that high school algebra orks in life<.
By and large, as it orks out, people can(t naturally and automatically do this. If you understand elementary psychology,
the reason they can(t is really -uite simple= The basic neural netork of the brain is there through broad genetic and cultural evolution.
And it is not 0ermat:9ascal. It uses a very crude, shortcut5type of approximation. It(s got elements of 0ermat:9ascal in it. ;oever,
it is not good.
*ithout it, you are giving a huge advantage to others.
"o you have to learn. If you don(t get this elementary, but mildly unnatural, mathematics of elementary probability into
your repertoire, then you go through life like a one5legged man in an ass5kicking contest. ,ou are giving a huge advantage to
everybody else.
8ne of the advantages of a fello like Buffett, is that he automatically thinks in terms of decision trees and the elementary
math of permutations and combinations.
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>ouble5entry bookkeeping as a hell of an invention.
?ext, you have to 1no0 accounting! It is the language of practical business life. But you have to kno enough about it
to kno its limitationsbecause although accounting is the starting place, it is only a crude approximation. 0or example, everyone
can see that you have to more or less )ust guess at the useful life of a )et airplane or anything like that. @ust because you express the
depreciation rate in neat numbers doesn(t make it anything you really kno.
In terms of the limitations of accounting, one of my favorite stories involves a very great businessman named #arl Braun
ho created #0 Braun Angineering #ompany. It designed and built oil refinerieshich are very hard to do. And Braun ould get
them to come in on time and not blo up and have efficiencies and so forth. This is a ma)or art.
;e thre out his accountants and used his engineers to devise a ne accounting method for building refineries. #arl Braun
ho demonstrated both the importance of accounting and the importance of knoing its limitations.
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Braun(s five *(s= *ho, *hat, *here, *hen and *hy.
;e had another rule, from .sychology, hich, if you are interested in isdom, ought to be part of you repertoirelike
elementary mathematics of permutations and combinations.
;is rule of all the Braun #ompany communications as called the five *(syou had to tell 0ho 0as going to do 0hat,
0here, 0hen and 0hy! And if you rote a letter or directive in the Braun #ompany telling somebody to do something, and you
didn(t tell him or her hy, you ould get fired. In fact, you ould get fired if you did it tice.
If you tell people hy, they(ll be much more likely to comply.
,ou might ask hy that is so important+ *ell, again that is a rule of psychology. @ust as you think better if you array
knoledge on a bunch of models that are basically ansers to the -uestion, hy, hy, hy, i/ you al0ays tell .eo.le 0hy they 0ill
understand it 7etter, they 0ill consider it more im.ortant, and they 0ill 7e more li1ely to com.ly!
"o there is an iron rule that )ust as you ant to start getting orldly isdom by asking hy, hy, hy in communicating
ith other people about everything, you ant to include hy, hy, hy. Aven if it is obvious, it is ise to stick in the hy.
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WELL!
*orldly *isdom by #harlie 1unger $%%75$%%2 B
The most reliable models+ Engineering models, of course.
Angineering models are the most reliable. Angineering -uality control is very much based on the elementary mathematics
of 0ermat and 9ascal.
,ou have to understand normal occurrence distributions.
,ou have to understand normal distributions5the ell Curve.
Angineering has more than its share of poerful models.
The engineering idea of back up systems is a poerful idea. The engineering idea of breakpointsthat is a very important
model too. The notion of critical massthat comes out of physicsis a very poerful model.
All of these things have great utility in looking at ordinary reality. And all of this cost5benefit analysishell that is all
elementary high school algebra, too. It has )ust been dolled up a little bit ith fancy lingo.
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8ur brains take shortcuts, so e are sub)ect to manipulation.
I suppose the next most reliable models are from 7iology8.hysiology because, after all, all of us are programmed by our
genetic makeup to be much the same.
8ur brains take shortcuts. "o e(re sub)ect to manipulation.
I suppose the next most reliable models are from biology:physiology because, after all, all of us are programmed by our
genetic makeup to be much the same.
And then hen you get into psychology, of course, it gets very much more complicated. But it is an ungodly important
sub)ect if you are going to have any orldly isdom.
8nce you can demonstrate that point -uite simply= There is not a person in this room vieing the ork of a very ordinary
professional magician ho doesn(t see a lot of things happening that are happening. And the reason hy is that the perceptual
apparatus of a brain has shortcuts in it. The brain cannot have unlimited circuitry. "o someone ho knos ho to take advantage of
those shortcuts and cause the brain to miscalculate in certain ays can cause you to see things that are not there.
Therefore you must kno your brain(s limitations.
?o you get into the cognitive function as distinguished from the .erce.tual function. And there, you are e-uallymore
e-ually in factlikely to be misled. Again, your brain has a shortage of circuitry and so forthand it(s taking all kinds of little
automatic shortcuts.
"o hen circumstances combine in certain aysor more commonly, your fello man starts acting like the magician and
manipulates you on purpose by causing your cognitive dysfunctionyou are a patsy.
And so )ust as a man orking ith a tool has to kno its limitations, a man orking ith his cognitive apparatus has to
kno its limitations. And this knoledge, by the ay, can be used to control and motivate other people<.
Cery eminent places miseducate people like you and me.
"o the most useful and practical part of psychologyhich I personally think can be taught to any intelligent person in a
eekis ungodly important. And nobody taught it to me by the ay. I had to learn it later in life, one piece at a time. And it as
fairly laborious. It is so elementary though that, hen it as all over, I )ust felt like a total horse(s ass.
And yeah, I(d been educated at #al Tech and the ;arvard Da "chool and so forth. "o very eminent places miseducated
people like you and me.
Psychology of misjudgment is terribly important to learn. 9999
#he elementary .art o/ .sychology6the .sychology o/ mis:udgment, as I call it6is terri7ly im.ortant to learn! #here
are a7out ;< little .rinci.les =Investor Psychology>! And they interact, so it gets slightly complicated. But the guts of it are
unbelievably important.
Terribly smart people make totally bonkers mistakes by failing to pay heed to it. In fact, I have done it several times during the last
to or three years in a very important ay. ,ou never get totally over making silly mista1es.
*orldly *isdom by #harlie 1unger $%%75$%%2 E
1an(s mind can be manipulated in amazing ays.
There is another saying that comes from 9ascal, hich I(ve alays considered one of the really accurate observations in the
history of thought. 9ascal said, .The mind of man at one and the same time is both the glory and the shame of the universe./
And that is exactly right. It has enormous poer. ;oever, it also had these standard malfunctions that often cause it to
reach rong conclusions. It also makes man extraordinarily sub)ect to manipulation by others. 0or example, roughly half of the army
of Adolph ;itler as composed of believing #atholics. 'iven enough clever psychological manipulation, hat human beings ill do
is -uite interesting.
#onsider the real interest and the psychological factors<
9ersonally, I(ve gotten so that I no use a kind of to5track analysis. 0irst, hat are the factors that really govern the interests
involved, rationally considered+ And second, hat are the subconscious influences here the brain at a subconscious level is
automatically doing these thingshich by and large are useful, but hich often malfunction.
8ne approach is rationality555the ay you ork 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 conclusionsmany of hich are rong.
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Dike it or not, the economy is a lot like an ecosystem.
?o e come to another somehat less reliable form of human isdommicroeconomics. And here, I find it -uite
useful to think of a free market economyor partly free market economyas sort of the e-uivalent of an ecosystem<.
This is a very unfashionable ay of thinking because early in the days after >arin came along, people like the robber
barons assumed that the doctrine of the survival of the fittest authenticated them as deserving poeryou kno, .I(m the richest.
Therefore, I(m the best. 'od(s in his heaven, etc./

And that reaction of the robber barons as so irritating to people that it made it unfashionable to think of an economy as an
ecosystem. But the truth is that it is a lot like an ecosystem. And you get many of the same results.
In nature and in business, specialization is key.
@ust as in an ecosystem, people ho narroly specialize can get terribly good at occupying some little niche. @ust as
animals flourish in niches, similarly, people ho specialize in the business orldand get very good because they specialize in the
business orldand get very good because they specializefre-uently find good economics that they ouldn(t get any other ay.
Advantages of scale are ungodly important.
And once e get into microeconomics, e get into the concept of advantages of scale. ?o e are getting closer to
investment analysisbecause in terms of hich businesses succeed and hich businesses fail, advantages of scale are ungodly
important.

0or example, one great advantage of scale taught in all of the business schools of the orld is cost reductions along the so5
called e@.erience curve. @ust doing something complicated in more and more volume enables human beings, ho are trying to
improve and are motivated by the incentives of capitalism, to do it more and more efficiently.
The very nature of things is that if you get a hole lot of volume through your )oint, you get better at processing that
volume. That is an enormous advantage. And it has a lot to do ith hich businesses succeed and fail<..
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There are even geometric economies of scale.
Det us go through a listalbeit an incomplete oneof possible advantages of scale. "ome come from simple geometry. If
you are building a great circular tank, obviously as you build it bigger, the amount of steel you use in the surface goes up ith the
s-uare and the cubic volume goes up ith the cube. "o as you increase the dimensions, you can hold a lot more volume per unit area
of steel.

And there are all kinds of things like that here the simple geometrythe simple realitygives you an advantage of scale.
0or example, netork TC advertising made the rich richer.
*orldly *isdom by #harlie 1unger $%%75$%%2 &
For e@am.le, you can get advantages o/ scale /rom #( advertising! *hen TC advertising first arrivedhen talking
color pictures first came into our living roomsit as an unbelievably poerful thing. And in the early days, e had three netorks
that had hatever it assay %34 of the audience.
*ell, if you ere 9roctor 6 'amble, you could afford to use this ne method of advertising. ,ou could afford to use this
ne method of advertising. ,ou could afford the very expensive cost of netork television because you ere selling so damn many
cans and bottles. "ome little guy couldn(t. And there as no ay of buying it in part., big volume, you could not use netork TC
advertisinghich as the most effective techni-ue.
'o 0hen #( came in, the 7randed com.anies that 0ere already 7ig got a huge tail0ind! Indeed, they prospered and
prospered and prospered until some of them got fat and foolish, hich happens ith prosperityat least to some people<..
The informational advantage of brands is hard to beat.
And your advantage of scale can be an informational advantage. If I go to some remote place, I may see *rigley cheing
gum alongside 'lotz(s cheing gum. *ell, I kno *rigley is a satisfactory product, hereas I don(t kno anything about 'lotz(s.
"o if one is &3 cents and the other is E3 cents, am I going to take something I don(t kno and put it in my mouthhich is a pretty
personal place, after all, for a lousy dime+

"o, in effect, *rigley simply by being so ell knon, has advantages of scalehich you might call an informational
advantage.
Averyone is influenced by hat others do and approve.
Another advantage o/ scale comes /rom .sychology. The psychologists use the term, social .roo/"! *e are all
influencedsubconsciously and to some extent consciouslyby hat e see others do and approve. Therefore, if everybody(s
buying something, e think it is better. *e don(t like to be the one guy ho is out of step.
Again, some of this is at a subconscious level and some if it isn(t. "ometimes e consciously and rationally think, I don(t
kno much about this. They kno more than I do. Therefore, hy shouldn(t I follo them+/
All told, your advantages can add up to one tough moat.
The social proof phenomenon hich comes right out of psychology gives the huge advantages to scalefor example, ith
very ide distributions, hich of course is hard to get. 8ne advantage of #oca5#ola is that it is available almost everyhere in the
orld.

*ell, suppose you have a little soft drink. Axactly ho do you make it available all over the Aarth+ The orldide
distribution setuphich is sloly on by a big enterprisegets to be a huge advantage<.And, if you think about it, once you get
enough advantages of that type, it can become very hard for anybody to dislodge you.
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Things tend to cascade toard inner take all.
There is another kind of advantage to scale. In some businesses, the very nature of things is to sort of cascade toard the
overhelming dominance of one firm. The most obvious is daily nespapers. There is practically no city left in the !.". aside from
a fe very big ones, here there is more than one daily nespaper.
And again, that is a scale thing. 8nce I get most of the circulation, I get most of the advertising. And once I get most of
the advertising and circulation, hy should anyone ant the thinner paper ith less information in it+ "o it tends to cascade to a
inner5take5all situation. And that is a separate form of the advantages of scale phenomenon.

"imilarly, all these huge advantages of scale allo greater specialization ithin the firm. Therefore, each person can be better
at hat he does.
It is not irrational to insist on being F$ or FB or out.
And these advantages of scale are so great, for example, that hen @ack *elch came into 'eneral Alectric, he )ust said,
.To hell ith it. *e(re either going to be F$ or FB in every field e are in or e are going to be out. I don(t care ho many people I
have to fire and hat I have to sell. *e are going to be F$ or FB or out./

That as a very tough minded thing to do, but I think it as the correct decision if you are thinking about maximizing
shareholder ealth. And I don(t think it is a bad thing to do for a civilization either, because I think that 'eneral Alectric is stronger
for having @ack *elch there.
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Bigger isn(t alays better. "ometimes, it is )ust the reverse<<
*orldly *isdom by #harlie 1unger $%%75$%%2 7

And there are also disadvantages o/ scale. 0or example, eby hich I mean Berkshire ;athaayare the largest
shareholders in #apital #ities:AB#. And e had trade publications there that got murderedhere our competitors beat us. And the
ay they beat us as by going to a narrower specialization.
*e(d have a travel magazine for business travel. "o somebody ould create one, hich as addressed solely at corporate
travel departments. Dike an ecosystem, you are getting a narroer and narroer specialization.
*ell, they got much more efficient. They could tell more to the guys ho ran corporate travel departments. 9lus, they didn(t
have to aste the ink and paper mailing out stuff that corporate travel departments ere not interested in reading. It as a more
e//icient system. And they beat our brains out as e relied on our broader magazine.
That is hat happened to the "aturday Avening 9ost and all those things. They(re gone. *hat e have no is Motor Cross
hich is read by a bunch of nuts ho like to participate in tournaments here they turn somersaults on their motorcycles. But they
#AGA about it. 0or them, it is the principle purpose of life. A magazine called Motor cross is a total necessity to those people. And
its profit margins ould make you salivate.
Cust thin1 o/ ho0 narro0cast that 1ind o/ .u7lishing is! "o occasionally, scaling don and intensifying gives you the big
advantage. Bigger is not alays better.
Another defect of scale5flush, fat, stupid bureaucracy.
The great defect of scale, of course, hich makes the game interestingso that the big people don(t alays inis that as
you get big, you get bureaucracy. And ith the bureaucracy comes the territorialityhich is again grounded in human nature.
And the incentives are perverse. 0or example, if you orked for AT6T in my day, it as a great bureaucracy. *ho in the
hell as really thinking about the shareholder or anything else+ And in a bureaucracy, you think the ork is done hen it goes out of
your in5basket. But, of course, it isn(t. It is not done until AT6T delivers hat it is supposed to deliver. "o you get big, fat, dumb,
unmotivated bureaucracies.
Bureaucracy(s a terrible problemespecially in government.
They also tend to become somehat corrupt. In other ords, if I have got a department and you have got a department and
e kind of share poer running this thing, there is sort of an unritten rule= .If you on(t bother me, I on(t bother you and e(re
both happy./ 'o you get layers o/ management and associated costs that no7ody needs! All the, hile people are )ustifying all
these layers, it takes forever to get anything done. #hey are too slo0 to ma1e decisions and nim7ler .eo.le run circles around
them!
The constant curse of scale is that it leads to big, dumb bureaucracyhich, of course, reaches it highest and orst form in
government here the incentives are really aful. That doesn(t mean e don(t need governmentsbecause e do. But it is a terrible
problem to get big bureaucracies to behave.
"ome companies deal ith bureaucracies ell= e.g., 'A.
"o people go to stratagems. They create little decentralized units and fancy motivation and training programs. 0or
example, for a big company, 'eneral Alectric has fought bureaucracy ith amazing skill. But that is because they have a combination
of a genius and a fanatic running it. And they put him in young enough so he gets a long run. 8f course, that is @ack *elch.
8thers don(t deal ith it very ell at all<.
But bureaucracy is terrible<.And as things get very poerful and very big, you can get some really dysfunctional
behavior. Dook at *estinghouse. They ble billions of dollars on a bunch of dumb loans to real estate developers. They put some
guy ho(d come up by some career pathI don(t kno exactly hat it as but it could have been refrigerators or somethingand all
of a sudden, he is loaning money to real estate developers building hotels. It is a very une-ual contest. And in due time, they lost all
those billions of dollars.
,ou get a lot of dysfunction in a big, fat happy place.
#B" provides an interesting example of another rule of psychology, namely, Pavlovian association. If people tell you hat
you really don(t ant to hearhat is unpleasantthere is an almost automatic reaction of antipathy. ,ou have to train yourself out
of it. It isn(t fore destined that you have to be this aay. But you ill tend to be this ay if you don(t think about it.
Television as dominated by one netork#B"in its early days. And 9alely as god. But he didn(t like to hear hat he
didn(t like to hear. And people soon learned that. "o they told 9alely only hat he liked to hear. Therefore, he as soon living in a
cocoon of unreality and everything as corruptalthough it as a great business.
"o the idiocy that crept into the system as carried along by this huge tide. It as a 1ad ;atter(s tea party the last ten years
under Bill 9aley.
And that is not the only example by any means. ,ou can get severe malfunction in the high ranks of business. And of course,
if you are investing, it can make a hell of a lot of difference. If you take all the ac-uisitions that #B" made under 9aley, after the
*orldly *isdom by #harlie 1unger $%%75$%%2 H
ac-uisition of the netork itself, ith all his dumb advisorshis investment bankers, management consultants and so forth ho ere
getting paid handsomelyit as absolutely terrible.
0or example, he gave something like B34 of #B" to the >umont #ompany for a television set manufacturer, hich as
destined to go broke. I think it lasted all of to or three years or something like that. "o very soon after he(d issued all that stock,
>umont as history. &ou get a lot o/ dys/unction in a 7ig /at ha..y .o0er/ul .lace 0here no one 0ill 7ring un0elcome reality
to the 7oss!
An everlasting battle beteen the pros and cons of size.
"o life is an everlasting battle beteen those to forcesto get these advantages o/ scale on one side and a tendency to
get a lot li1e the *!'! Agriculture %e.artment on the other sidehere they )ust sit around and so forth. I don(t kno exactly
hat they do. ;oever, I do kno that they do very little useful ork.
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A #hain store can be a fantastic enterprise.
8n the sub)ect of advantages of economies of scale, I find chain stores -uite interesting. @ust think about it. The concept of a
chain store as a fascinating invention. ,ou get this huge .urchasing .o0erhich means that you have loer merchandise costs.
,ou get a hole bunch of little laboratories out there in hich you can conduct experiments. And you get specialization.
If one little guy is trying to buy across BI different merchandise categories influenced by traveling salesmen, he is going to
make a lot of dumb decisions. But if your buying is done in .;J for a huge bunch of stores, you can get very bright people that kno
a lot about refrigerators and so forth to do the buying.
The reverse is demonstrated by the little store here one guy is doing all the buying. It is like the old story about the little
store ith salt all over its alls. And a stranger comes in and says to the storeoner, .,ou must sell a lot of salt./ And he replies,
.?o, I don(t. But you should see the guy ho sells me the salt./
"o there are huge purchasing advantages. And then there are the slick systems of forcing everyone to do hat orks. "o a
chain store can be a fantastic enterprise.
"am *alton played the game harder and better than anyone.
It is -uite interesting to think about *al51art starting from a single store in Bentonville, Arkagainst "ears, Goebuck
ith its name, reputation and all of its billions. ;o does a guy in Bentonville, Ark ith no money blo right by "ears, Goebuck+
And he does it in his on lifetimein fact, during his on late lifetime because he as already pretty old by the time he started out
ith one little store<.
;e played the chain store game better and harder than anyone else. Walton invented .ractically nothing! ut he co.ied
everything any7ody else ever did that 0as smartand he did it ith more than fanaticism and better employee manipulation. "o
he )ust ble right by them all.
And he had a very shred strategy<.
;e also had a very interesting competitive strategy in the early days. ;e as like a prizefighter ho anted a great record
so he could be in the finals and make a big TC hit. "o hat did he do+ ;e ent out and fought &B palookas. Gight+ And the result
as a knockout, knockout, and knockout&B times.
Walton, 7eing as shre0d as he 0as, 7asically 7ro1e other small to0n merchants in the early days! *ith his more efficient
system, he might not have been able to tackle some directly head5on at the time. But ith his better system, he could sure as hell
destroy those small ton merchants. And he ent around doing it time after time after time. Then as he got bigger, he started
destroying the big boys. *ell, that as a very, very shred strategy.
I believe the orld is better for having a *al51art.
,ou can say, .Is this a nice ay to behave+/ *ell, capitalism is a pretty brutal place. But I personally think that the orld
is a better for having a *al51art. I mean you can idealize small ton life. But I(ve spent a fair amount of time in small tons. And
let me tell youyou shouldn(t get too idealistic about all those businesses he destroyed.
9lus a lot of people ho ork at *al51art are very high grade, bouncy people ho are raising nice children. I have no
feeling that an inferior culture destroyed a superior culture. I think that is nothing more than nostalgia and delusion. But, at any rate,
it an interesting model of ho the scale o/ things and /anaticism combine to be very poerful.
"ears as a classic case study in dis 5economics.
And it is also an interesting model on the other sideho ith all its great advantages, the disadvantages of bureaucracy
did such terrible damage to "ears Goebuck. "ears had layers and layers of people it didn(t need. It as very bureaucratic. It as slo
*orldly *isdom by #harlie 1unger $%%75$%%2 I
to think. And there as an established ay of doing, thinking. If you poked your head up ith a ne thought, the system kind of
turned on you. It as everything in the ay of a dysfunctional big bureaucracy that you ould expect.
In all fairness, there as also much that as good about it. But it )ust asn(t as lean and mean and shred and effective as
"am *alton. And, in due time, all their advantages of scale ere not enough to prevent "ears from losing heavily to *al51art and
other similar retailers.
A M$%EL WE ,A(E ,A% #R$*LE WI#,6A)#ICI-A#I)2 C$M-E#I#I$) A)% I#' EFFEC#'
In some markets, no one makes out. In others, everyone does.
;ere is a model that e have had trouble ith. 1aybe you(ll be able to figure it out better. 1any markets get don to to
or three big competitorsof five or sixes. And in some of those markets, nobody makes any money to speak of. But in others,
everybody does very ell.
8ver the years, e(ve tried to figure out hy the competition in some markets gets sort of rational from the investor point
of vie so that the shareholders do ell, and in other markets, there is destructive competition that destroys shareholder ealth.
It is easy to understand hy air travel is so unprofitable<.
It is a pure commodity like airline seatsK you can understand hy no one makes any money. As e sit here, )ust think of
hat airlines have given to the orldsafe travel, greater experience, time ith your loved ones, you name it. ,et, the net amount of
money that has been made by the shareholders of airlines since Litty ;ak, is no a negative figurea substantial negative figure.
#ompetition as so intense that, once it as unleashed by deregulation, it ravaged shareholder ealth in the airline business.
But hy is the cereal business so profitable+
,et, in other fieldslike cereals, for examplealmost all the big boys make out. If you are some kind of medium grade
cereal maker, you might make $74 on your capital. And if you are really good, you might make &34. But hy are cereals so
profitabledespite the fact that it looks to me like they are competing like crazy ith promotions, coupons and everything else+ I
don(t fully understand it.
8bviously, there is a 7rand identity /actor in cereals that doesn(t exist in airlines. That must be the main factor that
accounts for it.
1aybe it boils don to individual psychology<.
And maybe the cereal makers by and large have learned to be less crazy about fighting for market sharebecause if you
get even one person ho is hell5bent on gaining market share<0or example, if I ere Lellogg and I decided that I has to have H34 of
the market, I think I could take most of the profit out of cereals. I(d ruin Lellogg in the process. But I think I could do it.
In some businesses, the participants behave like a demented Lellogg. In other businesses, they don(t. !nfortunately, I do
not have a perfect model for predicting ho that is going to happen.
0or example, if you look around at bottler markets, you ill find many markets here bottlers of 9epsi and #oke both
make a lot of money and many others here they destroy most of the profitability of the to franchises. That must get don to the
peculiarities of individual ad)ustment to market capitalism. I think you ould have to kno the people involved to fully understand
hat as happening.
A FEW W$R%' $) -A#E)#', #RA%EMAR5' A)% FRA)C,I'E'!
9atents haven(t made people much moneyuntil recently.
In microeconomics, of course, you have got the concept of patents, trademarks, exclusive franchises and so forth. 9atents
are -uite interesting. *hen I as young, I think more money ent into patents than came out. @udges tended to thro them out
based on arguments about hat as really invented and hat relied on prior art. That isn(t altogether clear.
But they changed that. They didn(t change the las. The )ust changed the administrationso that it all goes to one patent
court. And that court is no very much more pro5patent. "o I think people are no starting to make a lot of money out of oning
patents.
But trade market and franchised have alays been great.
#rademar1s, of course, have alays made people a lot of money. A trademark system is a onderful thing for a big
operation if it is ell knon.
The e@clusive /ranchise can also be onderful. If there ere only three television channels aarded in a big city and you
oned one of them, there ere only so many hours a day that you could be on. "o you had a natural position in an oligopoly in the
pre5cable days.
*orldly *isdom by #harlie 1unger $%%75$%%2 2
And if you get the franchise for the only food stand in an airport, you have a captive clientele and you have a small
monopoly of a sort.
A A'IC LE''$) $F#E) F$R2$##E)+ A )EW #EC,)$L$2& CA) 5ILL &$*!
&ou have to discern 0hen technology 0ill hel. and hurt!
The great lesson in microeconomics is to discriminate beteen hen technology is going to help you and hen it is going
to kill you. And most people do not get this straight in their heads. But a fello like Buffett does.
0or example, hen e ere in the textile business, hich is a terrible commodity business, e ere making lo5end
textileshich are a real commodity product. And one day, the people came to *arren and said, .They(ve invented a ne loom that
e think ill do tice as much ork as our old ones./
And *arren said, .'ee, I hope this doesn(t orkbecause if it does, I(m going to close the mill./ And he meant it.
Advances in commodity businesses go to buyers alone.
*hat as he thinking+ ;e as thinking, .It is a lousy business. *e are earning substandard returns and keeping it open
)ust to be nice to the elderly orkers. But e are not going to put huge amounts of ne capital into a lousy business./
And he kne that the huge productivity increases that ould come from a better machine introduced into the production of
a commodity product ould all go to the benefit of buyers of the textiles. ?othing as going to stick to our ribs as oners.
That is such an obvious conceptthat there are all kinds of onderful ne inventions that give you nothing as oners
e@ce.t the o..ortunity to s.end a lot more money in a 7usiness that is still going to 7e lousy. The money still on(t come to you.
All of the advantages from great improvements are going to flo through to the customers.
The nespaper business is another matter altogether<.
#onversely, if you on the only nespaper in 8shkosh and they ere to invent more efficient ays of composing the
hole nespaper, then hen you got rid of old technology and got ne fancy computers and so forth, all of the savings ould come
right through to the bottom line.
A three5year payback means a &4 per year return.
In all cases, the people ho sell the machineryand, by and large, even the internal bureaucrats urging you to buy the
e-uipmentsho you pro)ections ith the amount you ill save at current prices ith the ne technology. ;oever, they don(t do
the second step of the analysishich is to determine ho much is going to flo through to the customer. I(ve never seen a single
pro)ection incorporating that second step in all my life. And I see them all the time. Gather, they alays read= .This capital outlay ill
save you so much money that it ill pay for itself in three years./
"o you keep buying things that ill pay for themselves in three years. And after B3 years of doing it, someho you have
earned a return of only about &4 per annum. That is the textile business.
And it isn(t that the machines eren(t better. It is )ust that the savings didn(t go to you. The cost reductions came through
all right. But the benefit of the cost reductions didn(t go to the guy ho bought the e-uipment. It is such a simple idea. It is so basic.
And yet it is so often forgotten.
#,E )A#I$)AL CA', RE2I'#ER M$%EL I' E4AC#L& W,A# &$* ARE L$$5I)2 F$R
Aarly birds have huge advantages<
Then there is another model from microeconomics, hich I find very interesting. *hen technology moves as fast as it
does in a civilization like ours, you get a phenomenon, hich I call com.etitive destruction. ,ou kno, you have the finest buggy
hip factory all of a sudden in comes this little horseless carriage. And before too many years go buy your buggy hip business is
dead. ,ou either get into a different business or you are deadyou are destroyed. It happens again and again and again.
And hen these ne businesses come in, there are huge advantages for the early birds. And hen you are an early bird,
there is a model that I call .surfing/hen a surfer gets up and catches the ave and )ust stays there, he can go a long, long time.
But if he gets off the ave, he becomes mired in the shados<.
But people get long runs hen they are right on the edge of the avehether it is 1icrosoft or Intel or all kinds of
people, including ?ational #ash Gegister in the early days.
?ational #ash Gegister as a lead pipe cinch<
The cash register as on of the great contributions to civilization. It is a onderful story. 9atterson as a small retail
merchant ho did not make any money. 8ne day, somebody sold him a crude cash register, hich he put into his retail operation.
And it instantly changed from losing money to earning a profit because it made it so much harder for the employees to steal<.
*orldly *isdom by #harlie 1unger $%%75$%%2 %
But 9atterson, having the kind of mind that he did, didn(t think, .8h, good for my retail business./ ;e thought, .I(m going
into the cash register business./ And, of course, he created ?ational #ash Gegister.
And he surfed. ;e got the best distribution system, the biggest collection of patents and the best of everything. ;e as a
fanatic about everything important as the technology developed. I have in my files an early ?ational #ash Gegister #ompany report in
hich 9atterson described his methods and ob)ectives. And a ell5educated orangutan could see that buying into his partnership ith
9atterson in the early days, given his notions about the cash register business, as a total $334 cinch.
And, of course, that is exactly hat an investor should be looking for. In the long life, you can expect to profit heavily
from at least a fe of those opportunities if you develop the isdom and ill to seize them. At any rate, surfing is a very poerful
model.
FI2*RE W,ERE &$* ,A(E A) E%2E #,E), -LA& #,ERE A)% $)L& #,ERE!
If e don(t believe e have an advantage, e don(t play.
,o0ever, er1shire ,atha0ay, 7y and large, does not invest in these .eo.le that are sur/ing" on com.licated
technology! A/ter all, 0e are cran1y and idiosyncratic6as you may have noticed!
And *arren and I don(t feel like e have any great advantage in the high5tech sector. In fact, e feel like e are at a big
disadvantage in trying to understand the nature of technical developments in softare, computer chips or hat have you. "o e tend
to avoid that stuff, based on our personal inade-uacies.
0igure here you have an edgeand stay there.
Again, that is a very, very poerful idea. Avery person is going to have a circle of competence. And it is going to be very
hard to advance that circle. If I had to make my living as a musician<..I can(t even think of a level lo enough to describe here I
ould be sorted out to if music ere the measuring standard of the civilization.
'o you have to /igure out 0hat your o0n a.titudes are! If you play games here other people have the aptitudes and
you don(t , you are going to lose. And that is as close to certain as any prediction that you can make. ,ou have to figure out here
you have got an edge. And you have got to play ithin your on circle of competence.
Dife is much like trying to be a good plumbing contractor.
If you ant to be the best tennis player in the orld, you may start out trying and soon find out that it is
hopelessthat other people blo right by you. ;oever, if you ant to become the best plumbing contractor in Bemid)i, that is
probably all right by to5thirds of you. It takes 0ill. It takes the intelligence. But after a hile, you ill gradually kno all about
the plumbing business and master the art. That is an attainable ob)ective, given enough disci.line. And people ho could never in
a chess tournament or stand in center court in a respectable tennis tournament can rise -uite high in life by sloly developing a circle
of competencehich results partly from hat they ere born ith and partly from hat they sloly develop through ork.
"o some edges can be ac-uired. And the game of life to some extent for most of us is trying to be something like a good
plumbing contractor in Bemid)i. Cery fe of us are chosen to in the orld(s chess tournaments.
MAditor(s note= 1unger(s comments remind your editor of Buffett(s comments in @ohn Train(s The 1oney 1asters. Buffett asks
Train, .;o do you beat Bobby 0isher+/ Anser= .9lay him in anything but chess./N
8ne person(s garbage is another(s treasure.
"ome of you may find opportunities .surfing/ along in the ne high tech fields55The Intels, the 1icrosofts and so on. The
fact that e don(t think e are very good at it and have pretty ell stayed out of it doesn(t mean that it is irrational for you to do it.
#$ A MA) WI#, -R$FICIE)C& I) MA#,, EFFICIE)# MAR5E# #,E$R& L$$5' LI5E A )AIL!
8n to dessertthe selection of common stocks<
*ell, so much for the basic microeconomic models, a little bit of psychology, a little bit of mathematics, helping create
hat I call the general substructure of orldly isdom. ?o if you ant to go from carrots to dessert, I ill turn to stock picking
trying to dra on this general orldly isdom as e go.
I do not ant to get into emerging markets, bond arbitrage and so forth. I am talking about nothing but plain vanilla stock
picking. That, believe me, is complicated enough. And I am talking about common stock picking.
>o as I do, not as I say<.
The first -uestion is, .*hat is the nature of the stock market+/ And that gets you directly to this efficient market theory
that got to be the ragea total ragelong after I graduated from la school.
And it is rather interesting because one of the greatest economists of the orld is a substantial shareholder in Berkshire
;athaay and has been from the very early days After Buffett as in control. ;is textbook alays taught that the stock market as
*orldly *isdom by #harlie 1unger $%%75$%%2 $3
perfectly efficient and that nobody could beat it. But his on money ent into Berkshire and made him ealthy. "o, like 9ascal in
his famous ager, he hedged his 7et.
The iron rule of lifeK only B34 of us can be in the top 7
th
.
Is the stock market so efficient that people can(t beat it. *ell, the efficient market theory is obviously roughly right
meaning that markets are -uite efficient and it is -uite hard for anybody to beat the market by a significant margin as a stock picker by
)ust being intelligent and orking in a disciplined ay.
Indeed, the average result has to be the average result. By definition, everybody can(t beat the market. As I alays say,
the iron rule of life is that only B34 of the people can be in the top fifth. That is )ust the ay it is. "o the anser is that it is partly
efficient and partly inefficient.
Afficient market theory is seductive. 8nly it is not true<
And, by the ay, I have a name for people ho ent to the extreme efficient market theory that enable them to do pretty
mathematics. "o I understand its seductiveness to people ith large mathematical gifts. It )ust had a difficulty in that the fundamental
assumption did not tie properly to reality.
Again, to the man 0ith a hammer, every .ro7lem loo1s li1e a nail. If you are good at manipulating higher mathematics
in a consistent ay, hy not make an assumption, hich enables you to use your tool+
E##I)2 $) ,$R'E' A)% -IC5I)2 '#$C5' ,A(E M$RE #,A) A LI##LE I) C$MM$)!
8dds on horses and stocks are set by the market.
The model I liketo sort of simplify the notion of hat goes on in a market from common stocksis the pari5mutual
system at the racetrack. If you stop to think about it, a .ariDmutual system is a mar1et. Averybody goes there and bets and the odds
change based on hat has been bet.
That is hat happens in a stock market.
Any damn fool can see that a horse carrying a light eight ith a onderful in rate and a good post position etc., etc. is
ay more likely to in than a horse ith a terrible record and extra eight and so on and so on. But if you look at the damn odds, the
bad horse pays $33 to $, hereas the good horse pays E to B. Then it is not clear hich is statistically the best bet using the
mathematics of 0ermet and 9ascal. The prices have change in such a ay that it is very heard to beat the system.
And then the track is taking $I4 of the top. "o not only do you have to outit all the other betters, but you have got to
outit them by such a big margin that on average you can afford to take $I4 of your gross bets off the top and give it to the house
before the rest of your money can be put to ork.
Believe it or not, some people make money5betting horses<.
'iven those mathematics, is it possible to beat the horses only using one(s intelligence+ Intelligence should give some
edge, because lots of people ho don(t kno anything go out and bet lucky numbers and so forth. Therefore, somebody ho really
thinks about nothing but horse performance and is shred and mathematical could have a very considerable edge, in the absence of
the frictional cost caused by the house take.
!nfortunately, hat is a shred horseplayer(s edge does in most cases is to reduce his average loss over a season of betting
from the $I4 that he ould lose if he got the average result to maybe $34. ;oever, there are actually a fe people ho can beat
the game after paying the full $I4.
I used to play poker hen I as young ith a guy ho made a substantial living doing nothing but bet harness races<?o
harness racing is a relatively inefficient market. ,ou don(t have the depth of intelligence betting on harness races that you do on
regular races. *hat my poker pal ould do as to think about harness races as his main profession. And he ould bet only
occasionally hen he sa some mispriced bet available. And by doing that, after paying the full handle to the househich I
presume as around $I455he made a substantial living.
,ou have to say that is rare. ;oever, the market as not perfectly efficient. And if it eren(t for that big $I4 handle,
lots of people ould regularly be beating lots of other people at the horse races. It is efficient, yes. But it is not perfectly efficient.
And ith enough shredness and fanaticism, some people ill get better results than others.
It ain(t easy, but it is possible to outperform in stocks, too.
The stock market is the same ayexcept that the house hand is so much loer. If you take transaction coststhe spread
beteen the bid and the ask plus the commissionsand if you don(t trade too actively, you are talking about fairly lo transaction
costs. "o that ith enough fanaticism and enough discipline, some of the shred people are going to get ay better results than
average in the nature of things.
*orldly *isdom by #harlie 1unger $%%75$%%2 $$
It is not a bit easy. And, of course, 734 ill end up in the bottom half and I34 ill end up in the bottom I34. But some
people ill have an advantage. And in a fairly lo transaction cost operation, they ill get better than average results in stock
picking.
*hat orks betting horses also orks for stock picking.
;o do you get to be one of those ho is a innerin a relative senseinstead of a loser+
;ere again, look at the pari5mutuel system. I had dinner last night by absolute accident ith the president of "anta Anita.
;e says that there are to or three betters ho have a credit arrangement ith them, no that they have off5track betting, ho are
actually beating the house. They are sending money out net after the full handlea lot of it to Das Cegas, by the ayto people ho
are actually inning slightly, net, after paying the full handle. They are that shred about something ith as much unpredictability as
horse racing.
And the one thing that all those inning bettors in the hole history of people ho have beaten the pari5mutuel system
have is -uite simple. #hey 7et very seldom.
*inners bet big hen they have the oddsotherise, never.
It is not given to human beings to have such talent that they can )ust kno everything about everything all the time. But it
is given to human beings ho ork all the time. But it is given to human beings ho ork hard at itho look and sift the orld for
a mispriced betthat they can occasionally find one.
And the ise ones bet heavily hen the orld offers them that opportunity. They bet big heavily hen the orld offers
them that opportunity. They bet big hen they have the odds. And the rest of the time, they don(t. It is )ust that simple.
A' *'*AL, I) ,*MA) AFFAIR' W,A# WI)' ARE I)CE)#I(E'!
It is obvious to us, And yet nobody operates that ay.
That is a very simple concept. And to me it is obviously rightbased on experience not only from the pari5mutuel system,
but everyhere else.
And yet, in investment management, practically nobody operates that ay. *e operate that ayI(m talking about
Buffett and 1unger. And e(re not alone in the orld. But a huge ma)ority of people have some other crazy construct in their heads.
And instead of 0aiting /or a near cinch and loading u., they apparently ascribe to the theory that if they ork a little harder or hire
more business school students, they(ll come to kno everything about everything about everything all the time.
To me, that is totally insane. #he 0ay to 0in is to 0or1, 0or1, 0or1, 0or1 and ho.e to have a /e0 insights.
1ost of Berkshire(s billions came from a handful of ideas.
;o many insights do you need+ *ell, I(d argue that you don(t need many in a lifetime. If you look at Berkshire
;athaay and all of its accumulated billions, the top ten insights account for most of it. And that is ith a very brilliant man
*arren(s a lot more able than I am and very disciplineddevoting his lifetime to it. I don(t mean to say that he is only had ten
insights. I am )ust saying that most of the money came from ten insights.
"o you can get very remarkable investment results if you think more like a inning pari5mutuel player. @ust think of it as
heavy odds against game full of bullshit and craziness ith an occasional mispriced something or other. And you are not going to be
smart enough to find thousands in a lifetime. And 0hen you get a /e0, you really load u.! It is :ust that sim.le!
A simple but poerful ay to improve your results..
*hen *arren MBuffettN lectures at business schools, he says, .I could improve your ultimate financial elfare by giving
you a ticket ith only B3 slots in it so that you had B3 punchesrepresenting all the investments that you got to make in a lifetime.
And once you(d punched through the card, you couldn(t make any more investments at all./
;e says, .!nder those rules, you(d really think carefully about hat you did and you ould be forced to load up on hat
you really thought about. "o you ould do so much better./
As long as clients buy salt, investment managers ill sell it.
Again, this is a concept that seems perfectly obvious to me. And to *arren, it seems perfectly obvious. But this is one of
the very fe business classes in the !.". here anybody ill be saying so. It )ust isn(t the conventional isdom.
To me, it is obvious to me that the 0inner has to 7et very selectively. It has been since very early life. I don(t kno hy
it is not obvious to many other people.
*orldly *isdom by #harlie 1unger $%%75$%%2 $B
I don(t think the reason hy e got into such idiocy in investment management is best illustrated by a story that I tell about
the guy ho sold fishing tackle. I asked him, .1y 'od, they(re purple and green. >o fish really take these lures+/ And he said,
.1ister, I don(t sell to fish./
Investment managers are in the position of that fishing tackle salesman. They are like the guy ho as selling salt to the
guy ho already had too much salt. And as long as the guy ill buy salt, hy they ill sell salt. But isn(t hat ordinarily orks for
the buyer of investment advice.
As usual, in human affairs, hat ins are incentives.
If you invest Berkshire ;athaay5style, it ould be hard to get paid as an investment manager as ell as they are currently
paidbecause you ould be holding a block of *al51art and a block of #oca5#ola and a block of something else. ,ou(d be sitting
on your ass. And the client ould be getting rich. And, after a hile, the client ould think, .*hy am I paying this guy half a percent
a year on my onderful passive holdings+
"o hat makes sense for the investor is different from hat makes sense for the manager. And, as usual in human affairs,
0hat determines the 7ehavior are incentives /or the decision ma1er!
'etting the incentives right is a very, very important lesson
0rom all business, my /avorite case on incentives is Federal E@.ress. The heart and soul of their systemhich creates
the integrity of the productis having all their airplanes come to one place in the middle of the night and shift all the packages from
plane to plane. If there are delays, the hole operation can(t deliver a process full of integrity to 0ederal Axpress customers.
And it as alays screed up. They could never get it done on time. They tried everything= moral suasion, threats, you
name it. And nothing orked.
0inally, somebody got the idea to pay all these people not so much an hour, but so much a shiftand hen it is all done
they can all go home.. *ell, their problems cleared up overnight.
"o getting the incentives right is a very, very important lesson. It as not obvious to 0ederal Axpress hat the solution
as. But maybe no, it ill hereafter more often be obvious to you.
IF 'EC#$R R$#A#I$) I' (ER& L*CRA#I(E, WE ,A(E )E(ER 'EE) #,E E(I%E)CE!
8nce you factor in the odds, the market is not easy to beat.
All right, e have no recognized that the market is efficient as a pari5mutual system is efficientith the favorite more likely than
the long shot to do ell in racing, but not necessarily give any betting advantage to those that bet on the favorite.
In the stock market, some railroad that is beset by better competitors and tough unions may be available at one5third of
book value. In contrast, IB1 in its heyday might be selling at H times book value. "o it is )ust like the pari5mutuel system. Any
damn fool could plainly see that IB1 had better business prospects than the railroad. But once you put the price into the formula, it
asn(t so clear anymore hat as going to ork best for a buyer choosing beteen the stocks. "o it is a lot like a pari5mutuel system.
And, therefore, it gets very hard to beat.
I kno of no really rich .sector rotators/
*hat style should the investor use as a picker of common stocks in order to try to beat the marketin other ords, to get
above average long5term result+ A standard techni-ue that appeals to a lot of people is called .sector rotation/ ,ou simply figure out
hen oils are going to outperform retailers, etc., etc., etc. ,ou )ust kind of flit around being in the hot sector of the market making
better choices than other people. And presumably, over a long period of time, you get ahead.
;oever, I kno of no really rich sector rotator. 1aybe some people can do it. I am not saying they can(t. All I kno is
that all the people I kno ho got richand I kno a lot of themdid not do it that ay.
RIC, $R -$$R, I# I' 2$$% #$ ,A(E A ,*2E MAR2I) $F 'AFE#&!
A significant discount O more upside P a margin of safety
The second basic approach is the one that Ben 'raham usedmuch admired by *arren and me. As one factor, 'raham
had this concept of value to a private onerhat the hole enterprise ould sell for if it ere available. And that as calculable in
many cases.
Then, if you could take the stock price and multiply it by the number of shares and get something that as one third or less
of sellout value, he ould say that you have got a lot of edge going for you. Aven ith an elderly alcoholic running a stodgy business,
this signifies excess of real value per share orking for you, hich means that all kinds of good things can happen to you. ,ou had a
huge margin of safetyas he put itby having this big excess value going for you.
The aftermath of the $%E3s as a bargain hunter(s dream.
But he as, by and large, operating hen the orld as in shell shock from the $%E3shich as the orst contraction in
the Anglish5speaking orld in about H33 years. *heat in Diverpool, I believe, got don to something like a H335year lo, ad)usted
*orldly *isdom by #harlie 1unger $%%75$%%2 $E
for inflation. 9eople ere so shell5shocked for a long time thereafter that Ben 'raham could run his 'eiger counter over this detritus
from the collapse of the $%E3(s and find things selling belo their orking capital per share and so on.
Today, stated assets evaporate at the first sign of trouble.
And in those days, orking capital actually belonged to the shareholders. If the employees ere no longer useful, you )ust
sacked them all, took the orking capital and stuck it in the oners( pockets. That as the ay capitalism then orked.
)o0adays, o/ course, the accounting is not realistic67ecause the minute the 7usiness starts contracting, signi/icant
assets are not there! *nder social norms and the ne0 legal rules o/ the civiliEation, so much is o0ed to the em.loyees, that the
minute the enter.rise goes into reverse, some o/ the assets on the 7alance sheet are not there anymore!
"trange things can happen in the technology area.
?o, that might not be true if you run a little auto dealership by yourself. ,ou may be able to run it in a ay that there is
no health plan and this and that so that if the business gets lousy, you can take your orking capital and go home. But IB1 can(t or at
least it didn(t )ust look at hat disappeared from its balance sheet hen it decided that it had to change size both because the orld
had changed technologically and because its market position had deterioration.
And in terms of bloing it. IB1 is some example. Those ere brilliant, disciplined people. But there as enough turmoil
in technological change that IB1 got bounced off the ave after .surfing/ successfully for H3 years. And that as some collapsean
ob)ect lesson in the difficulties of technologies and one of the reasons hy Buffett and 1unger don(t like technology very much. *e
don(t think e are any good at it, and strange things can happen.
8ne ay to keep finding .bargains/ is to redefine the term.
At any rate, the trouble ith hat I call the classic Ben 'raham concept is that gradually the orld ised up and those real
obvious bargains disappeared. ,ou could run your 'eiger counter over the rubble and it ouldn(t click.
But such is the nature of people hy have a hammer Qto hom, as I mentioned, every problem looks like a nailthat the
Ben 'raham folloers respond by changing the calibration on their 'eiger counters. In effect, they started defining a bargain in a
different ay. And they kept changing the definition so that they could keep doing hat they(d alays done. And it still orked
pretty ell. "o the Ben 'raham intellectual system as a very good one.
;aving an unstable business partner has its reards.
8f course, the best part of it all as his concept of .1r. 1arket/. Instead of thinking the market as efficient. ;e treated
it as a manic5depressive ho comes by every day. And some days he says, .I(ll sell you some of my interest for ay less than you
think it is orth./ And other days, .1r. 1arket/ comes by and says, .I(ll sell you some of my interest at a price that is ay higher
than you think it is orth./ And you get the option of deciding hether you ant to buy more, sell part of hat you already have or do
nothing at all.
To 'raham, it 0as a 7lessing to 7e in 7usiness 0ith a manicDde.ressive 0ho gave you this series o/ o.tions all the
time. That as a very significant mental construct. And it has been very useful to Buffett, for instance, over his hole lifetime.
2RA,AM WA')# #R&I)2 #$ -LA& $*R 2AME6I!E!, -A&I)2 *- F$R E##ER *'I)E''E'
Ben 'raham asn(t trying to do hat e did.
;oever, if e(d stayed ith classic 'raham the ay Ben 'raham did it, e ould never have had the record e have.
And that is because 'raham didn(t ant to ever talk to management. And his reason as that, like the best sort of professor aiming
his teaching at a mass audience, he as trying to invent a system that anybody could use. And he did not feel that the man in the street
could run around and talk to managements and learn things. ;e also had a concept that the management ould often couch the
information very shredly to mislead. Therefore, it as very difficult. And that is still true, of coursehuman nature being hat it
is.
8ur leappaying up for -uality
And so having started out as 'rahamiteshich, by the ay, orked finee gradually got hat I ould call better
insights. And e realized that some company that as selling at B or E times book value could still be a hell of a bargain because of
the momentum implicit in its position, sometimes combined ith an unusual managerial skill plainly present in some individual or
other or some system or other.
And once e(d gotten over the hurdle of recognizing that a thing could be a bargain based on -uantitative measures that
ould have horrified 'raham, e started thinking about better businesses.
Bulk of Berkshire(s billions brought by better businesses.
*orldly *isdom by #harlie 1unger $%%75$%%2 $&
And, by the ay, the bulk of the billions in Berkshire ;athaay have come from the better businesses. 1uch of the first
RB33 or RE33 million came from scrambling around ith our 'eiger counter. But the great bulk of the money had come from the
great businesses.
And even some of the early money as made by being temporarily present in great businesses. Buffett 9artnership, for
example, oned American Axpress and >isney hen they got pounded don.
FR$M #,E (IEW-$I)# $F A RA#I$)AL CLIE)#, I)(E'#ME)# MA)A2EME)# #$%A& I' $)5ER'!
A tremendous advantage at Berkshireno clients.
Most investment managers are in a game 0here the clients e@.ect them to 1no0 a lot a7out a lot o/ things! *e did
not have any clients ho could fire us at Berkshire ;athaay. "o e didn(t have to be governed by any such construct. And e came
to this notion of finding a mispriced bet and loading up hen e ere very confident that e ere right. "o e are ay less
diversified. And I think our system is miles better.
;oever, in all fairness, I do not think a lot of money managers could successfully sell their services if they used our
system. But if you are investing for &3 years in some pension fund, hat difference does it make if the path from start to finish is a
little more bumpy or a little different than everybody else(s so long as it is all going to ork out ell in the end+ "o hat if there is a
little extra volatility.
Investment management today is really hobbling itself.
In investment management today, everybody ants not only to in, but also to have the path never diverge very much
from a standard path except on the upside. *ell, that is a very artificial, crazy construct. That is the e-uivalent in investment
management to the customer of binding the feet of the #hinese omen. It(s the e-uivalent of hat ?ietzsche meant hen he
criticized the man ho had a lame leg and as proud of it.
That is really hobbling yourself. ?o, investment managers ould say, .*e have to be that ay. That is ho e are
measured. And they may be right in terms of the ay the business is no constructed. But from the viepoint of a rational
consumer, the hole system is .bonkers/ and dras a lot of talented people into socially useless activity.
9999IF &$* %$)# L$A% *- $) 2REA# $--$R#*)I#IE', #,E) &$* ARE MA5I)2 A I2 MI'#A5E!9999
Weight your trades.
It is much better to attempt something attainable.
And the Berkshire system is not .bonkers/. It is so damned elementary that even the bright people are going to have limited,
really valuable insights in a very competitive orld hen they are fighting against other very bright, hard5orking people.
And it makes sense to load up on the very fe good insights you have instead of pretending to kno everything about
everything at all times! &ou are much more li1ely to do 0ell i/ you start out to do something feasible instead o/ something that
is not /easi7le! Isn(t that perfectly obvious+
;o many of you have 7H brilliant insights in hich you have e-ual confidence+ Gaise your hands please. ;o many of you
have to or three insights that you have some confidence in+ I rest my case.
I ould say that Berkshire ;athaay(s system is adapting to the nature of the investment problem as it really is.
The trick is getting into better businesses.
*e have really made the money out of high -uality businesses. In some cases, e )ust bought the hole businesses. And in
some cases, e )ust bought a big block of stock. But hen you analyzed hat happened, the big money has been made in the high
-uality businesses.
8ver the long term, it is hard for a stock to earn a much better return than the business, hich underlies it earnings. If the
business earns H4 on capital over &3 years and you hold it for &3 years, you are not going to make much different than a H percent
returneven if you originally buy it at a huge discount. #onversely, if a business earns $24 on capital over B3 or E3 years, even if
you pay an expensive looking price, you end up ith one hell of a result.
0inding Sem small is a very beguiling idea<
"o the trick is getting into better businesses. And that involves a lot of these advantages of scale that you could consider
momentum effects.
;o do you get into these great companies+ 8ne method is hat I ould call the method of finding them smallget Fem
0hen they are little. 0or example, buy *al51art hen "am *alton first goes public and so forth. And a lot of people try to do )ust
that. And it is a very beguiling idea. I/ I 0ere a young man, I might actually go into it!
*e have to buy them big. And it gets harder all the time.
*orldly *isdom by #harlie 1unger $%%75$%%2 $7
But it doesn(t ork for Berkshire ;athaay anymore because e have got too much money. *e can(t find anything that
fits our size parameter that ay. Besides, e are set in our ays. But I regard finding them small as a perfectly intelligent approach
for somebody to try ith discipline. It is )ust something that I have done.
0inding them big obviously is very hard because of the competition. "o far, Berkshire(s managed to do it. But can e
continue to do it+ *hat is the next #oca5#ola investment for us+ *ell, the anser to that is I don(t kno. I think it gets harder for us
all the time<
?ot loading up on great opportunities is a big mistake.
And ideallye have done a lot of thisyou get into a great business hich also had a great manager because
management matters. 0or example, it has made a hell of a difference to 'eneral Alectric that @ack *elch came in instead of the guy
ho took over *estinghouseone hell of a difference. "o management matters too.
And some if it is predictable. I do not think it takes a genius to understand that @ack *elch as a more insightful person
and a better manager than his on peers in other companies. ?or do I think it took tremendous genius to understand that >isney had
basic momentums in place, hich are very poerful and that Aisner and *ells ere very unusual managers.
"o you do get an occasional opportunity to get into a onderful business that is being run by a onderful manager. And,
of course, that is hog heaven day. If you don(t load up hen you get those opportunities, it is a big mistake.
It is usually better to bet on the business than the manager<
8ccasionally, you ill find a human being ho is so talented that he can do things that ordinary skilled mortals can(t. I ould
argue that "imon 1arks ho as second generation in 1arks and "penser of Anglandas such a man. 9atterson as such a man at
?ational #ash Gegister. And "ame *alton as such a man.
These people do come alongand in many cases, they are not that hard to identify. If you have got a reasonable handith
the fanaticism and intelligence and so on that these people generally bring to the partythen management can matter much.
;oever, averaged out, betting on the -uality of management. In other ords, if you have to choose one, 7et on the 7usiness
momentum, not the 7rilliance o/ the manager!
But, very rarely, you find a manager ho is so good that you have to follo him into hat looks like a mediocre business.
MA5E A FEW 2REA# I)(E'#ME)#' A)% 'I# $) &$*R A''E#'
There are huge mathematical advantages to doing nothing.
Another very simple effect I very seldom see discussed is the e//ect o/ ta@es. If you are going to buy something, hich
compounds for E3 years at $74 per annum and you pay one E74 tax at the very end, the ay that orks out is that after taxes, you
keep $E.E4 per annum.
In contrast, if you bought the same investment, but had to pay taxes every year of E74 out of the $74 that you earned, then
your return ould b e $74 minus E74 of $7455or only %.I74 per year compounded. "o the difference there is over E.74. and hat
E.74 does to the numbers over long holding periods like E3 years is truly eye opening. If you sit on your ass for long, long stretches
in great companies, you can get a huge edge from nothing but the ay income taxes ork.
Aven ith a $34 per annum investment, paying a E74 tax at the end gives you 2.E4 after taxes as an annual compounded
result after E3 years. In contrast, if you pay E74 each year instead of at the end, your annual result goes don to H.74. "o you add
nearly B4 of after5tax return per annum if you only achieve an average return by historical standards from common stock investments
in companies ith lo dividend payout ratios.
Tax5related motivations have led to many big boners.
But in terms of business mistakes that I(ve seen over a lifetime, I ould say that trying to minimize taxes too much is one of
the great standard causes of really dumb mistakes. I see terrible mistakes from people being overly motivated by tax considerations.
*arren and I personally do not drill oil ells. *e pay our taxes. And e(ve done pretty ell, so far. Anytime somebody
offers you anything ith a big commission and a B335page prospectus, don(t buy it. 8ccasionally, you ill be rong if you adopt
.1unger(s Gule/. ;oever, over a lifetime, you ill be a long ay aheadand you ill miss a lot of unhappy experiences that
might otherise reduce your love for your fello man.
1ake a fe great investments and sit on your assets
There are huge advantages for an individual to get into a position here you make a fe great investments and )ust sit on your
ass= ,ou are paying less to brokers. ,ou are listening to less nonsense. And if it orks, the governmental tax system gives you an
extra $, B or E percentage points per annum compounded.
*orldly *isdom by #harlie 1unger $%%75$%%2 $H
And you think that most of you are going to get that much advantage by hiring investment counselors and paying them $4 to
run around, incurring a lot of taxes on your behalf. Dots of luckT
'reat companies( stock prices often reflect their -uality.
Are there any dangers in this philosophy+ ,es, Averything in life has dangers. "ince it is so obvious that investing in great
companies orks, it gets horribly overdone from time to time. In the ?ifty50ifty days, everybody could tell hich companies ere the
great ones. "o they got up to 73, H3 and I3 times earnings. And )ust as IB1 fell off the ave, other companies did, too. #hus, a
large investment disaster resulted /rom too high .rices! And you have got to 7e a0are o/ that dangerG!
"o there are risks. ?othing is automatic and easy.. But if you can find some fairly priced great company and buy it and sit,
that tends to ork out very, very ell indeedespecially for an individual.
A)% #,ERE' #,E *L#IMA#E )$<DRAI)ER6LI5E FI)%I)2 M$)E& I) #,E '#REE#!
*ithin the groth stock model, there is a sub5position= There are actually businesses, that you ill find a fe times in a
lifetime, here any manager could raise the return enormously )ust by raising pricesand yet they have not done it. "o they have
huge unta..ed .ricing .o0er that they are not using. That is the ultimate no5brainer.
That existed in >isney. It is such a uni-ue experience to take your grandchild to >isneyland. ,ou are not doing it that often.
And there are a lot of people in the country. And >isney found that it could raise those prices a lot and the attendance stayed right up.
"o a lot of the great record of Aisner and *ells as utter brilliance but the rest came from )ust raising prices at >isneyland
and >isney *orld and through video cassette sales of classic animated movies.
#oca5cola had it all. It as !erfect.
At Berkshire ;athaay, *arren and I raised the prices of "ee(s #andy a little faster than others might have. And, of course,
e invested in #oca5#olahich had some untapped pricing poer. And it also had brilliant management. "o a 'oizueta and
Leough could do much more than raise prices. It as perfect.
,ou ill occasionally find money in the street.
,ou ill get a fe opportunities to profit from finding under pricing. There are actually people out there ho don(t price
everything as high as the market ill easily stand. And once you figure that out, it is like finding money in the streeti/ you have
the courage o/ your convictions!
M$%EL' FR$M ER5',IRE ,A#,AWA& I)(E'#ME)#'+ C$5E, 2ILLE##E, 2EIC$ & #,E WA',I)2#$)
-$'#
1odel F$= Betting on nespapers in to nespaper tons.
If you look at Berkshire(s investments here a lot of the money had been made and you look for the models, you can see that
e tice bought into to5nespaper tons, hich have since become one5nespaper tons. "o e made a bet to some extent<
The *ashington 9ost as a rare opportunity indeed.
In one o/ those6#he Washington -ost60e 7ought it at a7out ;<H o/ the value to a .rivate o0ner! 'o 0e 7ought it
on a en 2rahamDstyle 7asis6at one /i/th o/ o7vious value6and, in addition, 0e /aced a situation 0here you had 7oth the to.
hand in a game that 0as clearly going to end u. 0ith one 0inner and a management 0ith a lot o/ integrity and intelligence!
That one as a real dream. They are very high5class peoplethe Latherine 'raham family. That is hy it as a dreaman absolute
damn dream.
8f course, that came about aback in $%IE5I&. And that as almost like $%EB. That as probably a once5in5&35years5type
denouement in the markets. That investment(s up about 73 times over our cost. If I ere you, I ouldn(t count on getting any
investment in your lifetime -uite as good as the *ashington 9ost as in (IE and (I&.
But it doesn(t have to be that good to take care of you.
1odel FB= A lo5priced item P a global marketing advantage.
Det me mention another model. 8f course, 'illette and #oke make fairly lo5priced items and have a tremendous marketing
advantage all over the orld. And in 'illette(s case, they 1ee. sur/ing along on ne0 technology, hich is fairly simple by the
standards of microchips. But it is hard for competitors to do.
"o they have been able to stay constantly near the edge of improvements in shaving. There are hole countries here 'illette
has more than %34 of the shaving market.
1odel FE= The cancer surgery formula
*orldly *isdom by #harlie 1unger $%%75$%%2 $I
'AI#8 is a very interesting model. It is another one of the $33 or so models you ought to have in your head. I(ve had many
friends in the sic1D7usinessD/i@Dgame over a long lifetime. And they practically all use the folloing formulaI call it the cancer
surgery formula=
They look at this mess. And they figure out if there is anything sound left that can live on its on if they cut aay everything
else.
8f course, if that doesn(t ork, they li-uidate the business. But it fre-uently does ork.
And 'AI#8 had a perfectly magnificent businesssubmerged in a mess, but still orking. 1isled by success, 'AI#8 had
done some foolish things. #hey got to thin1ing that, 7ecause they 0ere ma1ing a lot o/ money, they 1no0 everything! And they
suffered huge losses.
All they had to do as to cut out all the folly and go back to the perfectly onderful business that as lying there. And hen
you think about it, that is a very simple model. And it is repeated over and over again.
And, in 'AI#8(s case, think about all the money e passively made< It as a 0onder/ul 7usiness com7ined 0ith a
7unch o/ /oolishness that could easily 7e cut out! And people ere coming in ho ere temperamentally and intellectually
designed so they ere going to cut it out. That is a model you ant to look for.
And you may /ind one or t0o or three in a long li/etime that are very good! And you may /ind ;< or I< that are good
enough to 7e Juite use/ul!
#,E I)(E'#ME)# MA)A2EME)# *'I)E''+ %$)# -RAC#ICE -'&C,$L$2ICAL %E)IAL
Investment managers as a hole don(t add any value<
0inally, I(d like to once again talk about investment management. That is a funny business, because on a net basis, the hole
investment management business together gives no value added to all buyers combined. That is the ay it had to ork.
8f course, that is not true of plumbing and it isn(t true of medicine. If you are going to make your careers in the investment
management business, you face a very peculiar situation. And most investment managers handle it ith psychological denial)ust
like a chiropractor. That is the standard method of handling the limitations o/ the investment management .rocess. But if you
ant to live the best sort of life, I ould urge each of you not to use the psychological denial mode.
;oever, it is not impossible to add value.
I think a select fea small percentage of the investment managerscan deliver value added. But I don(t think brilliance
alone is enough to do it. I think that you have to have a little of this disci.line o/ calling your shots and loading u.if you ant to
maximize your chances of becoming one ho provides above average real returns for clients over the long pull.
But I(m )ust talking about investment managers engaged in common stock picking. I am agnostic elsehere. I think there
may ell be people ho are so shred about currencies and this, that and the other thing that they can achieve good long5term records
operating on a pretty big scale in that ay. But that doesn(t happen to be my milieu. I(m talking about stock picking in American
stocks.
I think it is hard to provide a lot of value added to the investment management client, but it is not impossible.
"utstandin# $nvestor %i#est
W$RL%L& WI'%$M RE(I'I#E% =%ecem7er ;K, BKKL>Axcerpts from a lecture and ansers to student -uestions thereafter
during a visit last year to a "tanford Da "chool #ourse he endoed entitled, .Business= *hat Dayers "hould Lno./ The course is
taught by 9rofessor *illiam Dazier, ithout hose assistance this feature ould not have been possible M8I>N.
,$W %$ &$* 2E# W$RL%L& WI'%$MM #A5E #,E E'# M$%EL' FR$M !! %I'CI-LI)E'
*ithout learning, Berkshire ouldn(t be hat it is today.
*hat I(m going to try to do today is to extend the remarks I made to years ago at the !.".#. Business "chool< ,ou
ere assigned a transcript of my !.".#. talk. And there is nothing in them I said then that I ouldn(t repeat today. But I ant to
amplify hat I said then<.
It is perfectly clear<that if *arren Buffett had never learned anything ne after graduating from the #olumbia Business
"chool, Berkshire ould be a pale shado of its present self. Warren 0ould have gotten rich"7ecause 0hat he learned /rom en
2raham at Colum7ia 0as enough to ma1e any7ody rich! ut he 0ouldnt have the 1ind o/ enter.rise er1shire ,atha0ay is
i/ he hadnt 1e.t learning.
*hat do you need+ The best models from all disciplines
;o do you get orldly isdom+ *hat system do you use to rise into the tiny percentage of the orld in terms of having
sort of an elementary practical isdom+
*orldly *isdom by #harlie 1unger $%%75$%%2 $2
I(ve long believed that a certain systemhich almost any intelligent person can learnorks ay better than the systems
that most people use. As I said at the !.".# business "chool, hat you need is a lattice0or1 o/ mental models in your head. And
you hang your actual e@.erience and your vicarious e@.erience =that you get /rom reading and so /orth> on this lattice0or1 o/
.o0er/ul models! And, ith that system, things gradually get to fit together in a ay that enhances cognition.
And you need the modelsnot )ust from one or to disciplines, but also from all the important disciplines. ,ou need the
best $33 or so models from microeconomics, physiology, psychology particularly, elementary mathematics, hard science and
engineering Mand so onN.
,ou need not be an expert, but you must learn Sem ri#ht.
,ou don(t have to be a huge expert in any of those fields. All you have got to do is ta1e the really 7ig ideas and learn
them early and 0ell.
,ou can(t learn those $33 big ideas you really need the ay many students dohere you learn Sem ell enough to bang
em back to the professor and get your grade and then you simply empty them out as though you ere emptying a bathtub so you can
take in more ater next time. If that is the ay you learn the $33 big models you are going to need, you ill be an .also ran/ in the
game of life.
,ou have to learn the models so that they become part of your ever5used repertoire.
#,I)5 #,I)2' #,R$*2, F$RWAR% #$ AC5WAR%! I# W$R5' I) AL2ERA A)% I# W$R5' I) LIFE!
An incredibly useful trick= thinking things through backards.
By the ay, there is no rule that you can(t add another model or to even fairly late in life. In fact, I(ve done that. I got
most of the big ones -uite early. ;oever, once you have gotten these models in your head, hat else do you need+
*ell, there is one mental trick that is unbelievably useful. And that is, as you think through reality using these models,
think it through forard and also think it through backard. In other ords, follo the in)unction of the great algebraist, #arl @acobi,
ho said, .InvertU. Alays invert./
,ou are absolutely no good in algebra if you can(t turn the problems around and solve them backards. Indeed, if I ask
any of you ho plan to get married and have five children. .*hat are the odds that at least one of them ill be a girl+/, you can all
solve that immediately if you do it backards. But if you try and do it forard, it is hell on earth. "o @acobi as plainly ri#ht.
*hat orked for @acobi in algebra orks in life.
And hat orked for @acobi in algebra orks in the rest of life. 0or example, if you ere hired by the *orld Bank to help
India, it ould be very helpful to determine the three best ays to increase the man5years of misery in Indiaand, then, turn around
and avoid those ays. "o think it through backard as ell as forard. It is a trick that orks in algebra and a trick that orks in
life.
If you don(t, you ill never really be a good thinker. That is )ust the ay it is. *hen it gets complicated, it is very helpful to
think it through forard and backard.
Alays try to disprove your on assumptions.
And, of course, the mental habit of thinking backard forces o7:ectivitybecause one of the ays you think a thing
through backard is you take your initial assumption and say, Lets try to dis.rove it!"
That is not hat most people do ith their initial assumption. They try to confirm it. It is an automatic tendency in
psychologyoften called ./irstDconclusion 7ias./ But it is only a tendency. ,ou can train yourself aay from the tendency to a
substantial degree. ,ou )ust constantly take your on assumptions and try to disprove them. That is part of the inning game of
thinking both forard and backard.
>arin proved the value of a diligent, ob)ective curiosity.
>arin is a great model in terms of ob)ectivity. And the reason hy I especially like >arin is that his example provides
reasonable hope of mental im.rovement to a great many people. Almost everyone in this room has a higher IJ than >arin. ,et,
>arin(s body no lies right next to ?eton in *estminster Abbey.
9art of his secret as doggedness. 9art of his secret as an immense ob)ectivity. And part of his secret, of course, as an
extreme curiosity. And hat a diligent, ob)ective curiosity ill do for you in this life to elevate you above your intellectual bettersis
a lot. If >arin could take modest intellectual endoments and end up next to ?eton in *estminster Abbey, e can all learn
something from him.
And one o/ the great things to learn /rom %ar0in is the value o/ e@treme o7:ectivity! ;e tried to disconfirm his ideas
as soon as he got(em. ;e -uickly put don in his notebook anything that disconfirmed a much5loved idea. ;e especially sought out
such things.
*orldly *isdom by #harlie 1unger $%%75$%%2 $%
*ell, if you keep doing that over time, you get to be a perfectly marvelous thinker instead of one more klutz repeatedly
demonstrating first5conclusion bias.
A)% F$RCE' FR$M #,E'E M$%EL' %&'(I#) N'$ME )E2A#I(EL&, '$ME E4-L$'I(EL&!
Big forces from these models combine in more ays than one.
The next great model is the idea that especially big forces often come out of these $33 modelshich several models
combine<,ou get lolla.alooEa e//ects 0hen t0o, three or /our /orces are all o.erating in the same direction! And, fre-uently,
you don(t get simple addition. It is often like critical mass in physics here you get a nuclear explosion if you get to a certain point of
massand you don(t get anything much orth seeing if you don(t reach the mass.
"ometimes the forces )ust add like ordinary -uantities and sometimes they combine on a break point or critical mass basis.
And you have got to understand<..
It is true. Dife is )ust one damn relatedness after another.
1ore commonly, the forces coming out of these $33 models are conflictin# to some extent. And you get huge miserable
trade5offs.
But if you can(t think in terms of tradeDo//s and recogniEe tradeDo//s in hat you are dealing ith, you are a horse(s
!atoot. ,ou clearly are a danger to the rest of the people hen serious thinking is being done. ,ou have to recognize ho these
things combine. And you have to realize the truth of biologist of @ulian ;uxley(s idea that, Li/e is :ust one damn relatedness a/ter
another!" 'o you must have the models and you must see the relatedness and the e//ects /rom the relatedness!
,ou ant a lot of auto catalysts in your career and business life.
Another model that I like very much like, I(ve taken from A. 8. *ilson. ;arvard(s great ant specialist biologistand that
is autocatalysis in chemistry. If you get a certain kind of process going in chemistry, it speeds up on its on. "o you get this
marvelous boost in hat you are trying to do that runs on and on. ?o, the las of physics are such that it doesn(t run on forever.
But it runs on for a goodly hile. "o you get a huge boost. ,ou accomplish Aand, all of a sudden, you are getting APBP# for a
hile.
*ell, you ant a lot of autocatalysis in your career and your business life, etc. "o you look for autocatalytic effects.
#,E E'# ACA%EMIC (AL*E' REALL& W$R5 A' WELC,, *FFE## A)% 2RA,AM ,A(E ',$W)!
*orldly *isdom is -uite academic. *itness *elch and Buffett.
*ell, doesn(t this sound ay too academic for somebody ho is coming in from the marts of trade and talking about
orldly isdom+ Is practical orldly isdom as academic as all this sounds+ 1y anser is, .,eah, it is./ Gead the annual letters
from @ack *elch and *arren Buffett relating to 'eneral Alectric and Berkshire ;athaay, respectively. @ack *elch has a 9h>. In
engineering. And *arren plainly could have gotten a 9h>. in any field he anted to pursue. And both gentlemen are inveterate
teachers.
*orldly isdom is -uite academic hen you get right don to it. Dook at hat 'eneral Alectric has achievedand, for
that matter, hat Berkshire ;athaay has achieved.
And don(t forget 'raham<
8f course, *arren had a professor:mentorBen 'rahamfor hom he had great affection. 'raham as so academic
that hen he graduated from #olumbia, three different academic departments invited him into their 9h.>. programs and asked him to
start teaching immediately as part of the 9h.>. program= Those three departments being= literature, 'reek and Datin classics, and
mathematics.
'raham had a very academic personality. I kne him. ;e as a lot like Adam "mithvery preoccupied, very brilliant.
;e even looked like an academic. And he as a good one. And 'raham, ithout ever really trying to maximize the gaining of
ealth, died richeven though he as alays generous and spent E3 years teaching at #olumbia and authored or co5authored the best
textbooks in his field.
"o I ould argue that academia has a lot to teach about orldly isdom and that the 7est academic values really 0or1.
%$)# E LI5E #,E W$RL% 2E)ERALL&! I)'#EA%, E LI5E #,E LI##LE RE% ,E)!
Be multiDdisci.linary hatever academia 6 business say.
8f course, hen I urge a multi5disciplinary approachthat you have got to have the main models from a broad array of
disciplines and you have got to use them allI(m really asking you to ignore :urisdictional 7oundaries.
*orldly *isdom by #harlie 1unger $%%75$%%2 B3
And the orld isn(t organized that ay. It discourages the )umping of )urisdictional boundaries. Big bureaucratic business
discourages it. And, of course, academia itself discourages it. All I can say there is that, in that respect, academia is horribly rong
and dysfunctional.
And some of the orst dysfunctions in businesses come from the fact that they balkanize reality into little individual
departments and territoriality and turf protection and so forth. "o if you ant to be a good thinker, you must develop a mind that can
)ump the )urisdictional boundaries.
,ou don(t have to kno it all. @ust take in the best, big ideas from all these disciplines. And it is not that hard to do<.
I might try and demonstrate that point by using the analogy of the card game of contract bridge. "uppose you ant to be
good at declarer play in contract bridge. *ell, you kno the contractyou kno hat you have to achieve. And you can count up
the sure inners you have by laying don your cards and your invincible trumps.
But if you are a trick or to short, ho are you going to get the other needed tricks+ *ell, there are only six or so different
standard methods= ,ou have got long5suit establishment. ,ou have got finesses. ,ou have got thro in plays. ,ou have got
crossruffs. ,ou have got s-ueezes. And you have got various ays misleading the defense into making errors. "o it is a very limited
number of models.
But if you only kno one or to of those models, then you are going to be a horse(s patoot in declarer play.
*hat orks in contract bridge orks in life.
0urthermore, these things interact. Therefore, you have to kno ho the models interact. 8therise, you can(t play the
hand right.
"imilarly, I(ve told you to think forard and backard. *ell, great declarers in bridge think, .;o can I take the
necessary inners+/ But they think it through backards, too. They also think, .What could you .ossi7ly go 0rong that could
cause me to have too many losersM And both methods of thinking are useful. "o to in in the game of life, get the needed models
into your head and think it through forard and backard. *hat orks in bridge ill ork in life.
#hat contract 7ridge is so out o/ vogue in your generation is a tragedy! #hina is ay smarter than e are about bridge.
They are teaching bridge in grade school no. And 'od knos the #hinese do ell enough hen introduced to capitalist civilization.
If e compete ith a bunch of people that really kno ho to play bridge hen our people don(t, it ill be )ust one more
disadvantage e don(t need.
The orld isn(t multi5disciplinary. But you can be.
"ince our academic structure, by and large, doesn(t encourage minds )umping )urisdictional boundaries, you are at a
disadvantage because, in that one sense, even though academia(s very useful to you, you have been mis5taught.
1y solution for you is one that I got at a very early age from the nursery/ the story of the Dittle Ged ;en. The punch line,
of course, is, .Then I(ll do it myself, said the Dittle Ged ;en./
"o if your professors on(t give you an appropriate multi5disciplinary approachif each ants to overuse his on models
and underuse the important models in other disciplinesyou can correct that folly yourself. @ust because he is a horse(s patoot, you
don(t have to be one, too. ,ou can reach out and grasp the model that better solves the overall problem. All you have to do is kno it
and develop the right mental habits.
And it is kind of fun to sit there and out5think people ho are ay smarter than you are because you have trained yourself
to be more o7:ective and multiDdisci.linaryG
0urthermore, there is a lot of money in itas I can testify from my on personal experience.
#E'#I)2 $*# $*R M*L#ID%I'-LI)AR& A--R$AC, WI#, A =M$'#L&> ,&-$#,E#ICAL E4AM-LEG!
>oes this stuff really ork+ Det us find out<
If I am right in this multi5disciplinary approach, hich exalts proper academic values, I ought to be able to come up ith
some exercise that demonstrates its value. "o I ant you to )oin me today in a very odd mental construct= Det us go back to $227 in
Atlanta and invent from scratch a ne nonalcoholic beverage business out of hich e ill all get rich. *hat are e going to do+
8ur first decision= *ill our beverage be hot or cold+
*ell, our first decision is hether e are going to have a cold beverage or a hot beverage. By the ay, today e are
alloed to use all the models that academia has developed555including those developed after $227. That is the rule of today(s game.
*ell, to me, it is obvious that e go for a cold beverage. 1an has had fire for many eons and hat beverages are idely
available. #old beverages are hard. There is no refrigeration in $227. And the general theory of ice is galloping like crazy, but it is
far from having become ubi-uitous. 0urthermore, e kno enough physics to see that refrigeration is feasible and ill come along in
due course. *e also kno that physiology re-uires huge ingestion of preferably cold li-uid hen man is orking hard or is hot from
climatic effects. "o there is a huge tailind to be gained by creating a cold beverage that e are not going to have ith a hit beverage.
*orldly *isdom by #harlie 1unger $%%75$%%2 B$
"o )ust by knoing a fe simple models from physics and physiology, e can see it has to be a cold beverage.
FR$M EC$)$MIC' & LAW, #RA%EMAR5 & -R$#EC#I$), FR$M -'&C,$L$2&, C$)%I#I$)E% REFLE4E'G
*e ill never get very rich ithout a trademark and a brand
;o do e make a lot of money out of a ne cold beverage+ 8ut of tin doctrines from microeconomics and la,
obviously it must be a trademarked beverage ith its on label and trade dress.
And e have to arrange that people don(t order )ust a generic bottle or glass of out beverage. They must order it by name
our trademarked name. *e ill never get very rich from this business except by using a trademark and creating a brand strong
enough that people order our ne beverage by its trademarked name.
That, again, is obvious based on elementary models taken from the disciplines of la and microeconomics.
If it is repeat behavior e ant, e next turn to psychology<
8bviously, e must get a lot of repeat business for our beveragerepeat business that is triggered by our trademark.
*ell, hat model am I talking about hereby people automatically repeat the activity of buying and consuming something
in response to a trademark+ *ell, you look in your psychology book. And, lo and behold, in the most important to segments in
every psychology book, you find conditioned refle&es. 8bviously, if someone is constantly buying a trademarked beverage, they are
demonstrating a conditioned reflexith the trademark, the shape of the bottle, the color of the li-uid, etc. being the stimulus and
their buying it and consuming it being the response.
In ma)or part, your business is operant conditioning
'o you read on in the .sychology 7oo1 loo1ing /or very elementary models! And under conditioned re/le@es is
o.erant conditioning6'1innerism! The food value and so forth of the beverage is the reinforcer. And the trade dress, trade name
and look of the beverage is the stimulant. "o you have got operant conditioningstraight out of B.0. "kinner. #hat, in ma:or .art,
is 0hat your 7usiness is 0hen you try to esta7lish a 7everage sold under a trademar1!
MERE A''$CIA#I$) ,A' E)$RM$*' -$WER I) *'I)E''6A# LEA'# A' -R$-ERL& %EFI)E%!
.9avlovian mere5association effects/ have enormous poer.
Then, you go on to the second kind of conditioned reflexand that is straight 9avlov, except the textbooks call it
'classical conditionin#. That is a terrible namebecause it doesn(t guide the mind to the full poer of the idea.
"o, like the Dittle Ged ;en, I don(t have to use a silly name )ust because the psychology professors do. "o I(ll invent my
on name. I call hat the textbooks refer to as classical conditioning .9avlovian mere5association effects/5because mere association
has enormous poer. And your mind is guided to recognition of that hen you use a name like .9avlovian mere5association effects./
*ell, ho do you get 9avlovian mere5association effects+ 8bviously, you associate this beverage and its trademarks ith
every other good thing that people like generally= exalting events, sex ob)ects, happy timesyou name it.
9avlovian mere association distorts cognition.
8f course, that is hat #oca5#ola(s advertising campaign does. There is never a big, important, positive5image5type event
in the orld that #oca5#ola isn(t there. They kno that these 9avlovian mere5association effects increase the consumption of their
beverage.
In fact, it actually improves the drinker(s experience. The human mind, under principles of psychology, orks in such a
manner that advertising actually makes you en)oy #oke more hen you are drinking it. It doesn(t )ust induce you to try it. It actually
improves its effects. In effect, cognition is distorted by 9avlovian mere5association effects.
And, therefore, e are going to make this beverage a maximized reinforcer. And e are going to develop a very clever trade
name and trade dress in order to maximize -avlovian mereDassociation e//ects.
Business school professors haven(t -uite got it yet.
If you ask the average business school professor, .*hat is the business of the #oca5#ola #ompany+/ he on(t give you the
right anser. But the right anser as given to me once by >on Leoughthe very eminent, recently retired president of #oca5#ola.
And hat Leough said as, #he 7usiness o/ the CocaDCola Com.any is to create and maintain conditioned re/le@es!"
"o Leough and 1unger have the same idea exactly. And, by the ay, e are right. As for the business school professors
ho talk in a different languageell, maybe they should change.
& C$MI)I)2 A)% REI)F$RCI)2 ELEME)#', WE CA) AC,IE(E L$LLA-AL$$?A EFFEC#'!
*orldly *isdom by #harlie 1unger $%%75$%%2 BB
?ext, e ant as poerful a reinforcing effect as e can get.
In designing our ne beverage, e are mindful of combinatorial effects. And e are mindful of autocatalysis and so forth.
8nce e get this thing going, e ant it to run. *e ant as poerful a reinforcing effect as e can possible get. "o e together
think out hat e are going to do to this beverage to make it a poerful reinforcer. And hat do e do+ *e put in food value. The
reason rates, pigeons and so forth are trained in operant conditioning ith food is that food is nearly an automatic reinforcer. "o e(re
going to include some caloric value in our drink.
And hy stop ith food value+ *e can include a stimulant.
Another reinforcing trick is a stimulantfor instance, caffeine. *hy should e hold back+ *e ant fancy combinatorial
effects. And once e realize that e get extra5poerful effectshat I call lollapalooza effectsfrom combining a bunch of things
to ork in the same direction, e are not going to stop ith food value. *e are going to have food value plus a stimulant= caffeine. It
is obvious. Both plainly ork. "o there is no reason not to combine them. *e ant the double effect. It is bet&ter reinforcement.
And e care about the totality of the experience. "o flavor.
0lavor is a very important reinforcer. And, here again, e kno enough physiology and biology to kno that people are
genetically programmed to like seet flavors. "o it is going to be some kind of seet flavor.
Aroma and texture are also very much part of the experience. And, therefore, e are going to care about the totality of the
essential experience hich people have as they consume our ne beverage.
,ou in big by getting to or three forces orking together.
*e ill put sugar in because it is a stimulant, too. By making our caloric content sugar, e get food value plus to kinds
of stimulants<.Again, I(m trying to get lollapalooza effects by combining. It is perfectly obvious. This is the ay you in big in the
orld7y getting t0o or three /orces 0or1ing together in the same direction!
)E4#, #,I)5I)2 AC5WAR%, W,A# %$)# WE WA)#M AF#ER#A'#E, C$-&CA#', )E2A#I(E
A''$CIA#I$)'!
*hat don(t e ant+ 9eople discouraged from drinking it.
But, as I said, you have to think things through forard and backard. "o, next, e ill think it through backard. It is
dangerous )ust to think forard. That ay, you ill miss important points. Det me demonstrate=
*hat don(t e ant in our ne drink+ *ell, again, e kno enough elementary physiology to kno that animals are
genetically programmed to re)ect surfeits of certain flavors. It is not good for animals )ust to gorge and gorge and gorge on some
things. "o there are automatic turnoff mechanisms in human physiology.
And e ant people to )ust keep silling our ne drinktime after time ith no surfeit mechanism discouraging
additional consumption. If you try and drink six cream sodas in a ro on a hot day, you ill chock to death on the aftertaste. It ill
be a ghastly experience.
"o )ust by thinking backard, e get a huge and useful bit of isdom. *e don(t ant any aftertaste. *e ant people to
be able to sill this stuff all day long in hot climatesin cold climates, too, for that matter. *e don(t ant them discouraged by their
on physiological response to an aftertaste.
"o e ant to experiment around and get a flavor ith virtually no aftertaste. And, incidentally, that is exactly hat #oca5
#ola has5except they ere not smart enough to do it my ay on purpose hen they started out. They )ust stumbled onto the right
anser.
And e don(t the huge cost of shipping ater.
*hat else don(t e ant+ *ell, again, )ust using elementary engineering and mathematics, e kno that e don(t ant
to ship a lot of ater and extra eight and volume of containers all over the orld. 8bviously, that ould cost us a fortune.
Therefore, basically, hat e are going to sell is syru..
*hat else don(t e ant+ *e don(t ant it easily copied.
Also, e are trying to add additional lollapalooza effects. "o hat else can e do+ *ell, it happens that carbonation
increases the overall sensual experiencein terms of flavor and so forth<.Besides, e like making it a little more difficult for
competitors to copy. *e ant it to be reasonably complicated because e ant to achieve a big edge that others can(t easily copy.
Therefore, e carbonate our drink.
"o far, so good<
*orldly *isdom by #harlie 1unger $%%75$%%2 BE
"o after e have experimented, e are going to use caffeine and sugar as stimulants, have a marvelous flavor ith virtually
no aftertaste, carbonate our beverage and make it cold. All of this takes care of providing reinforcement to maximize the creation of a
conditioned reflex based on operant conditioning.
And e kno that e don(t ant it to look cheap.
The next problem is to maximize the obtaining of a conditioned reflex grounded in 9avlovian mere5association effects.
But hen e finally solve the earlier problems, our li-uid is clearlike I5!p. But if e think in terms of 9avlovian mere5association
effects, e realize that our li-uid looks cheap and ordinarylike ater. And e don(t ant that. *e ant it to look expensive and
exotic. "o e stick in burnt caramel and hatever color the natural flavor of the drink to something vaguely like ine.
*e think 9avlovian mere5association effects ill be ay stronger if our product doesn(t look cheap and ordinary. "o e
stick in this artificial color. And, no, e pretty ell have our beverage.
9avlovian mere5association effects suggest e make it look expensive, exotic and unusual. "o e invent in a name. And,
someho, e come up ith #oca5#ola. *e have an exotic script. *e make the bottles shaped in a slightly unusual ayand the
glasses, too, for that matter. And no e have got trade dress.
"o no e are prepared to go out into the orld ith our ne beverage.
MEREDA''$CIA#I$) EFFEC#' %IC#A#E L$$5 A)% FEEL6A 'ECRE# F$RM*LA, ,EA(& A%(ER#I'I)2,
E#C!
*e can(t copyright the flavor. "o e ill do the next best thing.
And, obviously, 0e 0ant .rotection. *e kno enough microeconomics to kno that anything that orks ill get
competition< e think forard and backards. And thinking backards, e kno that e need antidotes to competition.
*ell, you can(t copyright or trademark a flavor. "o e do the next best thing. *e are going to keep the formula secret.
0lavors can be -uite tricky to duplicateeven today.
And this is ay back in $227. They don(t have mass spectrometers. It is hard to duplicate flavors.
8ne of my favorite business stories comes from ;ershey. They get their flavor because they make their cocoa butter in old
stone grinders that they started ith in the $233s in 9ennsylvania. And a little bit of the husk of the cocoa bean inds up in the
chocolate. Therefore, they get that odd flavor that people like in ;ershey(s chocolate.
;ershey kne enough hen they anted to expand into #anada to kno that shouldn(t change their inning flavor.
Therefore, they copied their stone grinders< *ell it took them five years to duplicate their on flavor. As you can see, flavors can
get -uite tricky.
0lavors are so tricky that permanent royalties are paid.
Aven today, there is a company called International 0lavors and 0ragrances. It is the only company I kno that does
something on hich you can(t get a copyright or a patent, buy hich nevertheless receives a permanent royalty. They manage to do
that by helping companies develop flavors and aromas in their trademarked productslike shaving cream. The slight aroma of
shaving cream is very important to consumption. "o all of this stuff is terribly important.
At any rate, e are going to keep our formula secret. *e ill make a big hoopla over our secrecy. And that ill add to
our product(s mysti-uehich ill further enhance its mere5association effects.
1ere5association effects dictate heavy advertising and free signs.
And since e ant to play this 9avlovian mere5association game in all of our advertising, e kno a heavy percentage of
revenues ill have to go into advertising.
And e kno e have to give free signs to everybody ho sells our product because MAN it advertises the productK MBN
there is an informational advantage Mit tells people here they can get the product if they ant itNK and M#N e don(t have to pay for the
spaceK all e have to do is pay for the sign. "o e are going to give free signs to all the drug stores, etc.
2E##I)2 #,ERE FIR'# $FFER' ,*2E A%(A)#A2E'+ E!2!, '$CIAL -R$$F, EC$)$MIE', %I'#RI*#I$),
E#C!
If e seep the country fast, e can harness social proof.
And e get the idea early that e are going to distribute our product. "o e think through autocatalysis again. And e
realize that if e can seep the country fast ith our product, e harness another doctrine right our of the psychology books= social
.roo/! If you see everybody else drinking #oca5#ola, you are likely to drink it. 9eople are enormously influenced by hat they see
other people doing. Indeed, they are enormously influenced by hat they see other people doing. Indeed, they are enormously
influenced to misthink because they see other people misthinking in the same ay<.
*orldly *isdom by #harlie 1unger $%%75$%%2 B&
There are )ust ;!'A advantages to getting there first.
Also, e get a big informational advantage if e can buy all kinds of advertising, seep the country first and cheaply spread
our image over the countryide sales hile competitors suffer under poorer advertising economics. "o there are huge advantages to
getting there first.
#ompetitive factors dictate being ubi-uitous, too.
Also, think through o.erant conditioningagain, going into a reverse mode. ;o do you lose a conditioned reflex that is
orking for you+ *ell, the customer tries something else and discovers that it is a big reinforcer. "o he shifts brands.
*e kno, in matrimony, that if you are alays available, the spouse is less likely to shift brands.
And people don(t tend to organize marriage to include permanent long separations. "imilarly, if you are selling a product
and it is alays available, people are less likely to shift to some other product and get reinforced by it.
"o availability has to be a religion in our ne business. And, indeed, availability is a religion at #oca5#ola. And, again, it
ties right into the psychology books.
It helps distribution as a matter of logistics and so on, too. But it !rotects the conditioned refle& business by preventing the
other guy(s product from getting reinforced because yours is alays available.
LI5E C$CADC$LA, WELL FRA)C,I'E6*# WE W$)# MA5E #,EIR 'I*+,)*!
The fastest ay to seep the country is to franchise.
All right, no e have #oca5#ola. *e have our distribution is mind. *e then have to decide ho e are going to seep
that country fast. ?o e get into relatednesstradeoffs. The fastest ay to do it is to franchise. After all, e are poor and small
hen e start. And that is the ay that coca5cola did it.
*e on(t count on there never again being inflation.

But e have the advantage in today(s exercise of playing the game in $227, but knoing hat e kno todayof having
modern knoledge. And, therefore, very importantly, e on(t do hat the #oca5#ola #ompany as so mistaken to do as it started
outhich as to give bottling franchises in perpetuity at fixed prices for syrup. That as insane.
*ell, it )ust so happened that $227 as right in the middle of a long period of stable5to5declining prices in the Anglish5
speaking orlda very remarkable period. ;oever, the #oke people failed to think rationally about hat they ere doing.
If they(d assimilated a broad, general education, they(d have remembered that the price of heat in drachmas during the
decline of the Goman Ampire rose by 73,3334 and that the failure rate of all great civilizations is $33455and they ouldn(t have
assumed there as never going to be any inflation.
Again, i/ you have an a..ro.riate education, you can avoid some mista1es that other .eo.le ma1e! 8f course, the
#oke people should have made a different decision under hich they could make bottlers pay for advertising that the hole system,
including the bottlers, needed<. And, clearly, you on(t guarantee a fixed price for syrup ith its expensive ingredients, including
sugar. And ever5fixed syrup price can ruin youunder inflationary conditions or under conditions re-uiring more advertising.
And e(ll model our distribution more like 1c>onald(s.
And, clearly, e ant more control over our franchisees than #oca5#ola originally got. *e ant to do it more like
1c>onald(s did ay later.
*ell, you get the general idea. These academic ideas are enormously practical. And thinking things through forard and
backard has enormous utility. And my life and career tend to demonstrate, you have many defects, as I doand this ay of thinking
ill carry you through.
$*R RAI)' ARE M$RE '*I#E% F$R M$#I$) #,A) MA#,! F$R#*)A#EL&, #,ERE I' A REME%&6#,E
2RA-,!
There is a reason based in biology hy graphs ork so ell.
?o let(s return to another sub)ect. "uppose that e have a different problemonly this time in real time. This time, it is
$%%H. And e ant to predict the future of the #oca5#ola #ompany. *ill elementary models help us make a good prediction+
I have distributed to the class a Calue Dine graph demonstrating the #oca5#ola #ompany(s recent history and financial
results. I as illing to do that ithout paying a royalty to the Calue Dine #ompany because I(m going to tout its product. The Calue
Dine graphs, as short5form digests of reality, company by company, are the best of their kind that America produces. The Calue Dine
people have a sensationally good ideato put the data in exactly the form they put it in and to put it in graph form.
*orldly *isdom by #harlie 1unger $%%75$%%2 B7
And there is a reason rooted in biology hy gra.hs 0or1 so 0ell. If you turn a somersault or )uggle milk bottles, your
neural apparatus is doing automatic differential e-uations ith huge accuracy. ,et, if you try and think out numbers in ordinary
probabilities, you are a considerable klutz.
8ur brains are more suited to motion than math
1y friend, >r. ?at 1yhrvold, ho is the chief technology officer at 1icrosoft, is bothered by this. ;e(s a 9h> physicist
and knos a lot of math. And it disturbs him that biology could create a neural apparatus that could do automatic differential
e-uations at fast speedand, yet, every0here he loo1s, .eo.le are total 1lutEes at dealing 0ith ordinary .ro7a7ilities and
ordinary num7ers!
By the ay, I think 1yhrvold(s rong to be amazed by that. The so5called fitness landscape of our ancestors forced them
to kno ho to thro spears, run around, turn corners and hat have you long before they had to think correctly like 1yhrvold. "o I
don(t think he should be so surprised. ;oever, the difference is so extreme that I can understand ho he finds it incongruous.
A system that actually taps into our primitive neural netork.
At any rate, mankind invented a system to cope ith the fact that e are so intrinsically lousy at manipulating numbers. It
is called the graph. 8ddly enough, it came out of the 1iddle Ages. And it is the only intellectual invention of the monks during the
1iddle Ages I kno of that is orth a damn. The graph puts numbers in a form that looks like motion. "o it is using some of this
primitive neural stuff in your system in a ay that helps you understand it. "o the Calue Dine graphs are very useful.
Calue Dine graphs and data are )ust marvelously useful.
The graph I(ve distributed is on log paperhich is based on the elementary mathematics of compound interesthich is
one of the most important models there is on earth. "o there is a reason hy that graph is in that form.
And if you dra a straight line through data points on a graph on log paper, it ill tell you the rate at hich compound
interest is orking for you. "o these graphs are marvelously useful.
I don(t use their predictions because our system orks better for us than theirsin fact, a lot better. But I can(t imagine
not having their graphs and their data. It is a marvelous, marvelous product.
A)% IF &$* ARE #R&I)2 #$ L$$5 F$RWAR%, I2, 'IM-LE M$%EL' CA) ,EL- #,ERE, #$$!
*ill it continue+ The anser lies in our models.
"o e are trying to figure out if #oca5#ola #ompany can continue its utterly remarkable performance. ;ere is a company
that earns ay more than 734 per annum on book value after taxes. And it is groing like crazy.
;o are e going to figure out if it is going to continue+ It doesn(t help to sit there and mumble its past numbers to
yourself mindlessly. *hat you have to do is reach into your head for to or three of the big, simple models.
*e no kno that it is a conditioned reflex company that relies on trademarks. *hat are the chances that they can
continue doing it+
*ill they continue having legal protection internationally+
8bviously, the first thing e have to decide is hether they are going to continue having legal protection for their
trademarks. 8therise, e shouldn(t buy #oca5#ola.
*ell, that involves knoing enough microeconomics, knoing enough la and knoing enough about the history of the
international arena, Mbecause #oke makes over 234 of its profit outside of ?orth AmericaN, so that you can make a guess as to
hether trademarks are going to continue to be pretty ell respected all over the orld.
Trademarks create huge incentives to make products reliable.
*ell, e kno that in counterfeiting, in most of the long history of the orld, the ordinary remedy has been death
because everybody can see that a money exchange system on(t ork if people can counterfeit the currency.
And it is only a small step from that to realize that if your are talking about a food productand, after all, it can make you
sick, it can kill you, it can do a lot of thingsif you protect the trademark, you create this huge incentive in people to make the
product reliable.
A fish story Mone that got aayN about the poer of trademarks.
I might tell a little story to illustrate that point. #arnation didn(t have the total trademark on the name .#arnation/ hen it
started out. And as it got bigger and bigger, it kept buying up all the little #arnation trademarks that other people had on their
products.
*orldly *isdom by #harlie 1unger $%%75$%%2 BH
But there as this one guy ho sold #arnation 0ish. "o help me, 'od, that as his trade name, >on(t ask me hy. And
every time they(d say, .*e(ll pay you RB73,333,/ he(d say, I ant R&33,333./ And, then, four years later, they(d say, .*e(ll give you
R$ million,/ and he(d say, .I ant RB million./ And they )ust kept doing that all the ay through. And they never did buy the
trademarkat least, they hadn(t bought it the last time I looked.
In the end, #arnation came to him sheep5facedly and said, .*e(d like to put our -uality control inspectors into your fish
plants to make sure that your fish are perfectK and e ill pay all the costs,(hich he -uickly and smirkily alloed. "o he got free
-uality control in his fish plantscourtesy of the #arnation #ompany.
"o they should be protected, have been and probably ill be.
This history shos the enormous incentive you create if you give a guy a trademark Mhe can protectN. And this incentive is
very useful to the ider civilization< As you see, #arnation got so that it as protecting products that it didn(t even on.
That sort of outcome is very, very desirable Mfor societyN. "o there are some very fundamental microeconomic reasons hy
even communist countries should protect trademarks. They don(t all do it, but there are very poerful reasons hy they should. And,
by and large, averaged out around the orld, trademark protection has been pretty good.
"o I think e can bet reasonably that #oca5#ola ill en)oy pretty good trademark protection in the future. But e have to
be able to make a )udgment on that sub)ect before e kno enough to buy stock in the coca5#ola #ompany. "o that is one )udgment.
$*R M$%EL' '*22E'# L$#' $F *-'I%E -$#E)#IAL A)% -$WERF*L C$M-E#I#I(E A%(A)#A2E'!
Juantity of li-uid consumed is finite, but it is also huge.
)e@t, 0e have to /igure out ho0 7ig this mar1et could 7e. *ell, that isn(t so hard. *e )ust need ordinary physiology
and ordinary arithmetic.
Avery human being needs about H& ounces of li-uid every day to stay alive. *e have about H billion people on Aarth. "o
e )ust multiply the product of these numbers by the number of days in the year<And, obviously, e are not going to get more
beverage sold per year than that. But that is a hell of a lot of beverage.
#oke has room to gro its orldide volume many5fold.
And, then, e can figure out roughly hat share of the orld(s li-uid is currently ingested in the form of #oca5#ola
#ompany products. It is an aesome numberparticularly in the !.". <.
But per capita consumption of #oca5#ola products orldide averages out much loer than it is in the !.". And much of
the *orld(s population lives in markets here average consumption is still less than $3 25ounce servings per year. "o #oca5#ola still
has miles to go. #learly, they have room to multiply their current volume many5fold.
Add an extra $5B cents of profit per serving is not inconceivable.
*hat else could impact the profits of the #oca5#ola #ompany+ *ell, e(ve got to figure out ho much they are making
out of each serving of #oca5#ola. And I haven(t done that computation recently. But my guess is that it is something ithin hailing
distance of $ cent per serving. That is all that is sticking to the ribs of the #oca5#ola #ompany pre5tax.
#ould it go to B cents Qor even E cents. That doesn(t seem inconceivable for a company so dominant, does it+
"o there is no reason #oke(s profits couldn(t gro $H times.
Then, of course, there is the possibility of a little inflation. After all, they are selling syrup. ,ou could hardly imagine a
better5protected position versus inflation.
And hen you put all three of these factors together M55higher consumption, higher profits per serving and inflation55N it
isn(t hard at all for me to imagine the profits of the #oca5#ola #ompany in due course being $H times hat they are todayeven
though they are already making more than RE billion a year after5tax.
?o that may strike you as very extreme. But if you go through the arithmetic, it is not inconceivable. "o, at least,
something good could happen. It may take a long time. But hat the hell, you people have a long time. I ish I did.
They have competed successfully for yearsfor good reasons.
*e ant to estimate the chances that competition ill do in #oca5cola. Gememberthink it through forard and think it
through in reverse.
*ell, they have been competing for a long time. And look ho they are inning. #oca5#ola has certain advantages= They
can afford to sponsor the 8lympics. They can afford lots of things. They have the advantages of scale.
*orldly *isdom by #harlie 1unger $%%75$%%2 BI
And they are available all over the Aarth. That is an edge that others don(t have. And in recent years, their market share
has actually been going up a little, netin spite of the fact that they have so much already.
,ou can -uarrel ith my conclusion, but not the approach.
"o, going through these simple models, you get at least a rational ay to look at #oke(s future. ,ou may disagree ith me
hen I say something as extreme as I(ve )ust said. But I don(t think you can -uarrel ith my basic approach. It is a rational ay to
examine the outer limit of possibility on the upside. And, as you can see, it is -uite high.
,ou don(t have to sit there )ust tiddling your thumbs<.
;oever, you don(t have the basic mental models for dealing ith the models, then all you can do is sit there tiddling
your thumbs as you look at the Calue Dine 'raph. But you don(t have to tiddle your thumbs. ,ou have )ust got to learn $33
models and a fe mental tricks and keep doing it all of your life. It is )ust not that hard.
And the beauty of it is that most people on(t do itpartly because they have been miseducated. And I(m here trying to
help you avoid some of the perils, hich might otherise result from that miseducation.
And.
$I% March BI, BKKO
WE'C$ FI)A)CIAL' C,ARLIE M*)2ER W$RL%L& WI'%$M RE(I'#E%+ LE''$) A;, -AR# ; MA'#ER #,E
E'# #,A# $#,ER' ,A(E FI2*RE% $*# )$ $)E' 'MAR# E)$*2, #$ %REAM I# *- ,IM'ELF!"
This lecture as given to "tanford Da "chool. The lecture as called, .Business= *hat Dayers "hould Lno.U
$)E $F #,E M$'# E4#REME %I'#$R#I$)'6EWARE #,E I%E$L$2ICAL MI'F*)C#I$)'!
The most important missing models may be from psychology.
8L. *e(ve been through some of the general ideas in the search for orldly isdom. And no I ant to turn to
something even more extreme and peculiar than the talk I(ve already given you. 8f all the models that people ought to have in useful
form and don(t, perhaps the most important lie in the area of .sychology!
A )unior professor disputes the greatest semanticist ever<.
I recently had an instructive experience= I )ust returned from ;ong Long. I have a pal there ho is the headmaster of one
of the leading schools. ;e gave me this book called (he )an#ua#e $nstinct ritten by "teven 9inker. *ell, 9inker is a semanticist
professor ho rose in the shado of ?oam #homskylinguistics Institute 9rofessor at 1.I.T.ho is probably the greatest
semanticist ho ever lived<.
And 9inker says that human language ability is not )ust learnedit is deeply buried. To a considerable extent, in the
genome. It is not in the genome of the other animals, including the chimpanzee, to any really useful extent. It is a gift that came to
humans. And 9inker proves his point pretty ell.
8f course, #homsky(s already proven it. ,ou have to be pretty ignorant not to realize that a good deal of language ability
is right there in the human genome. And even though you have to ork like hell to improve it through education, you start ith a big
leg up in your genes.
And the )unior professor is clearly ri#ht .
9inker can(t understand hy #homskyho, again, is such a geniustakes the position that the )ury is still out about hy
this ability is in the human genome. 9inker, in effect, says= .Dike hell the )ury is still outT The language instinct got into humans in
exactly the same ay that everything else got therethrough >arinian natural selection./
*ell the )unior professor is clearly rightand #homsky(s hesitation is a little daft.
*hat(s blinded #homsky is -uite clearit is ideological bias .
But if the )unior professor and I are right, ho has a genius like #homsky made an obvious mis)udgment+ The anser is
-uite clear to me#homsky is passionately ideological. ;e is an extreme egalitarian leftist ho happens to be a
genius. And he is so smart that he realizes that if he concedes this particular >arinian point, the implications threaten his leftist
ideology. "o he naturally has his conclusion affected by his ideological bias.
I think that this is the ay the human mind orksand the process doesn(t exempt people merely because they are smart
and ork hard.
;eavy ideology is one of the most extreme distorters<
*orldly *isdom by #harlie 1unger $%%75$%%2 B2
And that gets into another lesson in orldly isdom= If ideology can scre up the head of a #homsky, imagine hat it
does to people like you and me.
;eavy ideology is one of the most extreme distorters of human cognition. Dook at these Islamic 0undamentalists ho )ust
gunned don a bunch of 'reek tourists shouting, .'od(s orkT/
Ideology does some strange things and distorts cognition terribly! If you get a lot of heavy ideology youngand, then,
you start expressing ityou are really locking your brain into a very unfortunate pattern. And you are going to distort your general
cognition.
*arren Buffett decided early on that ideology as dangerous.
There is a very interesting history if you take *arren Buffett as an example of orldly isdom= *arren adored his father
ho as a onderful man. But he as a very heavy ideologue, Mright ing, it happened to beN, ho hung around ith other very
heavy ideologues, Mright ing, naturallyN.
*arren observed this as a kid. And he decided that ideology as dangerousand that he as going to stay a long ay
from it. And he has throughout his hole life. That has enormously helped the accuracy of his cognition.
And I as lucky ideology5ise to have a good role model.
I learned the same lesson in a different ay. 1y father hated ideology. Therefore, all I had to do as imitate my father
and, thereby, stay in hat I regarded as the right path. 9eople like >ornan on the right or ?ader on the left have obviously gone a little
daft. They are extreme examples of hat ideology ill do to youparticularly violently expressed ideology. "ince it pounds ideas in
better than it convinces out, it is a very dangerous thing to do.
Therefore, in a system of multiple models across multiple disciplines, I should add as an extra rule that you should be very
ary of heavy ideology.
Being $334 sure on hard issues makes you a lousy thinker.
,ou can have heavy ideology in favor of accuracy, diligence, and ob)ectivity. But a heavy ideology that makes you
absolutely sure that the minimum age should be raised or that it shouldn(tand it is kind of a holy construct here you kno you
are rightmakes you a bit nuts.
This is a very complicated system! And li/e is one damn relatedness a/ter another. It is all right to think that, on
balance, you suspect that civilization is better if it loers the minimum age or raises it. Aither position is 8L. But being totally sure
on issues like that ith a strong violent ideology, in my opinion, turns you into a lousy thinker. "o beare of ideology5based mental
malfunctions.
#,REE (ER& -$WERF*L F$RCE' FR$M -'&C,$L$2&6*# %$)# L$$5 #$ #,E #E4#' $R #,E
-R$FE''$R'!
>on(t ask the barber if you need a haircut.
Another source of malfunction that comes directly out of psychology is hat I call incentiveDcaused 7ias= A doctor
decides that some procedure that is good for him is also good for you. 8r a layer decides that some case that is good for him to
litigate is good for youhen it is really not.
9eople at a subconscious level are so influenced by this incentive5caused bias that it is one of the principal things that you
ill have to deal ith all your life. "o, obviously, this is a very poerful psychological idea. But don(t look to the psychology texts.
They are daft.
And, yet, it is not effectively dealt ith in the psychology texts. ,ou ill not find an ade-uate account of incentive based
biashat it does to human cognition and ho it scres up human institutions5in any psychology book that I have read. Admittedly,
I have only read three. ;oever, they )ust don(t have it right.
Another reason that I mentioned 9inker, the semanticist ho rote the book that I told you about earlier, is that at the end
of his book, he says MroughlyN, .I(ve read the psychology textbooks. And they(re daft./ ;e says, .This hole sub)ect is misorganized
and misthought./
*ell, I have far less in the ay of -ualifications than 9inker. In fact, I(ve never taken a single course in psychology.
;oever, I(ve come to exactly the same conclusionthat the .sychology te@ts, 0hile they are 0onder/ul in .art, are also
signi/icantly da/t!
,ou on(t even find an ade-uate treatment of simple denial.
*orldly *isdom by #harlie 1unger $%%75$%%2 B%
In fact, )ust take simple psychological denial. A couple of centuries before the birth of #hrist, >emosthenes said, .*hat a
mans wishes, that also ill he believe./ *ell, >emosthenes as right.
I have a family ac-uaintance hose much5loved sonho as brilliant and a star football playerfle off an aircraft
carrier and never came back. *ell, his mother thought he as still alive. #he mind 0ill sometimes /li. so that the 0ish 7ecomes
the 7elie/! It ill do so at various levels. Individuals vary in ho much psychological denial they get. But mis5cognition from denial
overhelmingly pervaded the reality that you are going to have to deal ith. And, yet, you on(t find an ade-uate treatment of
simple psychological denial in psychology texts.
A lot has been discovered but one has put it all together.
"o you can(t learn psychology the ay your professors teach it. ,ou have got to learn a lot more that they don(t teach
because they don(t handle their on sub)ect correctly.
9sychology to me, as currently organized, is like electromagnetism after 0araday, but before 1axella lot has been
discovered, but no one mind has put it all together in proper form. And it should be done because it ouldn(t be that hard to doand
it is enormously important.
9sychology ithout envy, denial or incentive5caused bias+T
@ust open a psychology text, turn to the index and look up envy. *ell, envy made it into one or to or three of the (en
Commandments. 1oses kne all about envy. The old @es hen they ere herding sheep kne all about envy. It is )ust that
psychology professors don(t kno about envy.
Books that thick are teaching a psychology course ithout envy+T And ith no simple psychological denial+T And no
incentive5caused bias+T
,$W CA) 'MAR# -E$-LE E '$ %*MM )$ %-)%,!I*+. A)% WI#,$*# $)E, &$* WILL 'CREW *- #IME
AF#ER #IME!
Aven the most publicized experiment isn(t very ell understood.
And psychological texts don(t deal ade-uately ith combinations of factors. I told you earlier to be aare of the
lollapalooza effect hen to or three or more forces are operating in the same direction.
*ell, the single most publicized psychology experiment ever done is the 1ilgram experimenthere they asked people to
apply hat they had every reason to believe as heavy electrical torture on innocent fello human beings. And they manipulate most
of these decent volunteers into doin# the torture.
1ilgram performed the experiment right after ;itler had gotten a bunch of believing Dutherans, #atholics and so forth to
perform unholy acts they should have knon ere rong. ;e as trying to find out ho much authority could be used to manipulate
high5grade people into doing things that ere clearly and grossly rong.
And he got a very dramatic effect. ;e managed to get high5grade people to do many aful things.
But it asn(t )ust authority. It as a lollapalooza effect<..
But, for years it as in the psychology books as a demonstration of authorityho authority could be used to persuade
people to do aful things.
8f course, that is mere first5conclusion bias. That is not the complete and correct explanation. Authority is part of it.
;oever, there ere also -uite a fe other psychological principles, all operating in the same direction, hich achieved that
lollapalooza effect precisely because they acted in combination toard the same end.
;o can they be so stu!id* They don(t use a model checklist.
9eople have gradually figured that out. And if you read the recent psychology texts at a place like "tanford, you ill see
that they(ve no managed to get it about to5thirds right. ;oever, here is the main experiment in all of psychology. And even at
"tanford, they still leave out some of the important causes of 1ilgram(s results.
;o can smart people be so rong+ *ell, the anser is that they don(t do hat I(m telling you to dohich is to take all
the main models from psychology and use them as a checklist in revieing outcomes in complex systems.
?o pilot takes off ithout going through his checklist= A,B,#,><.And no bridge player ho needs to extra tricks plays a
hand ithout going don his checklist and figuring out ho to do it.
ut these .sychology .ro/essors thin1 they are so smart that they dont need a chec1list! But they are not that smart.
Almost nobody is. 8r, maybe, nobody is.
And ithout a checklist, you ill scre up time after time, too.
*orldly *isdom by #harlie 1unger $%%75$%%2 E3
If they use the checklist, they ould realize the 1ilgram experiment harnesses six psychological principles, at least, not
three. All they(d have to do is go don the checklist to see the ones they misses.
"imilarly, ithout this system of getting the main models and using them together in a multi5modular ay, you ill scre
up time after time after time, too.
&$* E##ER )$# %I'RE2AR% L$LLA-AL$$?A EFFEC#' ECA*'E #,E& CA) MA5E &$* RIC, $R ,I!!
&$*!
Because you can(t demonstrate it doesn(t )ustify i#norin# it.
8ne5reason psychology professors so scre up denial is that it is hard to do demonstrative experiments ithout conduct
forbidden by ethics. To demonstrate ho misery creates mental dysfunction in people, think of hat you have to do to your fello
human beings. And you have to do it ithout telling them about the in)ury to come. "o, clearly, there are ethical reasons hy it is
practically impossible to do the experiments necessary to best lay out the ays human misery creates human mental malfunction.
1ost professors solve this problem, in effect, by assuming, .If I can(t demonstrate it ith my experiments, then it doesn(t
exist./ ;oever, obviously, that is asinine. If something is very important, but can(t be perfectly and precisely demonstrated because
of ethical constraints, you can(t )ust treat it like it doesn(t exist. ,ou have to do the best you can ith itith such evidence as is
available.
Animal research is unpopular, but consider 9avlov(s data.
9avlov himself spent the last $3 years of his life torturing dogs. And he published. Thus, e have a vast amount of data
about misery5caused mental malfunction in dogsand its correction. ,et, it is in no introductory psychology book that you ill ever
see.
I don(t kno hether they don(t like the fact that 9avlov tortured dogs or hether B.0. "kinner, by over claiming hen he
lapsed into his literary mode, made the draing of implications from animal behavior into human behavior unpopular. ;oever, for
some crazy reason or other, the psychology books are grossly inade-uate in dealing ith misery5caused mental malfunction.
,ou can(t afford to miss lollapalooza effects5good or bad.
,ou may say, What di//erence does all this .sychological ignorance ma1eM" *ell, if I(m right, you need these models
that are blanked out by this ignorance. And, furthermore, you need them in a form hereby, if there are B3 constructs, you have all
B3. In other ords, you shouldn(t be operating ith $3. And you need to use them as a checklist. "o you have to go back and put it
in your on head hat I(d call the psychology of mis)udgment is a form hereby you have all of the important models and you can
use them.
And you especially need them hen four or five forces from these models come together to operate in the same direction.
In such cases, you often get lollapalooza effectshich can make you rich or they can kill you. "o it is essential that you beare of
lollapalooza effects.
There is only one right ay to do it/ ,ou have to get the main doctrines together and use them as a checklist. And, to repeat
for emphasis, you have to pay special attention to combinatorial effects that create lollapalooza conse-uences.
*'I)E'' 'C,$$L' ,A(E A%%RE''E% I# '$ME! LAW 'C,$$L' ',$*L%, #$$! MEA)W,ILEG!
Business schools had the sense to address the problem..
"ince the psychology professor refuses to put it on sub)ect in the proper order, my on idea has been that la schools
simply ought to do it for them.
And, in fact, business schools have done some of that. Almost no business school reaches out for a psychologist from the
undergraduate department. Instead, they change all the psychological terms. They invent ne terms such as .organizational
behavior/. And they have the sense to fix some of the deficiencies of undergraduate psychology and teach it to business school
students ho need it. But they don(t have the sense to do the hole )ob.
9roperly taught, it(d be the most interesting thing you study.
Da schools could do the hole thing. I think the sub)ect is so im!ortant that it ought to be the first thing that happens
hen you come to la school. I don(t think it ould take a eek for people as smart as you to romp through psychology properly,
learn the main ideas and ho they intertine. And the problems ould be so interesting that it might be the single most interesting
thing that ever happens to you at la school. And the rest of la school ould become more interesting too.
,ou are deficient. But you can fix it)ust as I did<
*orldly *isdom by #harlie 1unger $%%75$%%2 E$
But, of course, as far as I kno, it isn(t done. To me, it is perfectly asinine. ;o many of you are satisfied ith hat you
kno about .sychology and the .ractical utility o/ 0hat you have in your heads in terms o/ dealing 0ith 0hat you have to deal
0ithM ,o0 many o/ you thin1 you have a good re.ertoireM =)o Res.onse>!
;o many of you feel -uite deficient+ M1any respond.N *ell, you are right. But you can fix it. 8nce I realized ho
ignorant I as. I )ust bought three undergraduate psychology texts and aded right through. I )ust stuck everything that as
obviously right and important into my little list of principles. And the three or four important things that I could see that they ere
leaving out, I )ust stuck in as additions to my system of models.
>oing it that ay, you develop a complete system. And using such a complete system is the ay that you should go
through life if orldly isdom is hat you are after. Gemember the Little Red ,en and do it yourself.
5)$WI)2 ,$W &$*R MI)% CA) E R$5E), &$* CA) #R*L& #RAI) &$*R'ELF #$ EWARE!
1oonies have learned ho to create lollapalooza effects.
Det me give you an example I gave in a previous talk at #al Tech about ho these lollapalooza effects in psychology creep
in. Det(s take 1oonie conversions. ;o do you take a normal kid ho is )ust a little miserable, take him off for a eekend in the
country and turn him into a brainashed zombie ho, for the rest of his life, sells floers on the street corner+ Is that a lollapalooza
effect+ ,eah, it is obvious. It is a total lollapalooza.
;o does it happen+ ,ou ould think the introductory psychology books ould tell you. But they don(t.
*hat orked for 9avlov orks for the 1oonies.
But I ill tell you ho. 9avlov(s dogs broke don at a certain point. ;e could break don any dog. ;e never failed.
And li1e -avlovs dog, the human mind has a 7rea1 .oint, hich varies from person to person. Therefore, the 1oonies )ust apply
all of this pressure and get a high percentage of people(s minds to .snap/hich is the exact name they use in their .conversion/
game. The mind .snaps/. And it does. It breaks. "o 9avlov broke dogs( minds, hereas the 1oonies break people(s minds.
Again, 7rea1ing .eo.les minds is a lolla.alooEa e//ect! The 1oonies achieve it by combining psychological tendencies
to act in the same direction. There are about B3 standard tricks that can be used to trigger lousy cognition of that type. And the
1oonies have figured out ho to play four, five, six, seven. 8r eight of them at the same time. 0or example, they use social proof=
everyone present except the .conversion/ target is an ardent believer. They use stress. "tress. 'tress ma1es .eo.le suggesti7le.
That is another psychological principle. They do four, five or six things at onceand the .conversion/ process orks to create a
.snap/ in a sadly high fraction of cases.
But you are not totally doomed by it. ,ou can protect yourself.
Averyone should kno the principles involved in 1oonie tactics and their s.ecial .o0er in com7ination. !niversities
should kno and disseminate this knoledge as a matter of high moral obligation. They should hate losing students to .religious/
totalize in cults. @ust imagine having to call some loving parents to tell them, .,ou(ve lost your child to the 1oonies./ That is a
disgrace at any institution.
But one beauty of psychology that e should consider as e emphasize these horrors is that you are not totally doomed by
your natural psychological tendencies. ,ou can correct those psychological deficiencies to some extent. Ben 0ranklin did it. And
>arin did it. ;e trained himself out of first conclusion biashich is an automatic tendency of the human mind. 8nce you
understand elementary psychology ell, you can train yourself to beare confluences of psychological tendencies. "o tendency is not
destiny.
CA-#AI) C$$5 5)EW ELEME)#AR& -'&C,$L$2& &$* ',$*L%, #$$6F$R -R$#EC#I$) A)%
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And you can use these psychological tendencies to persuade.
,ou can also learn hen you are playing the game o/ .ersuasionfor a reputable reason MI hopeNto combine these
forces in a ay that makes you more effective.
Det me give you an example of thatof ise psychology of yore. In #aptain #ook(s day, he took these long voyages. At
the time, scurvy as the dread of the long voyage. And in scurvy, your living gums putrefy in your mouthafter hich the disease
gets unpleasant and kills you.
And being on a primitive sailing ship ith a bunch of dying sailors is a very akard business. "o everybody as terribly
interested in scurvy, but they didn(t kno about Citamin #. *ell, #aptain #ook, being a smart man ith a multiple model kind of
approach, noticed that >utch ships had less scurvy than Anglish ships on long voyages. "o he said, .*hat are the >utch doing that is
different+/
And he noticed they had all these barrels of sauerkraut. "o he thought= .I(m going on these long voyages. And it is very
dangerous. "auerkraut may help./ "o he laid in all this sauerkraut hich, incidentally, happens to contain a trace of vitamin #.
*orldly *isdom by #harlie 1unger $%%75$%%2 EB
,ou can lead a sailor to sauerkraut, but you can(t make him..
But Anglish sailors ere a tough, cranky and dangerous bunch in that day. They hated .krauts/. And they ere used to
their standard food and booze. "o ho do you get such Anglish sailors to eat sauerkraut+
*ell, #ook didn(t ant to tell(em that he as doing in the hope it ould prevent scurvybecause they might mutiny and
take over the ship if they thought that he as taking them on a voyage so long that scurvy as likely.
But #ook kne elementary psychology. And you should, too.
"o here is hat he did= 8fficers ate one place here the men could observe them. And for a long time he served
sauerkraut to the officers, but not to the men. And, then, finally, #aptain #ook said, .*ell, the men can have it one day a eek./
In due course, he had the hole cre eating sauerkraut. I regard that as a very constructive use of elementary psychology.
It may have saved 'od knos ho many lives and caused 'od knos ho much achievement. ;oever, if you don(t kno the right
techni-ues, you can(t use them.
If you don(t, your education has been gravely deficient.
"o the psychology is very important. And it has constructive, honorable uses, like that of #aptain #ook, and destructive,
dishonorable uses, like the 1oonies or the charlatan ho uses it to sell sampland to retired teachers. "o people should kno ho
these things ork.
But I(ll bet that not one person in this room could describe the eight standard psychological techni-ues used by the
1oonies to induce conversion. *ho thinks he can+ Mno responseN "ee+ I say that your education has been gravely deficient.
And it is not so hard to correct. ,ou can learn hat you need.
And it is not difficult. There are only about B3 or so psychological principles on a satisfactory checklist. And as you deal
ith a patch of reality, you run through your checklist and see if any principle explains anything. ,ou are not going to find it very
hard.
"o I recommend that you treat your educational deficiencies as a serious problem and fix them. And, in the course of
doing that, you ill learn the psychology you need.
W$RL%L& WI'%$M I' AC#*ALL& (ER& ELEME)#AR&, *# #,E REWAR%' ARE A'$L*#EL& AWE'$ME!
9sychology(s orked onders for #oke and Tupperare.
As I demonstrated, I think psychology has orked wonders for #oca5#ola. And )ust think of all the harmless pleasure that
their products have providedto say nothing of the REP billion per year after taxes.
And #u..er0ares made a huge and .ro/ita7le 7usiness! #u..er0areMP Dittle plastic containerssold ith no fancy
selling -uarters, but, instead, in people(s homes at Tupperare parties+T *hat in hell is going on here+
The 9rocter 6 'amble Gule is elementary orldly isdom.
There are to very good lessons in the case of Tupperare= Desson F$ is hat I call the .9rocter 6 'amble Gule/. 9rocter
6 'amble has an internal rule that they don(t allo their product development people to come in and say, .9rocter 6 'amble, you
have all of this marketing muscle. Therefore, you should use it to sell this so5so product./
*hat 9rocter 6 'amble says to its product development people is, .0irst, you make the product truly superior. Then, and
only then, ill e put our marketing muscle behind it./
That is a very good rule. ,ou ant lollapalooza effects, hich often come best from a combination of factors operating in
the same direction. It is foolish to use )ust good, clever marketing hen good clever marketing plus a superior product orks so much
better. It is obvious. "o 9roctor 6 'amble does that.
*hen I took you through the #oca5#ola example, I as folloing the 9rocter and 'amble Gule= 0irst, make the product
better, 'et out the aftertaste. Add all the bells and histles. Then, and only then, apply the muscle distributing it.
The 1oonies have nothing on Tupperare.
Tupperare is a very good product. Aven so, it ouldn(t have sold orth a damn except for the fact that they invented a
selling system ith considerable similarity to that of the 1ooniesexcept, of course, that Tupperare does little damage in the orld.
The Tupperare system uses about six psychological tricks, right out of the standard repertoire of B3 that they play at the same time at
the .Tupperare parties/.
And, lo and behold, Tupperare has earned pretax billionsfrom a combination of elementary psychology and the 9rocter 6
'amble Gule.
*orldly *isdom by #harlie 1unger $%%75$%%2 EE
It(s actually very simpleand the reards are aesome.
Again, the 9rocter 6 'amble Gule(s automatic. ,ou ant lollapalooza effects+ Incorporate clever marketing plus a good
product. >on(t try to do either one alone.
*orldly isdom is mostly very, very simple. And hat I(m urging on you is not that hard to if you have the ill to plo
through and do it. And the reards are aesomeabsolutely aesome.
But maybe you are not that interested in aesome reards or avoiding a lot of misery or being more able to serve everything
you love in life. And, if that is your attitude, then don(t pay attention to hat I(ve been trying to tell youbecause you are already on
the right track<.
#,E 'I)2LE E'# WA& #$ %E'#R$& &$*R CI(ILI?A#I$)+ C*'# CREA#E '&'#EM' #,A# ARE EA'& #$
C,EA#G
If you make it easy to steal, you(re orking a great in)ury.
It can(t be emphasized too much that the issues o/ morality are deeply entined ith orldly isdom considerations
involving psychology. 0or example, take the issue of stealing. A very significant fraction of the people in the orld ill steal if MAN it
is very easy to do and, MBN there is practically no chance of being caught.
And once they start stealing, the consistency .rinci.leD0hich is a 7ig .art o/ human .sychology60ill soon com7ine
0ith o.erant conditioning to ma1e stealing ha7itual! "o if you run a business here it is easy to steal because of your methods,
you are orking a great moral in)ury on the people ho ork for you.
Again, that is obvious. It is very, very im.ortant to create human systems that are hard to cheat! 8therise you are
ruining your civilization because these big incentives5caused bias and people ill rationalize that bad behavior is 8L.
It(s dangerous to ignore these principles 6 let slop creep in.
Then, if somebody does it, no you(ve got at least to psychological principles= incentiveDcaused 7ias .lus social .roo/.
?ot only that, but you have got +er!ico effects= If enou#h people are profiting in a general social climate of doing rong, then they
ill turn on you and become dangerous enemies if you try and blo the histle. It is very dangerous to ignore these principles and let
slop creep in. 9oerful psychological forces are at ork for evil.
To ruin civilization, create systems people can easily cheat.
;o does this relate to the la of business+ *ell, people graduate from places like "tamford Da "chool and go into the
legislatures of our nation and ith the best of motives pass las, hich are easily used by people to cheat. *ell, there could hardly be
orse thing you could do.
Det(s say you have a desire to do public service. As a natural part of your planning, you think in reverse and ask, .*hat can I
do to ruin our civilization+/ That(s easy. If hat you ant to do is ruin your civilization, )ust go to the legislature and pass las that
create systems herein people can easily cheat. It ill ork perfectly.
Take the orkers( compensation system in #alifornia. "tress is real. And its misery can be real. "o you ant to compensate
people for their stress in the orkplace. It seems like a noble thing to do.
But the trouble ith such a compensation practice is that it is practically impossible to delete huge cheating. And once you
reard cheating, you get crooked layers, crooked doctors, crooked unions, etc. participating in referral schemes. ,ou get a total
miasma of disastrous behavior. And the behavior makes all the people doing it worse as they do it. "o you ere trying to help your
civilization. But hat you did as create enormous dama#e, net.
"o it(s much better to let some things go uncompensatedto let li/e 7e hardthat to create systems that are easy to cheat.
,ou must stop the slop early. Detting it run leads to tragedy.
Det me give you an example= I have a friend ho made an industrial product at a plant in Texas not far from the border.
;e as in a lo margin, tough business. ;e got massive fraud in the orkers( compensation systemto the point that his premiums
reached EB4 of payroll. And it as not that dangerous to produce his product. It is not like he as a demolition contractor or
something<
"o he pleaded ith the !nion, .,ou(ve got to stop this. There is not enough money in making this product to cover all of this
fraud./
But, by then, everybody does it. It can(t be that rong. Aminent layers, eminent doctors, eminent chiropractorsif there
are any such thingsare cheating./
*orldly *isdom by #harlie 1unger $%%75$%%2 E&
And no one could tell them, .,ou can(t do that anymore./ Incidentally, that(s 9avlovian mere association, too. When .eo.le
get 7ad ne0s, they hate the messenger. Therefore, it as very hard for the union representative to tell all of these people that the
easy money is about to stop. That is not the ay to advance as a union representative. Anyay, the human tragedy as that they
couldn,t stop.
"o my friend closed his plant and moved the ork to !tah among a community of believing 1ormons. *ell, the 1ormons
ere not into orkers( compensation fraudat least they aren(t in my friend(s plant. And guess hat his orkers( compensation
expense is today+ It is B4 of payrolldon from EB4.
#his sort o/ tragedy is caused 7y letting the slo. run! &ou must sto. slo. early! It is very hard to stop slop and moral
failure if you let it run for a hile
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$$5'!
A very interesting psychology experimentin Das Cegas<
Det me explain one of the reasons hy it is hard to stop previously rearded slop. And here(s another example of
something that is not handled very ell in the psychology books. It is demonstrated by one of the most interesting recent experiments
in psychology. It as done not by professors, but by commercial types in Das Cegas. The old mechanical slot machine had a certain
natural number of near misses. And it could only have so manybecause that as ho it as constructed. But once they made it
electronic, they could program it to include as fe or as many near misses as they antedin other ords, bar, bar, almost bar, but
something else.
8ne company had the dominant share of slot machines. But another company built electronic slot machines ith an
artificially enhance number of near misses. And henever they put one of their machines besides another machine that as exactly
the same in every ay except that it asn(t programmed for so many near misses ould get about B34 more play over the course of a
dayand people ere pulling extra fast.
Too many near misses ould sulky ?evada(s reputations<
*ell, this as an extremely manipulative thing to do. But that is human nature in capitalism. -eo.le 0ill mani.ulate
their /ello0 man to ma1e money i/ they can get 7y 0ith it!
But hat happened as -uite interesting. The company ith the dominant share sued under ?evada las that say you
have to be honest in gambling. ,ou see, ?evada tolerates prostitution, but they don(t like pimps and hores rolling the @ohns because
it is bad for the state(s reputation. Dikeise, they don(t mind manipulating people to their disadvantage using standard practices of
legal gambling, but they hate .cheating/ gambling. "o the company ith the leading market share in slot machines no go to the
third *orld+ It is hat you ould e&!ect<
A very poerful phenomenon, but it is not even in the books.
*hat psychological principle is demonstrated by the fact, that play is so much higher on the machine ith the artificial
number of near misses+
If you turn to the psychology textbooks, you on(t find the anser very ell laid out. ,ou can hardly imagine a more
poerful phenomenon than contemporary gambling. 1oreover, gambling history is very instructive. 8ne reason hy horse races,
bingo and these things have alays been so popular is because of all the near misses. 8bviously, a very poerful psychological force
is at ork here. But it is not properly dealt ith in the psychology books.
There is a ay higher reaction to loss than gain.
*hat is the force+ I(ve invented my on name for it. I ill call it .deprival super5reaction syndrome/. And it happens MAN
hen a thing you like is taken aay from you and MBN hen you almost have something you like and .lose/ it. Aither ay, the result
is a poerful, subconscious, automatic deprival super5reaction syndrome that distorts your cognition.
And it is very interesting. In static electricity, it is so many unitscoulombs in that caseplus or minus, from a same5size
event. The forces are the same in amount, only reverse in direction.
In psychology, it doesn(t ork that ay. In many ays, people react to a minus five5unit force ay more negatively than
they react positively to a force of five unit plus, enhancing irrational attempts to .get even./ And that is very important to kno! #he
de.rival su.erDreaction syndrome o/ man hel.s cause much ruin as .eo.les cognition is distorted as a result o/ their su//ering
losses and seeing near misses!
>eprival super5reaction syndrome in business and history.
>oes all this miscognition caused by operation of elementary psychological principles have practical conse-uences+ ,ou
bet it does. Try to get takeaays in labor negotiations. MAN ,ou(re facing deprival super5reaction syndromepeople )ust go bananas.
And MBN the union representative has to bring his members the deprival message and endure the 9avlovian mere5association hatred
that results. Therefore, he on(t do itpsychological effects making it hell.
*orldly *isdom by #harlie 1unger $%%75$%%2 E7
All of those strikes in the late $233s and the early $%33s here 9inkerton guards ere shooting people ere about
takeaays. Arriving immigrants ere illing to ork cheap. And capitalist proprietors tried to reduce agessometimes because
they felt that they had to because their competitors ere doing it and sometimes because they simply anted to make more money.
At any rate, all of that murder and mayhem as the result of deprival super5reaction syndrome plus the reality that nobody
anted to be the carrier of bad nes. "o deprival super5reaction syndrome is a very poerful force ith enormous practical
conse-uences.
1oreover, deprival super5reaction syndrome helps cause hat I call the +er!ico +yndrome. In life, messy as it is, these
psychological tendencies interact in ays, hich are often -uite predictable.
'ambling(s a huge force in society, but not in psychology texts.
Therefore, it is hard to understand hy the psychology texts so underemphasize gambling<Dook at the present civilization
ith Indian tribal casinos and all of the illegal betting on sports<. #learly, e have a huge mass of gambling driven by poerful
psychological forces.
;oever, if you look under gambling in a $,333 Qpage psychology text, you ill occasionally find a sentence or to
pointing out that B.0. "kinner(s conditioned5reflex extinction curves partly explain ho gambling hooks you. And, by the ay, they
do. But that is only a small part of it.
"o to understand gambling, you have to do it yourself<
9art of ho gambling hooks you is that you get behind and ant to catch up. >eprival super5reaction syndrome sends a
surge of irrationality through your mind. And that is a big part of hat hooks and destroys people<
"o gambling can be explained by to or three psychological doctrines in combination. But it is easy to reduce this type of
miscognition if you ork at it. !nfortunately, the people ho teach psychology in America seem to feel no obligation to put them
together and teach it right. Therefore, you have got to do it yourself<
IF RILLIA)# F$L5' A# C$5E CA) MA5E A -./) $)ER, '$ CA) &$*, *# &$* %$)# ,A(E #$!
The .?e #oke/ snafu<.
#ould you describe hat psychological forces ent into the decision to change the #oke formula and here the big
psychological breakdon as there+
8h, that is a onderful -uestion<.#oke had consultants and layers and expertsincluding advertising experts ho ere
much trained in psychology. 9lus, the gentlemen running #okeLeogh and 'oizuetaere both brilliant. And so ere their )unior
executives. They(d spent their entire lives thinking about the soft drink business and building up 9avlovian mere5association effects
hich ere poerfully aiding their business.
But they learned that, by a slight but mildly significant margin, people preferred the taste of 9epsi in blind taste test results,
they decided to change #oke(s flavor. And it as such a big change that they couldn(t )ust sneak it in. Therefore, they decided that
they(d have to announce the changehich, of course, they announced as an improvement.
It as a ghastly errorcaused by ignorance.
But, by that time, of course, #oke had already spent umpteen5billion dollars to make people associate its long5established
flavor ith everything good in life. All it had as a trademarked flavor ith stimulation and food valuethe poer of hich had
been dramatically enhanced by #oke( past use of psychology. ?o #oke as going to tell the public that the flavor as going to
change and that the change as an improvement+T
8f course, the .?e #oke/ decision as totally asinine. I )ust taught you about deprival super reaction syndrome and ho
it is such a basic poerful forcenot so much in the psychology textbooks, but in psychology as it really is. #oke as sure to get, a
huge hostile reaction.
"o it as a ghastly error. But I ill say thisthey reversed course and scrambled back -uickly. If they hadn(t, #oke(s
competitors ould have brought out the .8ld #oke/ flavor under their on trademarks. "o that error almost led to the biggest single
mishap in the history of businessall as a result of ignorance about elementary psychology.
Brilliant people mad that blunder, but you don(t have to.
It demonstrates that universities .rovide gravely de/icient .sychological education! If it eren(t so, the brilliant, ell5
trained people at #oke could not have made such an error. And one of the reasons I(m here giving this talk is I figure that if people as
brilliant as the folks at #oke ere so miseducated that they couldn(t apply an ordinary lesson from psychology to something as
important as hat they ere doing ith the most valuable trademark in the orld, then I suspect that some of you might benefit from
a little of this instruction.
If all those smart peoplead experts, layers, 'oizueta and Leogh Mho, again, are both brilliantNcan make very
important mistakes like that, then so can you. But you don(t have to. All you have to do is o.en u. the .sychology te@ts, assimilate
*orldly *isdom by #harlie 1unger $%%75$%%2 EH
a7out BQ little doctrines into your re.ertoire, add the /our or /ive that the 7oo1s dont contain or e@.lain 0ell and add 7etter
recognition o/ ho0 these things com7ine! And 7oomDDDyouve got an edge on the rest o/ humanity! It(ll help you in business. It
ill help you in la. It ill help you in life. It ill help you in love. It ill help you in everythin#.
But that as a marvelous -uestion about #oke. The .?e #oke/ story, properly explained, ought hereafter to be in every
introductory psychology text, forever.
But there are limits to the use of these techni-ues<.
8f course, as I said before, there is one big consideration that needs huge and special attention as part of any use of
techni-ues deliberately harnessing elementary psychological forces= And that is that once you kno ho to do it, there are real moral
limits regarding ho much you should do it. ?ot all of hat you kno ho to do should you use it to manipulate people.
Also, if you are illing to transcend the moral limits and the person you are trying to manipulate realizes hat you are
doing because he also understands this psychology, he ill hate you. There is onderfully persuasive evidence of this effect taken
from labor relationssome in Israel. "o not only are there moral ob)ections, but there are also practical ob)ectionsbig ones in some
cases<..
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About %24 of the time, e agree ith @ack *elch<.
'#*%E)#= ;o do you incorporate psychology in your investment decisions+ I think it ould be more than )ust picking products
that ill appeal to everybody like coke. After all, there are a lot of smart people out there ho obviously think )ust the ay that you
shoed us today. "o are you looking for failure in the thinking of other investors as you go about picking successful companies+
M*)2ER+ *hat makes investment hard, as I said at !.".#., is that it is easy to see that some companies have better businesses than
others. ut the .rice o/ the stoc1 goes u. so high that, all o/ a sudden, the Juestion o/ 0hich stock is the 7est to 7uy gets Juite
difficult!
*e(ve never eliminated the difficulty of that problem. And %24 of the time, our attitude toard the market is MthatN e(re
a#nostics. *e don(t kno. Is '1 valued properly vis5V5vis 0ord+ *e don(t kno.
*e(ve succeeded by making the orld easy .
*e(re alays looking for something here e think 0e have an insight, 0hich gives us a 7ig statistical advantage.
And sometimes it comes from psychology, but often it comes from something else. And e only find a femaybe one or to a
year. *e have no system for having automatic good )udgment on all investment decisions that can be made. 8urs is a totally
different system.
We :ust loo1 /or a noD7rainer decisions! As Buffett and I say over and over again, e don(t leap over seven5foot fences.
Instead, e look for one5foot fences ith big reards on the other side. "o e(ve succeeded by making the orld easy for ourselves,
not by solving hard problems.
*e only find a fe that meet our criteria, But that(s enough.
'tudent+ Based on statistical analysis and insight+
M*)2ER= *ell, certainly hen e do make a decision, e think that e have the insight advantage. And it is true that some of the
insight is statistical in nature. ;oever, again, e find only a fe of those.
It doesn(t help us merely for favorable odds to exist. They have to be in place here e can recognize them. "o it takes a
mis.riced o..ortunity that 0e are smart enough to recogniEe. And that combination doesn(t occur often.
But it doesn(t have to. If you ait for the big opportunity and have the courage and vigor to grasp it firmly hen it arrives,
ho many do you need+ 0or example, take the top $3 business investments Berkshire ;athaay(s ever made. *e ould be very rich
if e(d never done anything elsein to lifetimes.
"o, once again, e don(t have any system for giving you perfect investment )udgment on all sub)ects at all times. That
ould be ridiculous. Im :ust trying to give you a method you can use to si/t reality to o7tain an occasional o..ortunity /or
rational reaction!
If you take that method into something as competitive as common stock picking, you(re competing ith many brilliant
people. "o, even ith our method, e only get a fe opportunities. 0ortunately that happens to be enough.
WE ,A(E A *P)%I! LAC5 $F A--I#*%E I) ,I2, #EC,! W,& ',$*L% WE -LA& W,E#RE WERE
$I*A%(A)#A2E%!
8penmindedness is not )ust a virtue. It(s a necessity.
*orldly *isdom by #harlie 1unger $%%75$%%2 EI
'tudent+ ;ave you been successful in creating an atmosphere here people belo you can do the same things you(re talking about
doing yourself+ 0or example, you have talked about the tendency toards commitment and consistency<.
M*)2ER+ <1ostly about the terrible mistakes it causes you to make.
'tudent= <;o have you created an atmosphere comfortable enough for people to abandon that tendency and admit they have made
a mistake+
0or example, someone earlier this year from Intel talked about problems that occurred ith their 9entium chip. 8ne of the
most difficult things for them to do as to realize that they have been going about it the rong ay and turn course. And it is very
difficult to do that in a complex structure.

;o do you foster that+
M*)2ER+ Intel and its ilk create a coherent culture here teams solve difficult problems on the cutting edge of science. That is
radically different from Berkshire ;athaay. Berkshire is a holding company.. *e(ve decentralized all the poer except for natural
head-uarters5type capital allocation.
y and large, 0eve chosen .eo.le 0e admire enormously to have the .o0er 7eneath us! It is easy for us to get along
ith them on average because e love and admire them. And they create the culture for hatever invention and reality recognition is
going on in their businesses. And included in that reality recognition is the recognition that previous conclusions ere incorrect.
But e(re a totally different kind of company. It is not at all clear to me that *arren or I ould be that good at doing hat
Andy 'rove does. *e don(t have special competence in that field. *e are fairly good at relating to brilliant people e love. But e
have defects. 0or example, some regard me as absentminded and opinionated. I might be a mess at Intel.
;oever, both *arren and I are very good at changing our prior conclusions. *e ork at developing that facility because
ithout it, disaster often comes.
*hy not high tech+ *e have a special lack of aptitude there.
'tudent= *ould you talk a little bit about your seeming predilection aay from investing in high technology stockson your on
part and the part of Berkshire ;athaay. 8ne of the things I found eye opening and a little surprising is ho the difficulties of
running a lo5tech business aren(t all that different.
Munger+ They(re all hard. But hy should it be easy to get rich+ In a competitive orld, shouldn(t it be impossible for there to be an
easy ay for everybody to get rich+ 8f course, they are all hard.
The reason e are not in high5tech businesses is that e have a special lack of aptitude in that area. And, yesa lo5tech
business can be plenty hard. @ust try to open a restaurant and make it succeed.
*hy play to our eaknesses instead of our strengths+
'tudent= ,ou seem to be suggesting that there is a special aptitude re-uired in high5tech businessthat they(re harder. But aren(t
they e-ually difficult+
Munger+ The advantage of lo5tech stuff for us is that e think e understand it fairly ell. The other stuff e don(t. And e(d
rather deal ith hat e understand.
*hy should e ant to play a competitive game in a field here e have no advantagemaybe a disadvantageinstead
of playing in a field here e have a clear advantage+
Aach of you ill have to figure out here your talents lie. And you ill have to use your advantages. But if you try to
succeed in 0hat you are 0orst at, you are going to have a very lousy career! I can almost guarantee it. To do otherise, you(d
have to buy a inning lottery ticket or get very lucky somehere else.
#,ERE' )$ WA& #$ A($I% L$#' $F MI'#A5E'! *# &$* ,A(E #$ LEAR) ,$W #$ ,A)%LE #,EM!
!"Air asn(t a bet on the common, but it as a mistake.
'tudent= *arren Buffett has said that the investment Berkshire mad in an airline as a good example of hat not to do. *hat chain
of thinking led to that rong decision+
Munger= *e ere not buying stock in !"Air on the theory that the common shareholders ere certain to prosperbecause the
history of the airline business in terms of taking care of shareholders has been terrible. It as a preferred stock ith a mandatory
redemption. In effect, e ere loaning money to !"Air and e had this e-uity kicker.
*e eren(t guessing hether it ould be a great place for the shareholders. *e ere guessing hether it ould be a great
place for the shareholders. *e ere guessing hether it ould remain prosperous enough to pay off a credit instrumentcarrying a
fixed dividend and a mandatory redemption. And e guessed that the business ould not get so bad that e(d have a credit threat for
*orldly *isdom by #harlie 1unger $%%75$%%2 E2
hich e ere not being ade-uately compensated by the high rate e ere getting. As it happened. !"Air ent right to the brink of
going broke. It as hanging by a thread for several months.
It(s since come back. And e(ll probably get all our money plus the hole coupon. But it as a mistake.
There is no ay you can avoid making many mistakes
Munger+ I don(t ant you to think e have any ay of learning or behaving so you on(t make a lot of mistakes. Im :ust saying
that you can learn to ma1e /e0er mista1es than other .eo.le6and ho0 to /i@ your mista1es /aster 0hen you do ma1e them!
ut there is no0 0ay that you can live an adeJuate li/e 0ithout ma1ing many mista1es!
8ne of the tricks in life is to get so you can handle mistakes.
Munger+ In fact, one trick in life is to get so you can handle mista1es Failure to handle .sychological denial is a
common 0ay /or .eo.le to go 7ro1e= ,ou have made an enormous commitment to something. ,ou have poured effort and money
in. And the more you put in, the more that the hole consistency principle makes you think, .?o it has to ork. If I put in )ust a
little more, then it ill ork./
And deprival super5reaction syndrome also comes in= ,ou(re are going to lose the hole thing if you don(t put in a little
more. 9eople go broke that aybecause they can(t stop, rethink and say, .I can afford to rite this one off and live to fight again. I
don(t have to pursue this thing as an obsessionin a ay that ill break me./
9art of hat you must learn is ho to handle mistakes and ne facts that change the odds. Dife, in part, is like a poker
game, herein you have to learn to -uit sometimes hen holding a much5loved hand.
A '01)!&.* M$%EL+ &$* C*'# 'I# #,ERE W,ILE #,E W$RL% CARRIE' &$* F$RWAR% & #,E (I!!I&#!
Dike #oke, >isney )ust got this enormous tailind.
'tudent+ #ould you talk about the thoughts that ent into your decision to sap your #apital #ities stock for >isney
rather than taking cash. In the media, it as reported that you mentioned thinking about taking the cash.
Munger+ >isney(s a perfectly marvelous company, but it is also very high5priced. 9art of hat it does is to make ordinary
movieshich is not a business that attracts me at all. ;oever, part of hat >isney has is better than a great gold mine. 1y
grandchildrenI mean, those videocassettes<.
>isney is an amazing example of autocatalysis.. They had all those movies in the can. They oned the copyright. And
)ust as #oke could prosper hen refrigeration came, hen the videocassette as invented, >isney didn(t have to invent anything or do
anything except take the thing out of the can and stick it on the cassette. And every parent and grandparent anted his descendents to
sit around and atch that stuff at home on videocassette. "o >isney got this enormous tailind from life. And it as billions of
dollars orth of tailind.
8bviously, that(s a marvelous model if you can find it. ,ou don(t have to invent anything. All you have to do is to sit
there hile the orld carries you forard<..
>isney(s been brilliant about creating the ne stuff, too.
M*)2ER+ >isney(s done a lot of ne things right. >on(t misunderstand me. But a lot of hat happened to >isney as
like hat a friend of mine said about an ignorant fraternity brother of his ho succeeded in life. .;e as a duck sitting on a pond.
And they raised the level of the pond./
Aisner and *ells ere brilliant in ho they ran >isney. But the huge tailind from videocassette sales on all of the old
stuff that as there hen they came in, that as )ust an automatic break for the ne management.
To be fair, they have been brilliant about creating ne stufflike Pocahantas and (he )ion -in#
To catch the same tailind. But by the time it is done, (he )ion -in# alone is going to do plural billions. And, by the ay, hen I
say/ hen it(s done/, I mean 73 years from kno or something. But plural billionsfrom one movie+
#,E MA)L& AR# $F WA2ERI)2 I' $)E #,I)2! -R$FE''I$)AL 2AMLI)2 I' 3*I#E A)$#,ER!
*hy investment over la+ I )ust did hat came naturally.
'#*%E)#+ #ould you talk about hy you left the la+
M*)2ER+ I had a huge family. ?ancy and I supported eight children< And I didn(t realize that the la as going to get
as prosperous as it suddenly got. The big money came into la shortly after I left it. By $%HB, I mostly out. And I as totally out by
$%H7. "o that as a long time ago.
*orldly *isdom by #harlie 1unger $%%75$%%2 E%
Also, I preferred making the decisions and gambling my on money. I usually thought I kne better than the client
anyay. "o hy should I have to do it his ay+ "o, partly, it as a desire to get resources permitting independence.
Also, the bulk of my clients ere terrific. But there ere one or to I didn(t en)oy, 9lus, I like the independence of a
capitalist. And I(d alays had assort of a gambling personality. I like figuring things out and making bets. "o I simply did hat
came naturally.
*hy ould I ever ant to ager against house odds+
'tudent+ >o you ever gamble Das Cegas style+
M*)2ER+ I on(t bet R$33 against house odds beteen no and the grave. I don(t do that. *hy should I+ I ill gamble
recreationally ith my pals. And I(ll occasionally play a much better bridge player, like Bob ;amman, ho might be the best card
player in the orld. But I kno I(m paying for the fun of playing ith him. That(s recreational.
As of gambling ith simple mechanical house odds against me, hy in the orld ould I ever ant to do that
particularly given ho I detest the manipulative culture of legalized gambling. And I(m not comfortable in Das Cegas, even though it
does no include a higher percentage of holesome family recreation. I don(t like to be ith many of the types ho hang around
card parlors and so forth. "o I don(t like legalized gambling.
8n the other hand, I do like the manly art of agering, so to speak. And I like light social gambling among friends. But I
don(t like the professional gambling milieu.
1oney management has been a #old mine, only not for us<
'#*%E)#+ #ould you say something about ho the mutual fund and money management business has changed since you got into it
and the groth of the capital markets+
M*)2ER+ Actually, I didn(t really get into it. I had a little private partnership for $& yearsup until a little over B3 years ago.
;oever, I never had enough money from other people to amount to a hill of beansat least by current investment5management
standards. "o I(ve never really been part of the mutual fund business.
But the money management business has been one of the great groth businesses in the recent history of the !nited "tates.
It(s created many affluent professionals and multi5millionaires. It(s been a perfect gold mine for people ho got in early. The groth
of pension funds, the value of American corporations, and the orld(s ealth have created a fabulous profession for many and carried
lots of them up to affluence.
And e deal ith them in a variety of ays. ;oever, e haven(t been part of it for many years. *e(ve basically invested
our on money for a long, long time.
'tudent+ do you expect this bull5run to continue+
M*)2ER+ *ell, I(d be amazed if the capitalized value of all American business eren(t considerably higher B7 years
from no. And if people continue to trade ith one another and shuffle these pieces of paper around, then money management may
to be a marvelous business for the managers.
But except for hat might be called our on money, e(re really not in it.
WARRE) A)% I ARE I) *)C,AR#ERE% #ERRI#$R&! A)% IM )$# '*RE #,A# WELL %$ I# RI2,#!
Ada.t your strategy to your nature and talents. $ did.
'tudent+ I as interested in the evolution of your investment strategy from hen you first beganusing the Ben 'raham modelto
the Berkshire ;athaay model ould you recommend that model to a beginning investori.e., dumping most of it or all of it into one
opportunity e think is a great one and leaving it there for decades+ 8r is that strategy really for a more mature investor+
M*)2ER+ Aach person has to play the game given his on marginal utility considerations and in a ay that takes into account his
on psychology. If losses are going to make you miserableand some losses are inevitableyou might be ise to utilize a very
conservative pattern of investment and saving all your life. "o you have to adapt your strategy to your on nature and your on
talents. I dont thin1 theres a oneDsiEeD/itsDall investment strategy that I can give you!
1ine orks fine for me. But, in part, that(s because I(m good at taking losses. I can take them psychologically. And,
besides, I have very fe. The combination orks fine.
*arren and I have never done this before. *e(re learning.
'tudent+ ,ou and Buffett have said that Berkshire(s stock is overvalued and you ouldn(t recommend buying it.
M*)2ER+ *e didn(t say Me thought it as overvaluedN. *e )ust said that ouldn(t buy it or recommend that our
friends buy it at the prices then prevailing. But that )ust related to Berkshire(s intrinsic value as it as at that time.
*orldly *isdom by #harlie 1unger $%%75$%%2 &3
'tudent+ If I had the money, I ould buy itbecause you have been saying that your returns ill go don for B3
years<<
M*)2ER+ *ell, I hope that your optimism is )ustified. But I do not change my opinion. After all, today, e(re in
unchartered territoryith high valuations and a huge amount of capital. *e(ve never done it before. "o e(re learnin#.
A continuation of hog heaven5level returns is impossible.
'tudent+ Averything you and Buffett say seems logical. But it sounds like exactly the same language that Ben 'raham
as using E3 years ago hen he as saying the stock market as overvalued5hen it as at %33.
M*)2ER+ 8h, I don(t think that e share that ith him. 'raham, great, great though he as as a man, had a scre loose
as he tried to predict outcomes for the stock market as a hole. In contrast, *arren and I are almost alays agnostic about the market.
8n the other hand, e have said that common stocks generally have generated returns of $35$$4 after inflation for many
years and that those returns can(t continue for a very long period. And they can,t. It is simply impossible. The ealth of the orld
ill compound at no such rate. *hatever experience "tanford has had in its portfolio for the last $7 years, its future experience is
virtually certain to be orse. It may still be 8L. But it(s been a hog heaven period for investors over the last $7 years. Bonanza
effects of such scale can(t last forever.
That our returns ill slo isn(t an opinion. It is a promise.
'tudent+ Berkshire(s annual report got a lot of press for being pessimistic and for expressing concern about the shrinking
pool of opportunities as the company gets bigger and bigger+ *here does that leave you $3 years from no+
M*)2ER+ *e(ve said over and over that our future rate of compounding our shareholders( ealth is going to go don
compared to our pastand that our size ill be an anchor dragging on performance. And e(ve said over and over again that this is
not an o!inion but a !romise.
;oever, Det(s suppose that e ere able to compound our present book value at $74 per annum from this point. That
ould not be so bad and ould out 8L for our long5term shareholder. I(m not )ust saying that e could afford to slo don some, as
e surely ill, and still do 8L for the long5term shareholder<.
By the ay, I(m not promising that e ill compound our present book value at $74 per annum.
W,A# C$*L% -$''IIL& E M$RE (AL*ALE I) LIFE #,A) 5)$WI)2 W,A# &$* 5)$W A)% W,A# &$*
%$)#!
&ou cant ma1e sure youre right! #hat is the point.
'#*%E)#+ ,ou have talked about ho important it as not to have an extreme ideology. *hat responsibility, if any, do
you think the business and legal communities have for helping inner city areas, spreading the ealth and so on+
M*)2ER+ I(m all for fixing social problems. I(m all for being generous to the less fortunate. And I(m all for being
generous to the less fortunate. And I(m all for doing things here, based on, a slight preponderance of the evidence, you guess that
it(s likely to do more good than harm<.
*hat I(m a#ainst is being very confident and feeling that you kno, for sure, that your particular intervention ill do more
good than harm given that you(re dealing ith highly complex systems herein everything is interacting ith everything else.
'tudent+ "o hat you are saying )ust make sure that hat your doing is doing more good<
M*)2ER+ ,ou can(t make sure. That(s my point<
*hat could be more than knoing hat you kno.+
M*)2ER+ 8n the other hand, I did recently reverse the conclusions of to sets of engineers. ;o did I have enough
confidence in such a complicated field to do that+ *ell, you might think, .8h, this guy is )ust an egomaniac ho(s made some money
and thinks he knos everything./
*ell, I may be an egomaniac, but I don(t think I kno everything. But I sa huge reasons in the circumstances for bias in
each set of engineers as each recommended a course of action very advantageous to itself. And hat each as saying as so
consonant ith a natural bias that it made me distrust it. Also, perhaps I kne enough engineering to kno that hat they ere saying
didn(t make sense.
0inally, I found a third engineer ho recommended a solution I approved. And, thereafter, the second engineer came to me
and said, .#harlie, hy didn(t I think of that+/hich is to his credit. It as a much better solution, both safer and cheaper.
*orldly *isdom by #harlie 1unger $%%75$%%2 &$
&ou must have the con/idence to override .eo.le 0ith more credentials than you 0hose cognition is im.aired 7y
incentiveDcaused 7ias or some similar .sychological /orce that is o7viously .resent! But there are also cases here you have to
recognize that you have no isdom to addthat your best course is to trust some expert<.
In effect, you have got to kno hat you kno and hat you don(t kno. *hat could possibly be more useful in life than
that+
*hen you don(t kno, don(t be afraid so say so<.
'#*%E)#+ ,ou(ve discusses #oke(s mistake. >o you have any thoughts about here Apple ent rong+
M*)2ER+ Det me give you a very good anserone I(m copying from @ack *elch, the #A8 of 'eneral Alectric. ;e
has a 9h.>. in Angineering. ;e is a star businessman. ;e is a marvelous guy. And recently, in *arren(s presence, someone asked
him, .@ack, hat did Apple do rong+/
;is anser+ .I don(t have any special competence that ould enable me to anser that -uestion./ And I(ll give you the same
anser. That is not a field in hich I(m capable of giving you any special insight.
8n the other hand, in copying @ack *elsh, I am trying to teach you something. *hen you don(t kno and you don(t have
any special competence, don(t be afraid to say so.
?obody expects you to kno everything<
M*)2ER+ There(s another type of person I compare to an example from biology= *hen a bee finds nectar, it comes back
and does a little dance that tells the rest of the hive, as a matter of genetic programming g, hich direction to go and ho far. "o
about &3 or 73 years ago, some clever scientist stuck the nectar straight up. *ell, the nectar(s never straight up in the ordinary life of
a bee. The nectar(s out. "o the bee finds the nectar and returns to the have. But it doesn(t have the genetic programming to do a
dance that says straight up. "o hat does it do+
*ell, if it ere like @ack *elch, it ould )ust sit there. But hat it actually does is to dance this incoherent dance that
gums things up. And a lot of people are like that bee. They attempt to anser a -uestion like that. And that is a huge mistake.
?obody expects you to kno everything about everything.
I try to get rid o/ .eo.le 0ho al0ays con/idently ans0er Juestions a7out 0hich they dont have any real 1no0ledge!
To me, they(re like the bee dancing its incoherent dance. They are )ust screing up the hive.
A 2REA# LE''$) M& FA#,ER #A*2,# ME EARL& #,A# I(E ,EL% #,R$*2, ALL #,E'E %ECA%E'!
There are perverse incentives at ork in la firms<
'tudent= As someone ho(s been in legal practice and business, ho did you incorporate, or did you incorporate, these
models into your legal practice+ And ho did it ork+ I suspect many of us have seen la firms that don(t appear to adhere to these
kinds of models.
Munger+ *ell, the models are there. But )ust as there are perverse incentives in academia, there are perverse incentives in
la firms. In fact, in some respects, at the la firms, it is much worse.
The 'rant 1c0ayden model<.
Munger+ ;ere(s another model from la practice= *hen I as very young, my father practiced la. 8ne of his best
friends, 'rant 1c0ayden8maha(s 9ioneer 0ord dealeras a client. ;e as a perfectly marvelous mana self5made Irishman
ho(d run aay uneducated from a farm as a youth because his father beat him. "o he mad his on ay in the orld. And he as a
brilliant man of enormous charm and integrity)ust a onderful man.
In contrast, my father had another client ho as a blohard, overreaching, unfair, pompous, difficult man. And I must
have been $& year old or thereabouts hen I asked, .>ad, hy do you do so much ork of 1r. Wthis blohard instead of orking
more for onderful men like 'rant 1c0ayden+/
1y father said, .'rant 1c0ayden treats his employees right, his customers right and his problems right. And if he gets
involved ith a psychotic, he -uickly alks over to here the psychotic is and orks out an exit as fast as he can. Therefore, 'rant
1c0ayden doesn(t have enough remunerative la business to keep you in coca5cola. But 1r. W is a alking minefield of onderful
legal business./
*hat drove me from practicing la<
Munger+ This case demonstrates one of the troubles ith practicing la. To a considerable extent, youre going to 7e
dealing 0ith grossly de/ective .eo.le! They create an enormous amount of the remunerative la business. And even hen your
on client is a paragon of virtue, you ill often be dealing ith gross deficiencies on the other side or even on the bench. That is
partly hat drove me out of the profession.
*orldly *isdom by #harlie 1unger $%%75$%%2 &B
The rest as my on greed, but my success in serving greed partly alloed me to make easier the process of being
honorable and sensible. Dike Ben 0ranklin observed, .It(s hard for an empty sack to stand upright./
,ou can ork for defectives, but live like 'rant 1c0ayden.
Munger= I(d argue that my father(s model hen I asked him about the to clients as totally correct deduction. ;e taught
me the right lesson. The lesson+ As you go through life, you may sell your services once in ahile to an unreasonable blohard if
that is hat you must do to feed your family. But run your on life like 'rant 1c0ayden. That as a great lesson.
And by making me reach, he taught me a lesson for good.
Munger= And he taught it in a very clever ay7ecause instead o/ :ust .ounding it in, he told it to me in a 0ay that
reJuired a slight mental reach! And I had to make the reach myself in order to get the idea that I should behave like 'rant
1c0ayden. And because I hade to reach for it, he figured, I(d hold it better. And, indeed, I(ve held it all the ay through until today
through all these decades. That is a very clever teaching method.
There, again, e(re talking about elementary psychology. It is elementary literature. 'ood literature makes the reader
reach a little for understanding. Then, it orks better. ,ou hold it better. It is the commitment and consistency tendency. If you(ve
reached for it, the idea(s pounded in better.
As a layer or executive, you ant to teach them something else. And you can use lessons like this. Isn(t that a great ay
to teach a child+ 1y father used indirection on purpose. And look at ho poerfully it orkedlike #aptain #ook(s ise use of
psychology. I(ve been trying to imitate 'rant 1c0ayden ever sincefor all my life. I have had a fe lapses. But, at least, I(ve been
trying.
& #,I)5I)2 C$RREC#L& A)% 5)$WI)2 A FEW #RIC5', &$* CA) A%% 2REA# (AL*E #$ #,$'E
AR$*)% &$*!
If you think correctly, you can add great value<
'tudent= At the end of your article in 8I>, you mentioned that only a select fe investment managers actually add any
value. "ince you are speaking to an audience of future layers, hat ould you encourage us to do in order to be able to add value in
our profession.
Munger= To the extent you become a person ho thinks correctly, you can add great value. To the extent that you have
learned it so ell that you have enough confidence to intervene here it takes a little courage, you can add great value. And to the
extent that you can prevent or stop some asininity, hich ould otherise destroy your firm, your client or something or someone that
you care about, you can add great value.
;umorous examples can enormously aid persuasion.
Munger+ And there are constructive tricks you can use. 0or example, one reason my old classmate, @oe 0lom of "kadden
Arps, had been such a successful layer is that he is very good at dreaming up little, vivid e@am.les that serve to .ounded the .oint
home in a 0ay that really 0or1s! It is enormously helpful hen you are serving clients or otherise trying to persuade someone in a
good cause to come up ith a little humorous example.
The ability to do that is a knack. "o you could argue that the @oe 0loms of the orld are almost born ith a gift. ut hes
honed the gi/t! And to one degree or another, all o/ you 0ere 7orn 0ith the gi/t! And you can hone it, too!
Another psychological principleappealing to interest .
Munger+ 8ccasionally, you get into borderline stuff. 0or instance, suppose you have got a client ho really ants to
commit tax fraud. If he doesn(t push the tax la ay beyond the line, he can(t stand it. ;e can(t shave in the morning if he thinks
there(s been any cheating he could get by ith that he hasn(t done. And there are people like that. They )ust feel they are not living
dangerously enough.
,ou can approach that situation in either of to ays= MAN ,ou can say, .I )ust on(t ork for him./ And duck it. 8r, MBN
you can say, .*ell, the circumstances of my life re-uire that I ork for him./ And hat I(m doing for him doesn(t involve my
cheating. Therefore, I(ll do it.
And if you see he ants to do something really stupid, it probably on(t ork to tell him, .*hat you are doing is bad. I
have better morals than you./
That offends him. ,ou(re young. ;e(s old. Therefore, instead of being persuaded, he is more likely to react ithy, .*ho
in the hell are you to establish the moral code of the hole orld+/
But, instead, you can say to him, .,ou can(t do that ithout three other people beneath you knoing about it. Therefore,
you are making yourself sub)ect to blackmail. ,ou are risking your reputation. ,ou are risking your family, your money, etc./
*orldly *isdom by #harlie 1unger $%%75$%%2 &E
That is likely to ork. And you are telling him something that is true. >o you ant to spend a lot of time orking for
people here you have to use methods like that to get them to behave ell+ I think the anser is no. But if you are hooked ith it,
appealing to interest is likely to ork better as a matter of human persuasion than appeal to anything else. That, again, is a poerful
psychological principle ith deep biological roots.
#A8(s don(t like the idea of being ruined, disgraced and fired.
Munger= I sa that psychological principle totally blon at "alomon. "alomon(s general counsel kne that the #A8,
'utfreund, should have promptly told the 0ederal authorities all bout "alomon(s trading improprieties in hich 'utfreund didn(t
participate and hich he hadn(t caused. And the general counsel urged 'utfreund to do it. ;e told 'utfreund, in effect, .,ou(re
probably not legally re-uired to do that, but that is the right thing to do. ,ou really should./
But it didn(t ork. The task as easy to put offbecause it as unpleasant. "o that is hat 'utfreund didhe put it off.
And the general counsel had very little constituency ithin "alomon except for the #A8. If the #A8 ent don, the
general counsel as going to go don ith him. Therefore, his hole career as on the line. "o to save his career, he needed to talk
the dilatory #A8 into doing the right thing.
It should have been child(s play to get the )ob done right. All the general counsel had to do as to tell his boss, .@ohn, this
situation could ruin your life. ,ou could lose your ealth. ,ou could lose your reputation</ And it ould have orked. #A8s
don(t like the idea of being ruined, disgraced and fired.
"alomon executives made that mistake.
Munger+ And the ex5general counsel of "alomon is brilliant and generousand he had the right idea. ;oever, he lost
his )ob because he didn(t apply a little elementary psychology. ;e failed to recognize that hat orks best in most cases is to appeal
to a man(s interest.
But you don(t have to get similarly lousy results hen you face similar situations. @ust remember hat happened to
'utfreund and his general counsel. #he right lessons are easily learned i/ you 0ill 0or1 at it! And if you do learn them, you can be
especially useful at crucial moments hen others fail. And to the extent that you do become ise, diligent, ob)ective and, especially
able to persuade in a good cause, then you are adding value<.
,I2,ER LE2AL A)% RE2*LA#$R& C$'#' ARE A REALI#&! A)% I# WILL E(ER E #,*'! *# '$CIE#&
A%A-#'!
?ot everyone favors less fraud<
'tudent+ *ould you discuss ho the threat of litigationshareholder lasuits and so forthand legal complexity in
general has effected decision making in big business+
Munger= *ell, every big business screams about its legal costs, screams about the amount of regulation, screams about the
complexity of its life, screams about the plaintiff(s barparticularly the class action plaintiff(s bar. "o there is an absolute catechism
on that here Kyou could )ust copy the screams from one corporation to another and you(d have hardly changed a ord.
But hat causes the screams has, so far, been a godsend for the la firms< The big la firms have had a long updraft.
And they no tend to kind of cluck like an undertaker in a plague. And undertaker, of course, ould look very unseemly if he ere
)umping up and don and playing his fiddle during the plague. "o la firm partners say, .8h, isn(t it sadall this complexity, all this
litigation, all this unfairness./
But, really they(re somehat schizophrenic on the sub)ect because it(s been very good for them. "ome recent #alifornia
initiatives created some interesting conduct. 9art of the defense bar lobbied -uietly against certain propositions and, effectively,
against their clients because they didn(t ant their clients to catch them in the process. And the reason that they did so as because
they sa that the defense bar ould suffer if it became harder for plaintiffs to bring cases.
If you make a living fighting overreaching and it keeps your children in school and somebody proposes a system that
eliminates itell, that is an adult experience and an adult choice that you have to make.
And it ill ever be thus<
Munger+ "o big corporations adapt. They have more litigation. They have a bigger legal department. They scream about
hat they don(t like. But they adapt.
'tudent+ But hadn(t that legal complexity consumed a lot more of accompanies( resources over the last fe decades+
Munger+ The anser is yes. ;ardly a corporation in America isn(t spending more on lasuits and on compliance ith
various regulations than it as B3 years a go. And, yes, some of the ne regulation is stupid and foolish. And some as damn ell
necessary. And it ill ever be thus, albeit some ebb and flo.
I don(t think big rich corporations should make helmets<
*orldly *isdom by #harlie 1unger $%%75$%%2 &&
'tudent+ But have you seen or experienced any change in decision5making at corporations in their being less likely to take
on riskier investments for fear of failure or liability+
Munger+ The only place I saith another friend, not *arren MBuffettN Q Mas hereN I as part oner of the biggest
shareholder in a company that invented a better policemen(s helmet. It as made of Levlar or something of that sort. And they
brought it to us and anted us to MmanufactureN it.
As a matter of ideology, e(re very pro5police< 8 believe civilization needs a police forcealthough I don(t believe in
policemen creating too many idos and orphans unnecessary either. But e like the idea of a better policemen(s helmet.
;oever, e took one look at it and said to the people ho invented it. .*e(re a rich corporation. *e can(t afford to
make a better policemen(s helmet. That is )ust ho the civilization orks. All risks considered, it can(t ork for us. But e ant the
civilization to have them.
"o don(t maximize hat e get for it. 'et somebody else to make it<. Transfer the technology or hatever to somebody
ho can do it. But e are not going to./
Thus, e didn(t try to disadvantage policeman by keeping them fromN getting ne helmets, but e decided not to
manufacture helmets ourselves.
There are businessesgiven the ay the civilization had developedhere being the only deep pocket around is bad
business. In high school football, for example, a paraplegic or -uadriplegic ill inevitably be created occasionally. And ho ith
deep pockets can the in)ured person best sue other than the helmet manufacturer<.
I think big, rich corporations are seldom ise to make football helmets in the kind of a civilization e(re in. And maybe it
should be harder to successfully sue helmet makers.
There are various ays of adapting to the litigation climate.
Munger+ I kno to different doctorseach of hom had a sound marriage. And hen the malpractice premiums got
high enough, they divorced their ives and transferred most of their property to their ives. And they continued to practiceonly
ithout malpractice insurance.
They ere angry at the civilization. They needed to adapt. And they trusted their ives. "o that as that. And they(ve
not carried any malpractice insurance since.
9eople adapt to a changing litigation climate. They have various ays of doing it. That is ho it(s alays been and ho it
is alays going to be.
)A(& M$%EL I' E##ER #,A) LAW 'C,$$L M$%EL6ECA*'E #,E CI(ILI?A#I$) W$R5' ()++)0!
Better a fe get treated harshly than society be corrupted.
Munger+ *hat I personally hate most are systems that make fraud easy. 9robably ay more than half of all chiropractic income in
#alifornia comes from pure fraud. 0or example, I have a friend ho had a little fender benderan auto accidentin a tough
neighborhood. And he got to chiropractors( cards and lone layer(s card before he(d even left the intersection. They(re in the
business of manufacturing claims that necks hurt.
In #alifornia, I believe the Gand statistics shoed that e have tice as many personal in)uries per accident as in many
other states. And e aren(t getting tice as much real in)ury per accident. "o the other half of that is fraud. 9eople )ust get so that
they think everybody does it and it is all right to do. I think it(s terrible to let that stuff creep in.
If I ere running the civilization, compensation for stress in orkers( comp ould be zeronot because there(s no ork5
caused stress, but because I think the net social damage of alloing stress to be compensated at all is orse than hat ould happen
if a fe people that had real ork5caused stress in)uries ent uncompensated.
The ?avy model causes people to pay attention.
Munger+ I like the ?avy system. If you(re a captain in the ?avy and you(ve up for B& hours straight and have to go to
sleep and you turn the ship over to a competent first mate in tough conditions and he takes the ship agroundclearly through no fault
of yoursthey don(t court martial you, but your naval career is over.
?apoleon said he liked luckier generalshe asn(t into supporting losers. *ell, the ?avy likes luckier captains. ,ou can
say, .That(s too tou#h. That is not la school. That(s not due process. Well, the )avy model is better in its conte@t than 0ould 7e
the la0 school model! #he )avy model really /orces .eo.le to .ay attention 0hen conditions are tough67ecause they 1no0
that there is no e2cuse! Cery simply, if your ship goes aground, your career is over.
.It doesn(t matter hether it as your fault or not. ?obody is interested in your fault. It(s )ust a rule that e happen to
havefor the good of all, all effects considered./
*orldly *isdom by #harlie 1unger $%%75$%%2 &7
The civilization orks better ith some of these rules.
Munger= I like some rules like that. I think that the civilization orks better ith some of these no5fault rules. But that
stuff tends to be anathema around la schools. .It(s not due process. ,ou(re not really searching for )ustice./
*ell, I am searching for )ustice hen I argue for the ?avy rulefor the )ustice of feer ships going aground. #onsidering
the net benefit, I don(t care if one captain has some unfairness in his life. After all, its is not like he is being court marshaled. ;e )ust
has to look for a ne line of ork. And he keeps vested pension rights and so on. "o it is not like it is the end of the orld.
"o I like things like that. ;oever, I(m in a minority.
AC,IE(I)2 W$RL%L& WI'%$M I')# #,A# ,AR%! A)% #,E E)EFI#' A)% F*) LA'# A LIFE#IME!
It is not that hard<.
'tudent+ I(d like to hear you talk a little bit more about :udgment! In talk, you said e should read psychology textbooks
and take the $7 or $H principles that are best or the ones that make sense<
Munger+ The ones that are obviously important and obviously right. That(s correct<.And then you stick in the ones that
are obviously important and not in the book555and you have got a system.
'tudent+ Gight. 1y problem seems to be the prior stephich is determining hich ones are obviously right. And that
seems to me to be a more essential -uestion to ask.
Munger+ ?o, no. ,ou overestimate the difficulty. >o you have difficulty understanding that people are heavily
influenced by hat other people think and hat other people doand some of that happens on a subconscious level+
'tudent+ ?o, I don(t I understand that.
Munger+ *ell, you can go right through the principles. And one after the other, they(re
like that. It is not that hard<
>o you have any difficulty ith the idea that operant conditioning orksthat people ill repeat hat orked for them
the last time+
If you ant it all laid out, maybe you should be a 1oonie.
'tudent+ It )ust seems to me like there is a lot of other things out there, as ell, that also make a lot of sense. The system
ould -uickly get too complicated, I imagineas a result of too much cross talk.
Munger+ *ell, if you(re like me, it is kind of fun for it to be a little complicated. If you ant it totally easy and totally laid
out, maybe you should be a 1oonie. I don(t think that is the ay to go! I thin1 you 0ill :ust have to endure the 0orld6as
com.licated as it is! Einstein has a marvelous statement on that+ Everything should 7e made as sim.le as .ossi7le, 7ut no
more sim.le!"
I(m afraid that is the ay it is. If there are B3 factors and they interact some, you ill )ust have to learn to handle it
because that is the ay the orld is. But you on(t find it that hard if you go at it >arin5like, step by step ith curious persistence.
,ou(ll be amazed ho good you(ll get.
It(s aesomein more ays than one<
'tudent+ ,ou(ve given us about three of the models that you use. I ondered here you found the other ones. And,
second, do you have an easier ay for us to find them than going through a psychology textbook. I(m not adverse to doing that, but it
takes longer<..
Munger+ There are a relatively small number of disciplines and a relatively small number of truly big ideas. And it is a lot
of fun to figure it out. 9lus, if you figure it out and do the outlining yourself, the ideas ill stick better than if you memorize them
using somebody else(s cram list.
Aven better, the fun never sto!s. I as mis5educated horribly. And I hadn(t bothered to pick up hat is called modern
>arinism. I do a lot of miscellaneous reading, too. But I )ust missed it. And in the last year, I suddenly realized I as a total
damned fool and hadn(t picked it up properly. "o I ent back. And ith the aid of >akins8xford(s great biologistand others, I
picked it up<.
*ell, it as an absolute circus for me in my I3s to get the modern %ar0in synthesis in my head. It is so aesomely
beautiful and so aesomely right. And it is so simple once you get it. "o one beauty of my approach is that the fun never stops< I
suppose that it does stop eventually hen you are drooling in the convalescent home at the end. But, at last, it lasts a long time.
A C$*R'E $) REME%IAL W$RL%L& WI'%$M" W$*L% E FA*L$*' (AL*EDWI'E A)% F*)DWI'E!
*orldly *isdom by #harlie 1unger $%%75$%%2 &H
Gemedial *orldy *isdom should be taught in la school.
Munger+ If I ere czar of a la schoolalthough, of course, no la school ill permit a czarI(d create a course hich
I(d call .Gemedial *orldly *isdom/ that ould, among other useful things, include a fair amount of properly taught psychology.
And it might last three eeks or a month.
I think you could create a course that as so interesting Qith pithy examples and poerful principles555that it ould be a
total circus. And I think that it ould make the hole la school experience better.
And I(d call it .Gemedial/ for a reason.
Munger+ 9eople raise their eyebros at that idea. .9eople don(t do that kind of thing./ They may not like the derision
that is implicit in the title= .Gemedial *orldly *isdom/. But the title ould be my ay of announcing, .Averybody ought to kno
this./ And, if you call it remedial, isn(t that hat you are saying+ .This is really basic and everybody has to kno it./
"uch a course ould be a perfect circus. The examples are so legion. I don(t see hy people don(t do it. They may not do
it mostly because they don(t ant to. But, also, maybe they don(t kno ho. And maybe they don(t ant to offend their
undergraduate departments. I don(t kno hat it is.
But the hole la school experience ould be much more fun if the really basic ideas ere integrated and pounded in ith
good examples for a month or so before you got into conventional la school material<. I think the hole system of education ould
ork better. But nobody has any interest in doing.
Inanity has a ay of creeping into most areas of academia.
1unger= But, boy, hat a school ould be like that pounded a lot of the silliness out. But the right ay to pound it out is
not to have some I3P year5old capitalist come in and tell seniors, .;ere is a little remedial orldly isdom./ This is not the ay to
do it.
8n the other hand, a month at the start of la school that really pounded in the basic doctrines< 1any of the legal
doctrines are tied to other doctrines. They(re )oined at the hi!. And, yet, they teach you those legal doctrines ithout pointing out
they(re tied to the other important doctrines+T That(s insanityabsolute insanity.
The human mind needs reasons. "o does education 6 society.
Munger+ *hy do e have a rule that )udges shouldn(t talk about legal issues that aren(t before them+ In my day, they
taught us the rule, but not in the ay giving reasons tied to the guts of the undergraduate courses. It(s crazy that people don(t have
those reasons. The human mind is not constructed so that it orks ell ithout having the reasons. ,ou(ve got to hang reality on a
theoretical structure ith reasons. That is the ay it hangs together in usable form so that you are an effective thinker.
And to teach doctrineseither ith no reasons or ith poorly explained reasons+T That(s wron#.
Aven the name ould force sense<
Munger= Another reason hy I like the idea of having a course on remedial orldly isdom is that it ould force more
sense on the professors. It ould be akard for them to teach something that as contravened by lessons that ere obviously
correct and emphasized in a course named .Gemedial *orldly *isdom./ 9rofessors doing so ould really have to )ustify themselves.
I#' A 'CREAMI)2 $--$R#*)I#& F$R '$ME$%&, *# IM )$# E4AC#L& ,$L%I)2 M& REA%#,!
Munger+ Is that a totally crazy idea+ It may be crazy to expect it to be done. ;oever, if somebody had done it, ould
you have found it useful+
'tudent= I think it ould be a onderful thing to have. !nfortunately, hen it is created, e on(t be here anymore.
,ou(re proposing that this ould be good to teach people in a course form so it ould be accessible to them. Is there any ay that it
could be more accessible to usother than having to.
Munger+ I get re-uests for pointers to easy learning all the time. And I(m trying to provide a little easy learning today.
But one talk like this is not the right ay to do it. The right ay ould be in a book<.
I ho.e that 0hat Im saying 0ill hel. you 7e more e//ective and 7etter human 7eings! And if you don(t get rich, that
on(t bother me. But I(m alays asked this -uestion= ."poon feed me hat you kno./ And, of course, hat they(re often saying is,
.Teach me ho to get rich ith soft hite hands faster, but teach me faster, too./
I don(t have much interest in riting a book about myself. 9lus it ould be a lot of ork for somebody like me to try and
do it in my I3s. And I have plenty else to do in life. "o I(m not going to do it. But it is a screamin# o!!ortunity for somebody. And
I(d provide the funds to support the riting of an appropriate book if I found someone ith the isdom and the ill to do the )ob
right.
9sychology professors may not be rocket scientists generally.
*orldly *isdom by #harlie 1unger $%%75$%%2 &I
Munger+ Det me turn to some of the probable reasons for present bad education. 9art of the trouble is caused by the
balkanization of academia. 0or instance, psychology is most poerful hen combined ith doctrines from other academic
departments. But if your psychology professor doesn(t kno the other doctrines, then he isn(t capable of doing the necessary
integration.
And ho ould anyone get to be a psychology professor in the first place if he ere good ith non5psychology doctrines
and constantly orked non5psychology doctrines into his material+ "uch ould5be professor ould usually offend his peers and
superiors.
There have been some fabulous psychology professors in the history of the orld. Cialdini o/ AriEona 'tate as very
useful to me, as as B.0. "kinnerfor his experimental results, if divorced from his monomania and utopianism. But averaged out, I
don(t believe that psychology professors in America are people hose alternative career paths ere in the toughest part of physics.
And that may be one of the reasons hy they don(t get it right.
I admire a college president ho tries to correct the disgrace.
Munger+ The schools of education, even at eminent universities, are perverted by psychology. And they(re almost an
intellectual disgrace. It is not unheard of for academic departmentseven at great institutionsto be -uite deficient in important
ays. And including a lot of material labeled as psychological is no cure5all.
And given the academic inertia, all academic deficiencies are very hard to fix. >o you kno ho they tried to fix
psychology at the !niversity of #hicago+ ;aving tenured professors ho ere terrible, the president there actually abolished the
entire psychology department.
And #hicago, in due course, ill probably bring back a ne and different psychology department. Indeed, by no, it probably
has. 9erhaps conditions are no better. And I must admit that I admire a college president ho ill do something like that.
And psychology(s unable to attract ?obel Daureate5types<
Munger+ I do not ish to imply in my criticism that the imperfections of academic psychology teaching are all attributable
to some kind of human fault common only to such departments. Instead, the causes of many of the imperfections lie deep in the
nature of thingsin irritating peculiarities that can(t be removed from psychology.
Det me demonstrate by a Uthoughtful experimentU involving a couple of -uestions= Are there not may fields that need a
synthesizing super5mind like that of Cames Clar1 Ma@0ell, but are destined never to attract one+ And is academic psychology, by its
nature, one of the most unfortunate of all the ould5be attractors of super5minds+ I think the ansers are yes and yes.
8ne can see this by considering the case of the fe members of each generation ho can, as fast as fingers can move,
accurately ork through the problem sets in thermodynamics, electromagnetism and physical chemistry. "uch a person ill be
begged by some of the most eminent people alive to enter the upper reaches of hard science.
*ill such a super5gifted person instead choose academic psychology herein lie very akard realities= MAN that the
tendencies demonstrated by social psychology paradoxically gro eaker as more people learn them, and, MBN that clinical Mpatient5
treatingN psychology has to deal ith the akard reality that happiness, physiologically measured, is often improved by believing
things that are not true+ The anser, I think, is plainly no. The super5mind ill be repelled by academic psychology much as ?oel
Daureate physicist, 1ax 9lanck, as repelled by economics, herein he sa problems that ouldnXt yield to his methods.
MA'#ER #,E E'# #,A# $#,ER' ,A(E FI2*RE% $*#! )$$%& I' 'MAR# E)$*2, #$ %$ I#
#,EM'EL(E'!
*orkaholic or orkaphobic, donXt neglect orldly isdom.
'tudent+ *e talk a lot about trade5offs beteen the -uality of out life and our professional commitments<.Is there a time
for a professional life, learning about these models and doing hatever else interests you+ >o you find time to do fun things besides
learning+
Munger+ IXve always taken a fair amount of time to do hat I really anted to do55some of hich as merely to fish or
play bridge or play golf<.
Aach of us must figure out his or her on life5style< ,ou may ant to ork I3 hours a eek for $3 years to make partner
at #ravath and thereby obtain the obligation to more of the same. 8r you may, say UIXm not illing to pay that price.U Aither ay, it is
a totally personal decision, hich you have to make by your on lights.
ut, 0hatever you decide, I thin1 it is a huge mista1e not to a7sor7 elementary 0orldly 0isdom i/ you are ca.a7le
o/ doing it 7ecause it ma1es you 7etter a7le to serve others, it ma1es you 7etter a7le to serve yoursel/ and it ma1es li/e more
/un! "o if you have an aptitude for doing it, I think youXd be crazy not to. ,our life ill be enriched55not only financially, but in a
host of other ays55if you do.
1any activities are dignified by the need for money.
*orldly *isdom by #harlie 1unger $%%75$%%2 &2
Munger+ ?o this has been a very peculiar talk for some businessman to come in and give at la school55some guy hoXs
never taken a course in psychology telling you that ll of the psychology textbooks are rong. This is very eccentric. But all I can tell
you is that IXm sincere.
ThereXs a lot of simple stuff that many of you are -uite capable of learning. And your lives ill ork ay better, too, if
you do. 9lus, learning it is a lot of fun. "o I urge you to learn it.
*e )ust pretend to be businessmen, but itXs a pretty good act.
'tudent+ Are you in effect fulfilling your responsibility to share the isdom that youXve ac-uired over the years+
Munger+ "ure. Dook at Berkshire ;athaay. I call it the ultimate didactic enterprise. *arren is never going to spend any
money. ;eXs going to give it all back to society. ;e is )ust building a platform so people ill listen to his notions. And the platformXs
not so bad either. But you could argue that *arren and I are academics in our on ay<.
Better to learn from the best. It is too hard to do otherise.
'tudent+ 1ost of hat you said is very compelling. And your -uest for knoledge and, therefore, command of the human
condition and money are all laudable goals.
Munger+ I donXt kno if the -uest for money is so laudable.
'tudent+ *ell, then55understandable.
Munger+ (hat IXll take. I donXt sneer, incidentally, at making sales calls or proofreading bond indentures. If you need the
money, it is fun earning it. And if you have to try a bunch of cases in the course of your career, you ill learn something from doing
that. ,ou ought to do something to earn money. 1any activities are dignified by the fact that you earn money.
'tudent+ I understand your skepticism about overly ideological people. But is there an ideological component to hat you
do+ Is there something that youXre irrationally passionate about+
Munger+ ,eah, I am passionate about wisdom. IXm passionate about accuracy and some kinds of curiosity. 9erhaps I have
some streak of generosity in my nature and a desire to serve values, hich transcend my brief life. But maybe IXm here to sho off.
*ho knos+
I believe in the discipline of mastering the 7est that other .eo.le have ever /igured out. I donXt believe in )ust sitting
don and trying to dream it all up yourself. ?obody is that smart.
)$#E'+
*hat capital spending is re-uired )ust to stay in placene vs. old investment.
'ood businesses thro off one no5brainer after another, hile poor businesses thro off ;obson choices.
It is tough to move to ne locations. If the business on(t stand mismanagement, then it is not the real thing. The business must
stand some mis)udgment.
0reddie 1ac is a marvelous business, but its success is its on anchor.
*hy buying assets at discount is tougher no MAug. $%%IN. Tax las changed so that a corporation ith appreciated assets including
goodill couldn(t sell out in a ay that got its shareholders money and gave the buyer a rite5up on those assets ithout imposing a
tax at the corporate level. That had a huge negative impact on li-uidating values.
?o business is so onderful that you can(t overpay for it.
There is a time to so and a time to reap and a time to )ust get through ithout getting killed.
,ou must have multiple models and run your reality through it. 0ocus on high returns to capital.
'enerally speaking, I am not dran to the idea of onderful opportunities here everybody is getting into everybody(s else(s
business. That looks to me as more competitive pressure.
It is very basic. *hat you are trying to do is find mis5priced bets available in the public markets. ,ou search in areas here you have
an advantage instead of a disadvantage.
Gead the "elfish 'ene. 'arret ;ardin(s Diving ithin Dimits.
*orldly *isdom by #harlie 1unger $%%75$%%2 &%
*hen you get into consumer products, you are really interested in finding out, or thinking about, hat is in the mind of ho many
people throughout the orld about a product right no555and hat is likely to be in their minds five or ten or B3 years from no.
"o it is not share of market but share of mind that counts.
If you protect your share of mind and execute, then nobody is going to catch you.
The name of the game is continuing to learn valuable lessons from success and failure.
*e learned that it made great sense to figure out hat pond to )ump into and hat pond to stay out of.
"ome businesses are inner take all but not soft drinks.
The problem is that most companies that repurchase shares are in so5so businesses. And the repurchases are being done for
motivations other than intensifying the interests of the shareholders in a onderful business.
"tudy the lesson of #oke.
Gead= 8nly the 9aranoid "urvivehich describes strategic inflection points.
$I% %ecem7er IB, ;<<; Wesco Annual Meeting
Buying a onderful business at a moderate price. 1unger is an astute observer of errors in human cognition and human nature
generally.
A 9ilot doesn(t take off ithout a checklist. An investor can crash ithout one, too.
;ave a list of useful models and use them in a checklist fashion.
*here can e have an insight that others don(t have+
I don(t think hyperactivity ill normally improve results. I kne a person ho only did 2 things in his lifetime. ;e started ith a
small poke, and if something asn(t a near cinch, he did not do it. It takes )udgment, a lot of discipline and an absence of
hyperactivity.
Ben 0ranklin(s Dife is a great example.
Gead 1oody(s.
"cientific literacy is terribly importantespecially outside of science.
9eople calculate too muchand they think too little.
*orldly *isdom by #harlie 1unger $%%75$%%2 73