# Poor Charlie's Almanack

**Author:** Charlie Munger / Peter Kaufman (ed.)
**Year:** 2005
**Pages:** 425

> Full text extracted from PDF for on-demand reference. Use grep/search to locate concepts.


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For Charles T. Munger,
who, in his own words, would tell you:
“Acquire worldly wisdom and adjust your behavior accordingly.
If your new behavior gives you a little temporary unpopularity with your
peer group … then to hell with them.”

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Experience Poor Charlie’s Almanack online at stripe.press/poor-
charlies-almanack

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© 2023 PCA Publications LLC
First edition published 2005 by The Donning Company Publishers
Fourth abridged edition 2023
Illustrations © Ed Wexler
Published in the United States of America by Stripe Press / Stripe Matter Inc.
Stripe Press
Ideas for progress
South San Francisco, California
press.stripe.com
Printed by Hemlock in Canada
ISBN 978-1-953953-23-0 (hardcover)
ISBN 978-1-953953-24-7 (ebook)
Library of Congress Control Number: 2023936297
Ebook by Legible Publishing Services
Also available in audiobook.

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TABLE OF CONTENTS
Foreword
by John B. Collison
Foreword
by Warren E. Buffett
Rebuttal
by Charles T. Munger
Introduction
by Peter D. Kaufman
Chapter 1
A Portrait of Charles T. Munger
Chapter 2
Remembering: The Children on Charlie
Chapter 3
The Munger Approach to Life, Learning, and Decision-Making
Chapter 4
Eleven Talks
Talk One
Harvard School Commencement Speech
Talk One Revisited

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Talk Two
A Lesson on Elementary, Worldly Wisdom as It Relates to
Investment Management and Business
Talk Two Revisited
Worldly Wisdom, Updated: Q & A with Charlie
Talk Three
A Lesson on Elementary, Worldly Wisdom as It Relates to
Investment Management and Business Revisited
Talk Three Revisited
Talk Four
Practical Thought about Practical Thought?
Talk Four Revisited
Talk Five
The Need for More Multi disciplinary Skills from Educational
Profes sionals: Implications
Talk Five Revisited
Talk Six
Investment Practices of Leading Charitable Foundations
Talk Six Revisited
Talk Seven
Breakfast Meeting of the Philanthropy Roundtable
Talk Seven Revisited

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Talk Eight
The Great Financial Scandal of 2003
Talk Eight Revisited
Talk Nine
Academic Economics: Strengths and Faults after Considering
Interdisciplinary Needs
Talk Nine Revisited
Talk Ten
USC Gould School of Law Commencement Address
Talk Eleven
The Psychology of Human Misjudgment
Talk Eleven Revisited
Appendix
Endnotes
Recommended Reading
Acknowledgments

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FOREWORD
COLLISON ON MUNGER
by John B. Collison
Dublin
April 2023
I ﬁrst came across Poor Charlie’s Almanack in my 20s, when I was
trying to learn everything I could about what made successful
businesses tick. As I leafed through its oversize pages, I found it
to be a refreshing rebuttal of conventional ﬁnancial wisdom,
delivered with unusual simplicity and candor. Never before had I
heard a venerated business person express such trenchant
insights about investing, ﬁnance, and the world more broadly,
and with such—to use a favored Munger phrase—chutzpah. One
can’t help but read a line like “Without numerical ﬂuency … you
are like a one-legged man in an ass-kicking contest” and come
away not only chuckling but also a little bit wiser.
Years after that ﬁrst encounter with “Poor Charlie,” I had the
privilege of meeting Charlie at his home in Los Angeles. I was
delighted to ﬁnd that he is just as engaging and intellectually
curious in person as he is on the page. (He also, I discovered, has
considerably more sta mina than I do—more than four hours into
our dinner, I was ready for bed while Charlie showed no signs of
ﬂagging.) Our conversation that night was wide-ranging,
touching on everything from the economics of ski resorts to
raising children to the evolution of the news industry.
Witnessing Charlie’s prodigious intellectual breadth and

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multidisciplinary mode of reasoning ﬁrsthand only reinforced
my admiration both for the man himself and for this book.
Poor Charlie’s Almanack is a testament to the power of thinking
across disciplines. It’s not just a book about investing; it’s a guide
to learning how to think for yourself to understand the world
around you. Charlie’s philosophy combines insights from nearly
every discipline in which he’s ever taken even a passing interest
—not only business and ﬁnance but also mathematics, physics,
history, ethics, and more—delivered with a characteristic
irreverence that has persisted for 99 years (and counting). His
essays extol the virtues of free enterprise, yes, but also of doing
business the right way, with integrity and rigor. Of taking your
work very seriously, but never yourself.
While the world looks very different today than it did nearly
100 years ago, when Charlie was born in Omaha, Nebraska—
arriving before the Great Depression, between two world wars,
and just two years after the establishment of the Irish Free State
—Charlie has remained a constant. His insatiable appetite for
learning; his uncanny ability to evaluate businesses using simple
frameworks that produce more reliable analysis than complex
ﬁnancial statements; and his partnership with the Buffett family
—which started humbly when a teenage Charlie took a job in
Warren’s grandfather’s grocery store and culminated in the one
of the most successful investing relationships of all time—have
persisted for decades, through boom times and bust. So, too,
have many of the esteemed businesses in which Charlie and
Warren invested their dollars and their conﬁdence.
Although Charlie didn’t invent the concept of compounding
growth, his success, and that of Berkshire Hathaway, is a
testament to its existence. The practical wisdom of Poor Charlie’s
Almanack, this ode to curiosity, generosity, and virtue, will
similarly compound, as successive generations of

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entrepreneurial readers extend his lessons to their own
circumstances.
Whether you are a seasoned investor or an enthusiastic new -
comer, whether you run a business or are seeking to improve
your decision-making skills in everyday life, I encourage you to
read Charlie’s speeches and essays with an open, curious mind.
You will be rewarded with insights that stay with you for a
lifetime. As Charlie once said, “There is no better teacher than
history in determining the future. There are answers worth
billions of dollars in a $30 history book.” The same might be said
of Poor Charlie’s Almanack. It is the ultimate value investment.
I am immensely grateful to Peter Kaufman for compiling this
classic tome, and to Charlie Munger for his irrefutable wisdom
and his gracious mentorship. Nothing further to add.

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FOREWORD
BUFFETT ON MUNGER
by Warren E. Buffett
From 1733 to 1758, Ben Franklin dispensed useful and timeless
advice through Poor Richard’s Almanack. Among the virtues
extolled were thrift, duty, hard work, and simplicity.
Subsequently, two centuries went by during which Ben’s
thoughts on these subjects were regarded as the last word. Then
Charlie Munger stepped forth.
Initially a mere disciple of Ben’s, Charlie was soon breaking
new ground. What Ben had recommended, Charlie demanded. If
Ben suggested saving pennies, Charlie raised the stakes. If Ben
said be prompt, Charlie said be early. Life under Ben’s rules
began to look positively cushy compared with the rigor
demanded by Munger.
Moreover, Charlie consistently practiced what he preached
(and oh, how he preached). Ben, in his will, created two small
philanthropic funds that were designed to teach the magic of
compound interest. Early on, Charlie decided that this was a
subject far too important to be taught through some posthumous
project. Instead, he opted to become a living lesson in
compounding, eschewing frivolous (deﬁned as “any”)
expenditures that might sap the power of his example.
Consequently, the members of Charlie’s family learned the joys
of extended bus trips while their wealthy friends, imprisoned in
private jets, missed these enriching experiences.
In certain areas, however, Charlie has not sought to improve
on Ben’s thinking. For example, Ben’s “Advice on the Choice of a

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Mistress” essay has left Charlie in the “I have nothing to add”
mode that is his trademark at Berkshire annual meetings.
As for myself, I’d like to offer some “Advice on the Choice of a
Partner.” Pay attention.
Look ﬁrst for someone both smarter and wiser than you are.
After locating him (or her), ask him not to ﬂaunt his superiority
so that you may enjoy acclaim for the many accomplishments
that sprang from his thoughts and advice. Seek a partner who
will never second-guess you nor sulk when you make expensive
mistakes. Look also for a generous soul who will put up his own
money and work for peanuts. Finally, join with someone who will
constantly add to the fun as you travel a long road together.
All of the above is splendid advice. (I’ve never scored less than
an A in self-graded exams.) In fact, it’s so splendid that I set out
in 1959 to follow it slavishly. And there was only one partner who
ﬁt my bill of particulars in every way—Charlie.
In Ben’s famous essay, he says that only an older mistress
makes sense, and he goes on to give eight very good reasons as
to why this is so. His clincher: “… and, lastly, they are so grateful.”
Charlie and I have now been partners for 45 years. I’m not
sure whether he had seven other reasons for selecting me. But I
deﬁnitely meet Ben’s eighth criterion. I couldn’t be more
grateful.

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REBUTTAL
MUNGER ON BUFFETT
by Charles T. Munger
I think there’s some mythology in the idea that I’ve been this
great enlightener of Warren. He hasn’t needed much
enlightenment. I frankly think I get more credit than I deserve. It
is true that Warren had a touch of brain block from working
under Ben Graham and making a ton of money. It’s hard to
switch from something that’s worked so well. But if Charlie
Munger had never lived, the Buffett record would still be pretty
much what it is.
It’s hard to believe that he’s getting better with each passing
year. It won’t go on forever, but Warren is actually improving. It’s
remarkable: Most men in their 70s are not improving, but
Warren is. Berkshire is drowning in money—we have great
businesses pounding out money. When Warren is gone, the
acquisition side of Berkshire will not do as well, but the rest will
do well. And the acquisition side will do just ﬁne.
I think the top guy won’t be as smart as Warren. But it’s silly to
complain, “What kind of world is this that gives me Warren
Buffett for 40 years, and then some bastard comes along who’s
worse?”

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INTRODUCTION
by Peter D. Kaufman
You are about to embark on an extraordinary journey toward
better investing and decision-making. You may arrive at a better
understanding of life as well, all thanks to the wit, wisdom,
speeches, and writings of Charlie Munger—this generation’s
answer to Benjamin Franklin. Charlie’s unique worldview, what
he calls his multi disciplinary approach, is a self-developed
model for clear and simple thinking—yet his concepts and
models are anything but simplistic. Notice how well Charlie’s
thinking stands the test of time: The earliest talk in this
collection is almost 20 years old, yet it is as relevant today as the
day he ﬁrst delivered it. As you will soon discover, Charlie’s
observations and conclusions are based on fundamental human
nature, basic truths, and core principles from a wide range of
disciplines.
Throughout the book, Charlie reveals his intellect, wit, values,
and no end of rhetorical ﬂair. His encyclopedic knowledge allows
him to cite references from classical orators to 18th- and 19th-
century European literati to pop culture icons of the moment.
Where else would you ﬁnd Demosthenes and Cicero juxtaposed
against Johnny Carson, or today’s investment managers set
against Nietzsche, Galileo, and a “one-legged man in an ass-
kicking contest”? Or how about Ben Franklin versus Bernie
Cornfeld in a battle of worldly wisdom? Using self-deprecation
and imagination to great effect, Charlie cheerfully compares
himself to a counting horse, proposes “Glotz’s Sugared,

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Caffeinated Water” as a marketing-bereft label for Coca-Cola,
and attests, “At least when I was young, I wasn’t a total klutz.”
In one talk (“Practical Thought about Practical Thought?”),
Charlie even takes on the challenge of building, from scratch, a
$2 trillion business, and then walks us through his diverse
mental models to accomplish that mighty feat.
The quotes, talks, and speeches presented here are rooted in
the old-fashioned Midwestern values for which Charlie has
become known: lifelong learning, intellectual curiosity, sobriety,
avoidance of envy and resentment, reliability, learning from the
mistakes of others, perseverance, objectivity, willingness to test
one’s own beliefs, and many more. But his advice comes not in
the form of stentorian admonishments; instead, Charlie uses
humor, inversions (following the directive of the great algebraist
[Carl] Jacobi to “invert, always invert”), and paradox to provide
sage counsel about life’s toughest challenges.
Charlie also employs historical and business case studies to
great effect. In these presentations, he makes his points with
subtlety and texture, often using a story-like context instead of
abstract statements of theory. He regales his audience with
humorous anecdotes and poignant tales rather than with a
blizzard of facts and ﬁgures. He well knows, and wisely exploits,
the traditional role of the storyteller as a purveyor of complex
and detailed information. As a result, his lessons hang together
in a coherent latticework of knowledge, available for recall and
use when needed.
It is clear throughout these talks and speeches that Charlie
places a premium on life decisions over investment decisions.
His mental models, drawn from every discipline imaginable,
recur repeatedly, and in no way focus on “business portfolio
strategy” or “beta” or “CAPM.” Rather, they center on
fundamental truth, human accomplishment, human foibles, and
the arduous path to wisdom. Charlie once said, “I wanted to get

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rich so I could be independent, like Lord John Maynard Keynes.”
Independence is the end that wealth serves for Charlie, not the
other way around.
ABOUT THE BOOK
We open with a portrait biography that chronicles Charlie’s
progress from a modest Omaha childhood to prodigious
ﬁnancial success. Next, we summarize the Munger approach to
life, learning, decision-making, and investing. This section
details both Charlie’s unconventional way of thinking and his
extraordinary work ethic—the twin fonts of his amazing success.
In the balance of the book, Charlie speaks to his audience via
speeches and talks he gave over a 20-year period. In the
expanded third edition of the book, we added a new talk Charlie
delivered at the USC Gould School of Law Commencement on
May 13, 2007. So the original Ten Talks have grown to become a
not-so-round Eleven Talks. These speeches and addresses cover
a wide spectrum of Charlie’s interests, ranging from how one
acquires worldly wisdom to how his multiple mental models can
be applied to business to how the investment strategies used by
charitable foundations can be improved. The 11th talk is a
special rendition of “The Psychology of Human Misjudgment”
that Charlie created especially for this book.
Each talk is well worth your time not only for the enjoyment it
will provide you but also for what you can absorb from the rich
assortment of ideas and practices that Charlie relies on. You will
probably never ﬁnd a better opportunity to learn from someone
so smart—and so forthright. In his talks, Charlie simply opens up
and tells it like it is. A special note: Charlie’s redundancy in
expressions and examples is purposeful; for the kind of deep

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“ﬂuency” he advocates, he knows that repetition is the heart of
instruction.
A word about the style and layout of the book: Charlie is
enormously curious about nearly everything he bumps into in
life. Accordingly, as we ourselves bumped into people, places,
and subjects mentioned by Charlie in his talks, we supplemented
his text with related information. The endnotes peppered
throughout the talks serve to explain concepts, add a supporting
voice, or emphasize an important Munger idea. We hope these
will not only inform but also amuse and even encourage you to
further pursue these subjects on your own.
I wish you good reading and an appreciation of the brightness
and dry humor that those of us who know Charlie Munger have
come to treasure and expect from him.

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CHAPTER 1
stripe.press/pca-1
A Portrait of Charles T. Munger
BY MICHAEL BROGGIE
Behind the extraordinary story of Berkshire Hathaway are two
ﬁnancial geniuses: the widely acclaimed Warren Buffett and his
“silent partner,” Charlie Munger, who relishes his obscurity.
Charlie is Warren’s friend, lawyer, adviser, devil’s advocate
(Warren once called him the “abominable no-man”), and one of
the largest stockholders in one of the most successful publicly
traded companies in American business history. Since 1964,
when Warren—and, some years later, Charlie—assumed
management of Berkshire, its market value has increased an
astonishing 13,500 times, from $10 million to roughly $135
billion, without much of an increase in outstanding shares. Such
phenomenal growth is the singular achievement of these two
unassuming Midwesterners, who combine their synergistic
abilities to recognize and seize opportunities other businessmen
consistently overlook.
While Warren is one of the most admired and publicized
business leaders in the country, Charlie has purposefully
sidestepped the limelight, choosing relative anonymity instead.
To better understand this complex and highly private
businessman, we must start at the beginning. Charles Thomas
Munger was born on January 1, 1924, in America’s heartland,

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Omaha, Nebraska. Many notables share his Midwestern roots:
Will Rogers, Henry Fonda, John Pershing, Harry Truman, Walt
Disney, Ann Landers, Gerald Ford—and, of course, Warren
Buffett.
Charlie initially crossed paths with the Buffett family during
the formative years of his life when he worked at Buffett & Son,
an upscale grocery store in Omaha, about six blocks from the
Munger household. The boss and part owner was Warren’s
grandfather, Ernest. A strict disciplinarian, he scheduled his
young workers for 12-hour shifts with no meals or breaks.
According to Charlie, his boss’s staunch anti-socialist attitude
was manifested in his rule requiring the boys to present two
pennies at the end of their shifts to cover their share of the cost
of the new Social Security Act. In return, they received a $2 daily
wage—along with a considerable lecture about the evils of
socialism.
The arduous working conditions in the Buffett grocery store
had a lasting inﬂuence on both Charlie and Warren. Warren, six
years younger, served his hard times under Grandpa Ernest
several years after his future business partner had moved on.
Charlie’s formal education began at Dundee Elementary
School, where he and his younger sisters, Mary and Carol, were
indoctrinated with ethical homilies. Charlie’s teachers
remember a smart kid who was also inclined to be a bit of a
wiseacre. He enjoyed challenging the conventional wisdom of
teachers and fellow students with his ever-increasing knowledge
gained through voracious reading, particularly biographies.
Today, he can’t remember the ﬁrst time he was exposed to the
aphorisms of Ben Franklin, but they fueled an ineffaceable
admiration for the eclectic and eccentric statesman and
inventor. Charlie’s parents, Al and Florence Munger, encouraged
reading and gave each of their children several books at
Christmas, usually devoured by that night.

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At the nearby home of the Mungers’ close friends, the Davises,
Charlie often read the medical journals belonging to Dr. Ed Davis,
who was both his father’s best friend and a family physician.
Charlie’s early exposure to Dr. Davis’s medical library spawned a
lifelong interest in science. By the time he was 14, the precocious
learner had also become one of the doctor’s best friends. Charlie
became so interested in medicine that he watched motion
pictures of Dr. Davis, a urologist, performing surgery and
became fascinated with the statistical outcomes of similar
procedures in the ﬁeld.
At home, Charlie developed a fondness for raising hamsters
and periodically traded them with other children. Even at an
early age, Charlie showed a sagacious negotiating ability and
usually gained a bigger specimen or one with unusual coloring.
When his brood grew to 35 animals, his mother ordered an end
to his hobby because of the pungent odor from his basement
hamster farm. One of his sisters remembered years later that the
family had to endure the incessant squeaking of hungry
hamsters until Charlie arrived home from school to feed them.
Charlie attended Central High School, a very large public
school that was recognized as a good college preparatory school.
The teachers, mostly women, were dedicated to their work and to
their students. The Central High curriculum provided a
conventional classic education, in which Charlie naturally
excelled because of his logically driven, inquiring mind.
Throughout elementary and secondary school, Charlie was
younger and smaller than his classmates, having been moved
ahead in elementary school after his mother taught him to read
phonically. Too small to compete in regular high school sports,
he joined the riﬂe team, earned a varsity letter, and eventually
became team captain. His letterman’s sweater (“a large letter on
a very small chest” is Charlie’s memory) attracted attention from
coeds who wondered how such a scrawny kid could earn a

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varsity letter. Fortunately for Charlie, his father was an avid
outdoorsman and duck hunter and took joy in his son’s
marksmanship.
Omaha in the 1920s was the proverbial melting pot; different
races and religions mixed socially and commercially, and crime
was practically unknown. Doors and vehicles were left unlocked,
and a person’s word was trusted implicitly. Kids played kick the
can on warm summer evenings and went to Saturday matinees
to see the latest talkies, such as King Kong, a favorite of 8-year-old
Charlie.
The 1930s brought hard times, and Omaha experienced the
severity of the Great Depression. Charlie’s observations of the
plight of those less fortunate made a lasting impression. He saw
hobos roaming the streets looking for handouts and others who
were willing to sweep a driveway or porch in exchange for a
sandwich. Thanks to family connections, Charlie landed a boring
job counting passersby; it paid 40¢ an hour. Charlie preferred
this work to carrying heavy boxes of groceries.
Charlie’s grandfather was a respected federal judge, and his
father followed in his footsteps to become a prosperous lawyer.
Charlie’s immediate family was not dramatically affected by the
Depression, but some members of Charlie’s extended family
were. This era provided real learning experiences for young
Charlie. He witnessed the generosity and business acumen of his
grandfather as he helped rescue a small bank in Stromsburg,
Nebraska, that was owned by Charlie’s uncle Tom. Because of the
miserable economy and drought-damaged crops, the bank’s
farm-based clients were defaulting on loans. Tom had rolled up
$35,000 in uncollectible notes when he called upon Grandpa
Munger for support. The judge risked nearly half of his assets by
exchanging $35,000 in sound ﬁrst mortgages for the bank’s weak
loans, thus enabling Tom to open his doors after Roosevelt’s

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bank holiday. The judge eventually recovered most of his
investment, but not until a great many years later.
Judge Munger also sent his daughter’s husband, a musician,
to pharmacy school and helped him buy a well-located
pharmacy that had closed because of the Depression. The
business prospered and secured the future for Charlie’s aunt.
Charlie learned that by supporting each other, the Mungers
weathered the worst economic collapse in the nation’s history.
Fortunately, Al Munger’s law practice prospered during the
Depression and was given a boost when the United States
Supreme Court agreed to review a tax case involving a small
soap-making company he represented. Coincidently, the huge
Colgate-Palmolive Company was also affected by the court’s
decision. Concerned that the Midwestern attorney didn’t have
the requisite experience to argue successfully before the highest
court, Colgate offered to pay Al liberally to step aside and allow a
famous New York attorney to take his place. The big-city lawyer
lost the case while Al pocketed a substantial fee. Later, Al joked
that he could have lost the case just as well for a much smaller
fee. The amount of the fee has never been revealed, but it was
enough, when combined with income Al earned from his other
clients, to help keep the Mungers comfortable during the
Depression. Charlie also helped the family by working to earn his
own spending money and thus learned ﬁrsthand the value of
ﬁnancial independence.
In 1941, as the war raged across the Atlantic, Charlie
graduated from Central High School and left Omaha for the
University of Michigan. There he chose mathematics as his
major, drawn by the appeal of numerical logic and reason. He
also discovered physics after enrolling in a basic course to fulﬁll
an academic requirement for science. Charlie was fascinated by
the power of physics and its boundless reach. In particular, he
was impressed by the process followed by physicists such as

## Page 27

Albert Einstein to address the unknown. Physics-like problem-
solving was to become a passion for Charlie and is a skill he
considers helpful in framing the problems of life. He has often
stated that anyone who wants to be successful should study
physics because its concepts and formulas so beautifully
demonstrate the powers of sound theory.
College-aged men were then in high demand for military
service. Days after turning 19 and completing his second year at
Michigan, Charlie enlisted in the Army Air Corps in a program
that would eventually make him a second lieutenant. He was
sent to the Albuquerque campus of the University of New Mexico
for studies in general science and engineering. Next, he was
shufﬂed to the prestigious California Institute of Technology in
Pasadena, California. He was schooled in thermodynamics and
the science of meteorology—then essential to ﬂyers—and trained
to become a meteorologist. After completing his studies at
Caltech, Charlie was dispatched to a permanent duty station in
Nome, Alaska.
While still in the service, he married Nancy Huggins, a young
woman from Pasadena who was a good friend of his sister Mary
at Scripps College. They were stationed in Albuquerque and then
San Antonio until Charlie was discharged from the Army Air
Corps in 1946. Soon Charlie and Nancy had their ﬁrst child, a
boy whom they named Teddy.
Although he had attended several universities, Charlie still
did not have a bachelor’s degree. Nevertheless, using the GI Bill,
he applied to Harvard Law School, where his father had
preceded him. His lack of an undergraduate degree threatened
to derail him, but a family friend, former Harvard Law School
dean Roscoe Pound, interceded on Charlie’s behalf. Charlie was
admitted, despite the determination of the admissions ofﬁce to
ﬁrst send him back to college.

## Page 28

As it turned out, Charlie had little trouble succeeding at
Harvard, though he annoyed a few people along the way. Because
of his intellect (the Army measured his IQ at the top of the curve),
Charlie had a tendency to be abrupt, which was often interpreted
as rudeness. Actually, Charlie was just in a hurry, and the
customary pleasantries of the classroom were of little concern to
him. Even so, he was liked by most of his peers and fully enjoyed
the social aspects of student life in Cambridge.
Charlie graduated from Harvard Law School in 1948 and was
one of 12 in his class of 335 to graduate magna cum laude. He
considered joining his father’s law practice, but after a
discussion with his father, both of them concluded that Charlie
should try a larger city. He headed off to Southern California, a
place he had liked while a student at Caltech. After passing the
California bar exam, he joined the ﬁrm of Wright & Garrett, later
renamed Musick, Peeler & Garrett. Charlie built a house,
designed by his architect uncle, Frederick Stott, in South
Pasadena, where he and Nancy and their three children, Teddy,
Molly, and Wendy, lived.
Despite outward appearances, all was not sunny in Charlie’s
world. His marriage was in trouble, and he and his wife ﬁnally
divorced in 1953. Not long thereafter, Charlie learned that his
adored son, Teddy, was terminally ill with leukemia. It was a
signiﬁcant burden for 29-year-old Charlie. In that era, before
bone marrow transplants, there was no hope. A friend
remembers that Charlie would visit his dying son in the hospital
and then walk the streets of Pasadena crying.
During this sad time, his friend and law partner, Roy Tolles,
arranged through a friend for Charlie to meet Nancy Barry
Borthwick, who lived in Los Angeles. She was a Stanford
graduate and had two small boys, close to the ages of his girls.
Charlie and Nancy had much in common and had fun together,
and after a few months of dating became engaged. They were

## Page 29

married in a small family wedding in January 1956, and all four
children—his girls and her boys, aged 4 to 7—attended the
wedding.
Charlie and Nancy lived in her house in the hills of West Los
Angeles for several years. Then, partly to shorten Charlie’s daily
commute, they moved to Hancock Park, where they still reside.
The house they built there was large enough for their ever-
expanding family: three more boys and a girl, for a total of eight.
Fortunately, both liked children! They also liked golf, the beach,
and social clubs. Charlie and Nancy were soon members of the
University Club, the California Club, the Los Angeles Country
Club, and the Beach Club.
With many new responsibilities, Charlie worked hard at his
law practice. Even so, his earnings were unsatisfactory to him as
they were based on a combination of billable hours and seniority.
He wanted more than what a senior law partner would be able to
earn. He sought to be like his ﬁrm’s leading capitalist clients, in
particular the universally admired Harvey Mudd, later the
founder of the college bearing his name. With Nancy’s support,
he turned to outside ventures and alternative ways to generate
income. However, he never forgot the sound principles taught by
his grandfather: to concentrate on the task immediately in front
of him and to control spending.
Following this conservative approach, Charlie seized
opportunities to build wealth. He began investing in stocks and
acquired equity in one of his clients’ electronics businesses, a
practice common among lawyers in the mid-1950s and 1960s.
This investment was mutually beneﬁcial: Charlie gained
invaluable knowledge about business, while his client enjoyed
the proactive attention of a lawyer who knew more than just the
law.
In 1961, Charlie tackled property development for the ﬁrst
time, in partnership with Otis Booth, a client and friend. The

## Page 30

venture, building condominiums on land near Caltech, was a
smashing success, and the partners earned a handsome proﬁt of
$300,000 on a $100,000 investment. Charlie and Otis then
undertook other successful construction and development
projects in Pasadena. Later, Charlie participated in similar
projects in Alhambra, California. He sharpened his business
acumen by handling the negotiations and contracts. In all cases,
he left all of his proﬁts in real estate ventures so that bigger and
bigger projects became possible. When he stopped in 1964, he
had a nest egg of $1.4 million from real estate projects alone.
In February 1962, he joined four colleagues from Musick,
Peeler & Garrett in establishing a new law ﬁrm. The original
partners were Roy Tolles, Rod Hills, Dick Esbenshade, Fred
Warder, and Charlie. They were joined by Rod’s wife, Carla, and
James T. Wood, a sole practitioner and friend of the Hills. They
named the ﬁrm Munger, Tolles & Hills. Over the years, the ﬁrm
had several names, always beginning with Munger, Tolles. With
the addition of Ron Olson, it ﬁnally became Munger, Tolles &
Olson, shortened as Munger, Tolles or MTO.
The successful practice of law was by then a backstop rather
than an ending objective for Charlie. At about the time that he
was launching his new law ﬁrm, he was carefully crafting his exit
plan. Charlie set up an investment partnership with Jack
Wheeler, and they were later joined by Al Marshall. The idea for
this partnership arose a few years earlier when the death of
Charlie’s father required him to return to Omaha to administer
the estate. To welcome him home, the children of Charlie’s friend
and medical mentor, Dr. Ed Davis, arranged for a dinner party.
Both of the Davis boys, Eddie Jr. and Neil, were former childhood
chums of Charlie and were now physicians, while their sister
Willa had married an Omaha businessman, Lee Seemann. The
dinner party included Willa and Lee, Neil and his wife Joan, and
a fellow named Warren Buffett.

## Page 31

Charlie recognized Warren’s family name from his days at
Buffett & Son, and Warren had heard of Charlie a few years
earlier when he was raising investment capital in Omaha. At one
point, Warren had met with Dr. Davis and his wife, Dorothy, to
explain his investment philosophy, and they agreed to place a
large part of their life savings—$100,000—with him. Why? The
doctor explained that Warren reminded him of Charlie Munger.
Warren didn’t know Charlie but already had at least one good
reason to like him.
During the homecoming dinner, Charlie and Warren realized
they shared many ideas. It also became evident to the others at
the table that this was going to be a two-way conversation. As the
evening progressed, the two young men—Warren was 29 and
Charlie 35—became engrossed in a wide-ranging dialogue
covering many aspects of business, ﬁnance, and history. Where
one was knowledgeable, the other was just as excited to learn.
Warren was unenthusiastic about Charlie’s continued
practice of law. He said that while law might be a good hobby for
Charlie, it was a far less promising business than what Warren
was doing. Warren’s logic helped Charlie to decide to quit law
practice at the earliest point he could afford to do so.
When Charlie returned to Los Angeles, the conversations
continued via telephone and lengthy letters, sometimes as long
as nine pages. It was evident to both that they were meant to be
in business together. There was no formal partnership or
contractual relationship—the bond was created by a handshake
and backed by two Midwesterners who understood and
respected the value of one’s word.
There were many beneﬁts to their partnership: friendship,
investment opportunities, and the unique ability to grasp each
other’s ideas and observations. Later, the two organizations they
headed were also beneﬁciaries. As Warren was investing in and
acquiring companies, he sent business to Munger, Tolles, a

## Page 32

practice that allowed him over time to beneﬁt from having one of
the nation’s top law ﬁrms at his disposal. Munger, Tolles,
meanwhile, not only got Buffett’s legal fees but also gained
because his reputation attracted other blue-chip clients to the
ﬁrm.
Munger, Tolles is not just about money, though. Mirroring the
way Charlie conducts his personal life, the ﬁrm has an enviable
record of quietly providing pro bono assistance to support
groups for impoverished and disadvantaged people in the Los
Angeles community. To this day, Charlie continues to inﬂuence
the ﬁrm’s attorneys, reminding them, “You don’t need to take the
last dollar” and “Choose clients as you would friends.” Though
Charlie left the ﬁrm as an active partner in 1965 after only three
years, his indelible inﬂuence remains, as indicated by the fact
that his name still heads the listing of 175 attorneys. When he
left, he didn’t take his share of the ﬁrm’s capital. Instead, he
directed that his share go to the estate of his young partner, Fred
Warder, who left behind a wife and children when he died of
cancer.
Charlie’s plan for ﬁnancial independence was soon working
with great success. He spent much time building the asset base
of Wheeler, Munger & Co., his investment partnership with Jack
Wheeler. He also spent time working on various real estate
developments. All was going as planned, with no signiﬁcant
reverses. At Wheeler, Munger & Co., Charlie was investing in
stocks partly with his own money and partly with other people’s
money. Charlie concentrated more on putting his capital to work
than attracting new clients. Because Jack Wheeler held two seats
on the Paciﬁc Coast Stock Exchange, the partnership paid low
trading commissions while Wheeler, Munger kept the overhead
cost at close to zero.
As time passed, Charlie and Warren kept up their frequent
telephone conversations and letters, sharing ideas and

## Page 33

investment concepts. Sometimes they would agree to invest in
the same company. Other times they went in different directions.
In time, their independent portfolios had overlapping
investments. Warren invested in the Blue Chip Stamp Co. and
became the largest single shareholder. Charlie became the
second-largest shareholder, and, eventually, Berkshire Hathaway
ended up acquiring the company.
Charlie built the Wheeler, Munger partnership from 1962
through 1975. It did exceptionally well for the ﬁrst 11 years,
compounding at 28.3 percent gross (20 percent net) versus 6.7
percent for the Dow, without a single down year. But the
partnership was hit hard in the vicious bear market of 1973 and
1974 when it fell 31.9 percent and 31.5 percent in back-to-back
years, as the partnership’s largest holdings, Blue Chip Stamps
and New America Fund, fell sharply. This decline was despite, as
Charlie puts it, “having its major investments virtually sure of
eventually being saleable at prices higher than the quoted
market prices.” But the partnership rebounded strongly in 1975,
rising 73.2 percent, bringing the overall record over 14 years to
19.8 percent (13.7 percent net) compounded annual returns
versus 5 percent for the Dow.
After this difﬁcult experience, Charlie followed Warren in
concluding that he no longer wanted to manage funds directly
for investors. (Warren had closed his own partnerships in 1969.)
Instead, they resolved to build equity through stock ownership in
a holding company. When Wheeler, Munger was liquidated, its
stakeholders received shares in Blue Chip Stamps and
Diversiﬁed Retailing. Later, these shares were converted into
Berkshire Hathaway stock, which ended 1975 at $38. Today,
each share is worth more than $85,000, making Charlie a
member of the Forbes list of the 400 wealthiest individuals. While
he doesn’t mind the wealth, he regrets having his name on any

## Page 34

such list. Despite his healthy self-image, Charlie would prefer to
be anonymous.
The story of Berkshire Hathaway’s extraordinary success
under Warren and Charlie’s leadership has been told many times
elsewhere, so the details won’t be repeated here. To summarize,
however, they have a spectacular track record of identifying
undervalued companies and then either buying large stakes in
the public markets or acquiring them outright. Regarding the
latter, they have acquired a diverse assortment of businesses
such as Johns Manville, The Buffalo Evening News, FlightSafety
International, NetJets, Shaw Carpet, Benjamin Moore, GEICO,
and Dairy Queen. In addition, they have purchased meaningful
stakes in public companies such as The Washington Post, Coca-
Cola, Gillette, and American Express. For the most part, they
have held their major investments for the long term—in fact, they
still own almost every business they’ve ever acquired outright.
Charlie’s afﬁnity for Benjamin Franklin’s expansive career in
government, business, ﬁnance, and industry can be found in his
many speeches and whenever he holds an audience, large or
small. At the 75th anniversary of See’s Candies, Charlie said:
I am a biography nut myself. And I think when you’re
trying to teach the great concepts that work, it helps to tie
them into the lives and personalities of the people who
developed them. I think you learn economics better if you
make Adam Smith your friend. That sounds funny, making
friends among the “eminent dead,” but if you go through
life making friends with the eminent dead who had the
right ideas, I think it will work better for you in life and
work better in education. It’s way better than just giving
the basic concepts.

## Page 35

Franklin used his self-made wealth to achieve ﬁnancial
independence so he could concentrate on societal improvement.
Charlie admires that trait in his mentor and strives to emulate
Franklin. He has had a long involvement with Good Samaritan
Hospital and Harvard-Westlake School, both in Los Angeles, and
has chaired the boards of each. He and Nancy have also long
supported Stanford University and the Huntington Library, Art
Collections, and Botanical Gardens in San Marino, California.
They provided funding for a major expansion to the Huntington
called the Munger Research Center. Although Charlie is a self-
described conservative Republican, chief among his causes is
Planned Parenthood. He believes that every child deserves to be
born to a welcoming mother. He also supports efforts to improve
the environment and the quality of education. As the father of 8
and grandfather of 16, Charlie regards his legacy as helping
future generations inherit a better world.

## Page 36

CHAPTER 2
stripe.press/pca-2
Remembering: The Children onCharlie
FROM CHARLES T. MUNGER JR.
On the last day of a family ski vacation in Sun Valley when I was
15 or so, my dad and I were driving back in the snow when he
took a 10-minute detour to gas the red Jeep we were driving. He
was pressed for time to have our family catch the plane home, so
I was surprised to notice as he pulled into the station that the
tank was still half full. I asked my dad why we had stopped when
we had plenty of gas, and he admonished me, “Charlie, when you
borrow a man’s car, you always return it with a full tank of gas.”
My freshman year at Stanford, an acquaintance lent me his
car, more because friends we had in common twisted his arm
than because he knew me all that well. The tank was half full,
and the Audi Fox was red. So I remembered the Jeep and topped
up the tank before I brought the car back. He noticed. We’ve had
a lot of good times since, and he stood as a groomsman at my
wedding.
After Stanford, I learned that on that vacation we had been
staying at Rick Guerin’s house and driving Rick Guerin’s Jeep.
Rick is one of my dad’s friends who, on his return to Sun Valley,
certainly wouldn’t have been troubled, and was unlikely even to
notice, if his Jeep had had less gas than when he left it. My dad

## Page 37

still didn’t skip a point of fairness and consideration. So I was
taught that day not only how to get a good friend but also how to
keep one.
FROM WENDY MUNGER
My dad often used the forum of the family dinner table to try to
educate his children. His favorite educational tools were the
Morality Tale, in which someone faced an ethical problem and
chose the correct path, and the Downward Spiral Tale, in which
someone made the wrong choice and suffered an inevitable
series of catastrophic personal and professional losses.
His specialty was the Downward Spiral Tale. He could really
warm to the topic of apocalyptic consequences. He used such
extreme and horriﬁc examples that we were often
simultaneously groaning and laughing by the time he ﬁnished.
He’s in a league of his own when it comes to describing negative
outcomes and the lessons to be learned from them.
His Morality Tales were more straightforward. I remember
the story my dad told his kids, then ranging from age 5 to 25,
about a ﬁnancial ofﬁcer at one of his companies who made a
mistake that resulted in the loss of hundreds of thousands of
dollars to the company. As soon as this ofﬁcer realized his
mistake, he went to the president of the company and told him
about it. My dad told us that the president then said, “This was a
terrible mistake, and we don’t want you ever to make another
one like it. But people make mistakes, and we can forgive that.
You did the right thing, which was to admit your mistake. If you
had tried to hide the mistake, or cover it up for even a short time,
you would be out of this company. As it is, we’d like you to stay.” I
think back on this story every time I hear of yet another

## Page 38

government ofﬁcial who chose the cover-up instead of the honest
confession after making a mistake.
I don’t know why I use the past tense in describing my dad’s
educational efforts at the dinner table. His oldest children are
heading toward their 60s, the table is now crowded with
grandchildren, and he’s still using his distinctive style of
storytelling to keep us on the side of the angels. We’re very lucky
to have him at the head of our table.
FROM WILLIAM H. (HAL) BORTHWICK
It has been a fascinating and wonderful 50 years (nearly) since
Charlie and my mother were married. There were many
opportunities that I offered Charlie for formative education. Here
are a couple:
Do the job right the ﬁrst time
This story goes back to Minnesota times. One of my jobs as a
driving-age teen was to pick up and deliver the housekeeper
from the town of Cass Lake. This wasn’t just a drive down the
street; the boat had to be driven across the lake to the marina,
where I would hop into the car to drive to town, and then the
process was reversed. Part of my job in the morning was to pick
up a newspaper while I was in town.
Well, one day a big storm blew in: rain, waves, wind, etc., big
time. With all the excitement and difﬁculty, I did get to town in
the morning and returned with the maid, but I forgot the paper.
Charlie and I had a one-second or so discussion after I answered
the question “Where’s my paper?” in the negative. “Go back and
get the paper and never forget it again!” So back I went through
the storm to get the paper, bouncing in the waves with rain

## Page 39

sheeting off the boat, thinking to myself that I wasn’t going to
allow anything like this ever to happen again.
Be responsible
Charlie’s mother drove herself from Omaha to Minnesota each
summer. When she was there, we used her car for errands. There
was but one set of keys, and while I was playing with friends in a
sailing boat on the lake, the keys fell out of my pocket into 5 feet
of murky water. I went home and confessed. Of course, in the
Great North Woods, there aren’t many locksmiths, and with
Charlie, there wasn’t patience for such stupidity. The solution,
again in about a second, was: “Go out with your friends and keep
diving till you get those keys, and don’t come home without
them.” After about two hours of diving, with the sun sinking like
a stone, the miraculous glint of metal in the weeds was before my
eyes, and I could go home.
There are a lot of these gems from Minnesota because, in
those days when Charlie worked so hard and so long, that was
the only meaningful time we spent with him. During the work
weeks, he was off before dawn and home about dinner time, and
then studied Standard & Poor’s and, later, would spend a couple
of hours on the phone with Warren.
FROM DAVID BORTHWICK
Many years ago, Father decided our Minnesota lake cabin
absolutely had to have a tennis ball practice machine for the
court that had been built a few years earlier. While he certainly
wanted the children to groove their groundstrokes, there was a
bit more to it than that. For it was Father who was out on the
court more than anyone, with the machine positioned so he
could endlessly practice-volley close by the net. Before long, he

## Page 40

mastered the well-placed easy put-away volleys, the kinds of
shots everyone else instinctively tried to kill but usually hit into
the net or 10 feet out. By working on the tennis version of golf’s
short game, which few others could be bothered to practice,
Father, as he’s done throughout his life, gave himself a fair if
maddening competitive advantage. I really dreaded playing
against him, especially in doubles, where the net play really
counts. Thank God it was tennis, not business.
Thinking about Father made me remember a long-ago
humorous TV beer ad in which a smartly dressed man at a table
is so engrossed in his glass of beer as to be oblivious to a
rampaging bull charging a bullﬁghter right in front of him. He
doesn’t ﬂinch, even when the bull smashes the table into
matchsticks. The announcer’s tagline was “Try this beer for a
truly unique experience,” or something like that.
Take away the beer and substitute the ﬁnancial market
listings, architectural plans, or a scholarly biography of Keynes
and you have a dead-on comedic take on Father night after night
in his favorite chair poring over something, all but deaf to the
roughhousing younger children, blaring TV, and Mom trying to
summon him to dinner.
Even when not reading, Father was often so deep in
contemplation that a routine drive to take Molly and Wendy back
to Pasadena could have turned into an excursion to San
Bernardino without Mom calling out the correct freeway
turnoffs. Whatever was on his mind, it wasn’t the outcome of a
football game or a botched golf shot. Father’s ability to Chinese
wall off the most intrusive distractions from whatever mental
task he was engaged in—a practice alternately amusing and
irritating if you were trying to get his attention—accounts as
much as anything else for his success.

## Page 41

FROM MOLLY MUNGER
When I went to college in 1966, I was very lucky to have been
thoroughly steeped in Daddy’s inﬂuence. In an angry and radical
era, I would buy The Wall Street Journal or Fortune at the subway
kiosk just outside the college gates, tuck it under my Oxford-
cloth arm, and stride off to economics and business classes.
People were occupying the dean’s ofﬁce, going to jail. I was in the
basement of the Lamont Library learning how to read a balance
sheet.
Daddy raised us to be skeptical, even contrarian, and that was
a particularly helpful way of thinking to carry into the maelstrom
of the late ’60s. Over many years, sitting in the library at our
house on June Street, he had told us often funny stories of people
who either followed the group too blindly or lashed out too
reﬂexively. “Crazy,” “maladjusted,” “pompous,” “self-satisﬁed”—
we knew from his adjectives what he thought we should avoid.
In Minnesota, he found a way to hard-wire the same message
into our very bodies. He had arranged for the old Larson Boat
Works to make us an “aquaplane,” a heavy wooden affair we
stood on as he towed it behind the boat. He would make sharp
turns to see if we could hold on, and the only way to avoid the
disgrace of a fall was to keep shifting our weight to compensate
for the extreme angles. Then, and on into the future, I would
always be viscerally terriﬁed if it seemed any thought or activity
was getting out of hand in one direction or another.
When I was in college, Daddy had seven other children to
raise, worked in a seedy part of Spring Street, and owned but one
company, a small, grimy outﬁt that made motor additive. But he
saw these were unhinged times. He sent me the allowance of a
much richer father, keeping me in professionally ironed shirts

## Page 42

and making me feel sharp as a bandbox. From 3,000 miles away,
he continued to help me keep my balance.
I could go on. Sufﬁce it to say that our father has always
known what he was doing, as a parent as in so much else. I
appreciated it greatly. I still do.
FROM EMILIE OGDEN
“You have your father’s hands,” my husband remarked out of the
blue, as we shared a glass of wine. I looked at him, a little
stunned, not by the comparison but by his telepathy. I had been
devising a short piece about my father, and the very subject had
been on my mind.
I had already noticed that my oldest son’s hands are like his
grandfather’s, with ﬁngertips slightly square and nail beds
shaped like teacups rather than ovals. But it’s something about
the way our hands take positions that ﬁrst sparks the
comparison. My father, my son, and I all cross our hands behind
us in the same distinct manner, the left hand holding the wrist of
the right, as we walk, minds elsewhere.
“What is it about my hands, exactly, that reminds you of my
father’s?” I asked.
“It’s in the ‘U’ where your index ﬁnger curves into your
thumb,” he said, showing me. “It’s the way you hold things there.”
My father is holding his hands out above me. His ﬁngers are
curled, and his thumbs are pointing at each other, like handles
on a bike. I reach my girl arms up straight, and I grasp each of his
thumbs as he lifts me off the ground. I hang on, delighted, until
my strength is spent. And when one child is too big for “thumbs,”
there is always another, down through the line of grandchildren.
Sometimes we’d get him to put down The Wall Street Journal
and play “sandwich.” As he sits in the green armchair in the

## Page 43

library, we pile on like the bacon, lettuce, and tomato of a BLT,
his hands squeezing us together in a multilayered hug.
My father holds a perfect chicken egg. We’ve won the father– -
daughter egg toss, earning me one of my favorite possessions: a
marble cube sprouting gilt acanthus leaves, with a life-size
golden replica of an egg on top. This trophy sits on my desk,
reminding me of the sunny day when my dad was so present and
so gentle as to keep a ﬂying egg from breaking in either of our
hands.
My father’s hands know the tensile strength of different
ﬁshing lines by feel. They tie on a chartreuse jig or a plain old
hook. His hands rise to his lips where he cinches his knots with
his teeth and bites off the extra line. His hands get wet reaching
into tin bait buckets. They pinch twisting black leeches or one of
Leroy’s famous minnows, “guaranteed to catch ﬁsh, or die
trying.” His hands hold yellow-green Zingers, pickles so spicy-
hot a bite will bring a laugh, and peanut butter-mustard
sandwiches.
My father’s hands rise early, with the rest of him, and appear
at the edges of the business pages. In Minnesota, he might
crumple this newsprint into loose balls, build kindling pyramids,
strike long hearth matches, and press spade-shaped wooden
bellows. With the ﬁre lit, he might cook blueberry buckwheat
pancakes on the Ben Franklin wood stove, using an old wood-
handled spatula with chipped red paint.
But if you play Password and give the clue “Charlie Munger’s
hands,” anyone will ﬁrst answer “books.” No matter where he is,
his hands are always holding open a volume, typically a Ben
Franklin biography or the latest treatise on genetics. One might
also answer “graph paper,” for the buildings he’s been designing.
When I think of my father’s hands, I also see them up on stage,
in front of thousands in Omaha every year. His ﬁngers encircle a
Diet Coke, pinch peanut brittle or the stick of a Dilly Bar, or try to

## Page 44

search incognito through a See’s Candies box, zeroing in on the
rum nougat. His hands are crossed in front of him as he shakes
his head, saying “I have nothing to add.” Or they move to the
rhythm of a longer philosophical answer, making all the hands in
the stadium clap together.
My father’s hands, gesturing alongside every colorful joke and
guiding story, have molded me as surely as a sculptor’s. I can be
nothing but glad, and grateful, for the touch of my father’s hands
in mine, and in my son’s.
FROM BARRY MUNGER
Several years ago, I came across a book by Calvin Trillin called
Messages from My Father, a memoir about Trillin’s father, Abe, who
was born in Ukraine, grew up in Missouri, and spent much of his
career operating neighborhood grocery stores in Kansas City.
Abe Trillin regarded thrift as a moral virtue, paid his bills the day
they arrived, and got up at 4 in the morning, six days a week, to
pick the produce for his stores. A man of few words, he was
nevertheless convivial, trenchantly funny, and spoke naturally to
small children. He was skilled at cards. He was sardonic but had
an underlying optimism that one could get along in the world
with the proper outlook and character.
The fact that my father shares many of these qualities, even if
he’s not known for his discernment about produce, does not fully
explain my attachment to this light, deft, and anecdotal little
book. Reading it somehow conjures my father for me, even
though in the broad outlines of his life my father has almost
nothing in common with Abe Trillin, other than the fact that my
father once worked part-time at a Midwestern grocery store,
Buffett & Son in Omaha.

## Page 45

Like my father, Abe Trillin had a fundamental reserve,
partially Midwestern in origin, that was at odds with his
personable qualities. He did not regard a long drive in a car or a
ﬁshing outing as an opportunity to catch up. He did not linger on
the telephone. His son eventually came to marvel at “how much
my father managed to get across to me without those heart-to-
hearts that I’ve read about fathers and sons having in the study
or in the rowboat or in the car.” The title Messages from My Father
comes from the author’s surmise that his father must have been
communicating his expectations through coded messages. “It’s
possible that my father had a code so subtle that I didn’t know of
its existence,” he writes.
Anyone who knows my father knows that his manner of
expression is not always subtle, but he has many ways of sending
his messages. If he doesn’t like the way his bridge partner plays
out a hand, for example, he might say, “You played that like a
plumber,” but if he wants to offer serious counsel to one of his
children, he is more likely to couch the message in an anecdote,
preferably delivered in a group setting so that no one is singled
out. In both instances, he appears blunt and avuncular—that
inimitable Charlie—but at the card table, he uses a lack of
indirection for harmless ribbing, and at the dinner table, he uses
indirection to spare feelings. He’s more subtle than he appears.
A friend of mine recently began an anecdote about my father
by saying, “So your dad’s sitting in his chair, like Rushmore …” I
knew exactly what he meant. Not many people can summon up
the image of a 5,700-foot granite mountain and the faces of four
presidents simply by taking possession of an upholstered chair,
but my father can. All of the Munger children have at one time or
another approached Rushmore to make a request and felt like
Dorothy approaching Oz, except that Oz was more voluble.
Rushmore did not always respond. Sometimes my father made a
low steady noise from somewhere around his larynx, as though

## Page 46

Rushmore had gone volcanic, but that was not so easy to
interpret. Can you be more subtle than silent?
Unlike Abe Trillin, perhaps, my father really does send
messages, in the form of speeches he has written, letters he has
received and sent, and articles from varied sources about social
policy, psychology, business ethics, and law, among other topics.
Many of them appear in this book. What doesn’t appear is the
note my father scrawled on the enclosure. The note is usually
extremely brief, and often just a “send to” list, but every once in a
while the note will have a wry ﬁllip, like this one from 1996,
which was appended to a long, appreciative letter from a
Berkshire Hathaway shareholder in Sweden: “I hope you ﬁnd
this amusing,” my father wrote. “If only I had the inﬂuence with
my wife and children that I have in some other quarters!”
When I ﬁnished the Trillin book, I sent it to my father. Even if
he didn’t recognize himself in it, I ﬁgured he would enjoy the
book’s Midwestern milieu, the immigrant striving of the Trillin
family, and the humor. The book is written with so much
affection that I thought I could even use it to communicate such
feelings to my dad indirectly, which is the preferred route. At the
very least, I thought the book might reassure my father that his
messages were being received, even if they were not always
heeded.
About a week later, the book came back, in a padded
envelope, with an address label supplied by his secretary. There
was no note, so I wasn’t sure whether he had read the book or
rejected it. It seemed untouched, so I concluded that my
message had gone unreceived, loose pages tossed on Rushmore.
Not much escapes my father, however. It turned out that he had
simply instructed his secretary to send copies to the whole
family.

## Page 47

FROM PHILIP MUNGER
Some of my most affectionate memories of my father are of
shopping for clothes at Brooks Brothers and Marks & Spencer.
Most people already know that Father is not a big fashion man.
He once said that he was nonconformist enough in his behavior
and opinions that it made sense to chart a very straight course in
attire. His going along with normal social customs and his sense
of humor, he said, were what allowed his otherwise sometimes
prickly temperament to harmonize with other people.
I vividly recall going with my father to Brooks Brothers, when
it was still housed in that beautiful old wood-paneled building in
downtown Los Angeles, to buy my ﬁrst serious suit. I must have
been about 11 or 12. I can see those polished brass elevator
doors opening. We looked through the racks. Father picked out a
pinstriped, charcoal gray suit. When I was 16, we went to buy
another suit, this time a three-piece, which I wore religiously
during my debate days. It kept the icy wind blowing off the lake
at Northwestern during a tournament at bay. We bought, at the
same time, a pair of wingtip shoes for my summer stint at The
Daily Journal (a coming-of-age ceremony required by Father for
each boy), shoes which have lasted to this day. There is another
theme here. When we bought a brown tweed coat at Marks &
Spencer in London, Father said, “This will always keep its
crease.” He admired both stores because they were durable
institutions and because their merchandise was too, and fairly
priced. Durability has always been a ﬁrst-rate virtue in my
father’s view, along with ritual and tradition. He never had a
desire to change his primary habits, sartorial or otherwise, once
he had, like Franklin, acquired them.
I still shop at Brooks, partly because each year at Christmas
Father gives every child a gift card, which is perfectly timed for

## Page 48

the winter sale. But I always end up going more often than that.
One year, I used his largesse to purchase trousers with pleats. My
father looked at them askance and said, “Do you want to look like
a jazz drummer?”
In New York, Brooks is still housed in its grand old building. I
think of my father every time I go; I’m very attached to the place.
When I went to study at Oxford, in winter 1988, he gave me an
old Brooks coat of his, dating from the ’40s, of a sort of tannish-
olive hue, I think, with a warm zip-in lining. As I walked home
from the Bodleian Library each night, that nasty, damp,
penetrating English cold would not get through. When I returned
to the United States, I realized I had left the coat on a bus. I wept
at the loss. Even now I wish I had that coat.

## Page 49

CHAPTER 3
stripe.press/pca-3
The Munger Approach to Life,Learning, and Decision-Making
Despite being largely self-taught, Ben Franklin was spectacularly
successful in such diverse ﬁelds as journalism, publishing,
printing, philanthropy, public service, science, diplomacy, and
inventing. Much of Franklin’s success was due to the essential
nature of the man—most especially his appetite for hard work,
but also his insatiable curiosity and patient demeanor. Above all,
he possessed a quick and willing mind that enabled him to easily
master each new ﬁeld of endeavor he chose to undertake. It is
not surprising that Charlie Munger considers Franklin his
greatest hero, for Munger is also largely self-taught and shares
many of Franklin’s unique characteristics. Like Franklin, Charlie
has made himself into a grandmaster of preparation, patience,
discipline, and objectivity. He has parlayed these attributes into
great success in both his personal and business endeavors,
especially in his investing.
To Charlie, successful investing is simply a by-product of his
carefully organized and focused approach to life. Warren Buffett
once said, “Charlie can analyze and evaluate any kind of deal
faster and more accurately than any man alive. He sees any valid
weakness in 60 seconds. He is a perfect partner.” Why does
Buffett proffer such high praise? The answer lies in the markedly
original approach Munger applies to life, learning, and decision-
making—the principal subject of this overview.

## Page 50

A word to the wise before we begin: Given the complexity of
Charlie’s approach, what follows is not intended as a how-to
lesson for the aspiring investor. Instead, it is a general overview
of how he seems to do it. Our goal here is to present the basic
outline of Charlie’s approach to prepare you for the voluminous
details that follow in the rest of the book. If you are anxious to get
to the heart of the matter, the Eleven Talks section—presented
verbatim in Charlie’s own words—is the best source for exacting
how-to advice on a broad range of topics. Here we will content
ourselves with a presentation of the general thought processes
Charlie employs when considering an investment, followed by an
outline of his guiding investment principles.
MUNGER’S “MULTIPLE MENTAL MODELS” APPROACH
TO BUSINESS ANALYSIS AND ASSESSMENT
Charlie’s approach to investing is quite different from the more
rudimentary systems used by most investors. Instead of making
a super ﬁcial stand-alone assessment of a company’s ﬁnancial
information, Charlie conducts a comprehensive analysis of both
the internal workings of the investment candidate as well as the
larger, integrated ecosystem in which it operates. He calls the
tools he uses to conduct this review his multiple mental models.
These models, discussed at length in several of the talks
(especially Talks Two, Three, and Four), serve as a framework for
gathering, processing, and acting on information. They borrow
from and neatly stitch together the analytical tools, methods, and
formulas from such traditional disciplines as history,
psychology, physiology, mathematics, engineering, biology,
physics, chemistry, statistics, economics, and so on.
The unassailable logic of Charlie’s ecosystem approach to
investment analysis: Just as multiple factors shape almost every

## Page 51

system, multiple models from a variety of disciplines, applied
with ﬂuency, are needed to understand that system. As John
Muir observed about the interconnectedness of nature, “When
we try to pick out anything by itself, we ﬁnd it hitched to
everything else in the universe.”
Charlie seeks to discover the universe hitched to each of his
investment candidates by gaining a ﬁrm grasp on all, or at least
most, of the relevant factors comprising both its internal and
external environment. When properly collected and organized,
his multiple mental models (about 100 in number, he estimates)
provide a context, or lattice work, that leads to remarkable
insights as to the purpose and nature of life. More pertinent to
our purpose here, his models supply the analytical structure that
enables him to reduce the inherent chaos and confusion of a
complex investment problem into a clariﬁed set of
fundamentals. Especially important examples of these models
include the redundancy and backup system models from
engineering; the compound interest model from mathematics;
the breakpoint, tipping moment, and autocatalysis models from
physics and chemistry; the modern Darwinian synthesis model
from biology; and cognitive misjudgment models from
psychology.
The net result of this broad-spectrum analysis is a heightened
understanding of how the many factors affecting an investment
candidate blend and link to one another. Sometimes this
understanding reveals the existence of second-order, ripple, or
spillover effects. Other times the factors employed combine to
create enormous “lollapalooza-level” results, good or bad. By
applying this framework, Charlie lives in a different world from
most investors when it comes to investment analysis. His
approach accepts the reality that investment problems are
inherently complex, and in a manner more in keeping with the
rigors of scientiﬁc inquiry than conventional investing, he

## Page 52

attacks them with a staggering degree of preparation and broad-
based research.
Charlie’s “big ideas from the big disciplines” approach to
investment evaluation is certainly unique in the business world—
as is its origin. Not ﬁnding any existing approach adequate to the
task, Charlie painstakingly created his own largely self-taught
system. The “self-taught” statement is no exaggeration; he once
said, “To this day, I have never taken any course, anywhere, in
chemistry, economics, psychol ogy, or business.” And yet these
disciplines, especially psychology, form the foundation upon
which his system is built.
It is this signature approach, backed by Charlie’s formidable
intellect, temperament, and decades of relevant experience, that
have made him the virtuoso of business pattern recognition so
valued by Buffett. Like a chess grandmaster, through logic,
instinct, and intuition, he determines the most promising
investment moves, all the while projecting the illusion that the
insight came easily, even simply. But make no mistake: This
simplicity comes only at the end of a long journey toward
understanding—not at the beginning. His clarity is hard-won, the
product of a lifetime of studying the patterns of human behavior,
business systems, and a myriad of other scientiﬁc disciplines.
Charlie counts preparation, patience, discipline, and
objectivity among his most fundamental guiding principles. He
will not deviate from these principles, regardless of group
dynamics, emotional itches, or popular wisdom that “this time
around it’s different.” When faithfully adhered to, these traits
result in one of the best-known Munger characteristics: not
buying or selling very often. Munger, like Buffett, believes a
successful investment career boils down to only a handful of
decisions. So when Charlie likes a business, he makes a very
large bet and typically holds the position for a long period.
Charlie calls it “sit-on-your-ass investing” and cites its beneﬁts:

## Page 53

“You’re paying less to brokers, you’re listening to less nonsense,
and if it works, the tax system gives you an extra 1, 2, or 3
percentage points per annum.” In his view, a portfolio of three
companies is plenty of diversiﬁcation. Accordingly, Charlie is
willing to commit uncommonly high percentages of his
investment capital to individual, “focused” opportunities. Find a
Wall Street organization, ﬁnancial adviser, or mutual fund
manager willing to make that statement!
Given Charlie’s record of success, not to mention Buffett’s
endorsement, why aren’t his investment practices more
routinely emulated by others? Perhaps the answer is that, for
most people, Charlie’s multidisciplinary approach is simply too
hard. Further, few investors share Charlie’s willingness to appear
foolish by not following the herd. Religious in his objectivity,
Charlie is content to swim imperturbably against the tide of
popular opinion—indeﬁnitely, if necessary—which is a rare
attribute in the average investor. And while this behavior can at
times appear simply stubborn or contrarian, that is not the
deﬁning characteristic. Charlie is simply content to trust his own
judgment even when it runs counter to the wisdom of the herd.
This lone-wolf aspect of Charlie’s temperament is a rarely
appreciated reason why he consistently outperforms the larger
investment community. Indeed, if temperament chieﬂy arises
from inborn tendencies, it may be that hard work, intellect, and
experience, regardless of their intensity, are by themselves
insufﬁcient to make a great investor like Charlie Munger. As we
shall witness throughout the remainder of this book, the right
kind of genetically predetermined wiring is needed as well.
At the 2004 Berkshire Hathaway annual meeting, a young
shareholder asked Buffett how to succeed in life. After Buffett
shared his thoughts, Charlie chimed in: “Don’t do cocaine. Don’t
race trains. And avoid AIDS situations.” Many would dismiss his
seemingly ﬂippant answer as merely humorous (which it

## Page 54

certainly was), but in fact it faithfully reﬂects both his general
views on avoiding trouble in life and his particular method for
avoiding missteps in investing.
Often, as in this case, Charlie generally focuses ﬁrst on what
to avoid—that is, on what not to do—before he considers the
afﬁrmative steps he will take in a given situation. “All I want to
know is where I’m going to die, so I’ll never go there” is one of his
favorite quips. In business, as in life, Charlie gains enormous
advantage by summarily eliminating the unpromising portions
of the chessboard, freeing his time and attention for the more
productive regions. Charlie strives to reduce complex situations
to their most basic, unemotional fundamentals. Yet, within this
pursuit of rationality and simplicity, he is careful to avoid what
he calls physics envy, the common human craving to reduce
enormously complex systems (such as those in economics) to
one-size-ﬁts-all Newtonian formulas. Instead, he faithfully
honors Albert Einstein’s admonition: “A scientiﬁc theory should
be as simple as possible, but no simpler.” Or, in his own words:
“What I’m against is being very conﬁdent and feeling that you
know, for sure, that your particular action will do more good than
harm. You’re dealing with highly complex systems wherein
everything is interacting with everything else.”
Another Benjamin—Graham, not Franklin—played a
signiﬁcant role in forming Charlie’s investing outlook. One of the
most enduring concepts in Graham’s The Intelligent Investor is Mr.
Market. Usually, Mr. Market is a temperate and reasonable fellow,
but some days he is gripped by irrational fear or greed. Graham
cautioned the investor to carefully use his own unemotional
judgment of value instead of relying on the often manic-
depressive behavior of the ﬁnancial markets. Similarly, Charlie
recognizes that even among the most competent and motivated
of people, decisions are not always made on a purely rational
basis. For this reason, he considers the psychological factors of

## Page 55

human misjudgment some of the most important mental models
that can be applied to an investment opportunity:
Personally, I’ve gotten so that I now use a kind of two-track
analysis. First, what are the factors that really govern the
interests involved, rationally considered? And second,
what are the subconscious inﬂuences where the brain, at a
subconscious level, is automatically doing these things—
which, by and large, are useful but which often
misfunction? One approach is rationality, the way you’d
work out a bridge problem: by evaluating the real interests,
the real probabilities, and so forth. And the other is to
evaluate the psychological factors that cause subconscious
conclusions, many of which are wrong.
For more speciﬁcs on this topic see Talk Eleven, in which
Charlie applies mental models from the ﬁeld of psychology to
illustrate 25 common causes of human misjudgment.
Obviously, the methods described to this point can’t be
learned in a university classroom or on Wall Street. They were
developed by Charlie, from scratch, to satisfy his own exacting
requirements. They probably deserve a title of their own,
something like “Quickly eliminate the big universe of what not to
do; follow up with a ﬂuent, multidisciplinary attack on what
remains; then act decisively when, and only when, the right
circumstances appear.”
Is it worth the effort to develop and adhere to such an
approach? Charlie seems to think so: “It’s kind of fun to sit there
and outthink people who are way smarter than you are because
you’ve trained yourself to be more objective and more
multidisciplinary. Furthermore, there is a lot of money in it, as I
can testify from my own personal experience.”

## Page 56

MUNGER’S INVESTMENT EVALUATION PROCESS
As we’ve noted, Charlie doesn’t make a lot of investments. His
approach is perhaps best summarized by Thomas Watson Sr.,
the founder of IBM: “I’m no genius. I’m smart in spots, and I stay
around those spots.” If Charlie knows anything, he knows his
spots: his carefully identiﬁed circles of competence. To stay
within these circles, he ﬁrst applies a basic, overall screen,
designed to limit his investment ﬁeld to only “simple,
understandable candidates.” As he says, “We have three baskets
for investing: yes, no, and too tough to understand.”
To identify potential “yes” candidates, Charlie looks for an
easy-to-understand, dominant business franchise that can
sustain itself and thrive in all market environments.
Understandably, few companies survive this ﬁrst cut. Many
investor favorites such as pharmaceuticals and technology, for
example, go straight to the “too-tough-to-understand” basket.
Heavily promoted “deals” and IPOs earn immediate nos. Those
that do survive this ﬁrst winnowing are subjected to the screens
and ﬁlters of Charlie’s mental-models approach. The process is
intense and Darwinian but also efﬁcient. Charlie detests placer
mining, the process of sifting through piles of sand for specks of
gold. Instead, he applies his “big ideas from the big disciplines”
to ﬁnd the large, unrecognized nuggets of gold that sometimes lie
in plain sight on the ground.
Throughout his exhaustive evaluation, Charlie is no slave to a
database: He takes into account all relevant aspects, both
internal and external to the company and its industry, even if
they are difﬁcult to identify, measure, or reduce to numbers. His
thoroughness, however, does not cause him to forget his overall
ecosystem theme: Sometimes the maximization or minimization
of a single factor (notably specialization, as he likes to point out

## Page 57

regarding Costco’s discount warehouses) can make that single
factor disproportionately important.
Charlie treats ﬁnancial reports and their underlying
accounting with a Midwestern dose of skepticism. At best, they
are merely the beginning of a proper calculation of intrinsic
valuation, not the end. The list of additional factors he examines
is seemingly endless and includes such things as the current and
prospective regulatory climate; the state of labor, supplier, and
customer relations; the potential impact of changes in
technology; competitive strengths and vulnerabilities; pricing
power; scalability; environmental issues; and, notably, the
presence of hidden exposures. (Charlie knows that there is no
such thing as a riskless investment candidate; he’s searching for
those with few risks that are easily understandable.) He recasts
all ﬁnancial statement ﬁgures to ﬁt his own view of reality,
including the actual free or owners’ cash being produced,
inventory and other working capital assets, ﬁxed assets, and
such frequently overstated intangible assets as goodwill. He also
completes an assessment of the true impact, current and future,
of the cost of stock options, pension plans, and retiree medical
beneﬁts. He applies equal scrutiny to the liability side of the
balance sheet. For example, under the right circumstances, he
might view an obligation such as insurance ﬂoat—premium
income that may not be paid out in claims for many years—more
properly as an asset. He especially assesses a company’s
management well beyond conventional number crunching—in
particular, the degree to which they are “able, trustworthy, and
owner-oriented.” For example, how do they deploy cash? Do they
allocate it intelligently on behalf of the owners or do they
overcompensate themselves or pursue ego-oriented growth for
growth’s sake?
Above all, he attempts to assess and understand competitive
advantage in every respect—products, markets, trademarks,

## Page 58

employees, distribution channels, societal trends, and so on—
and the durability of that advantage. Charlie refers to a
company’s competitive advantage as its moat: the virtual
physical barrier it presents against incursions. Superior
companies have deep moats that are continuously widened to
provide enduring protection. In this vein, Charlie carefully
considers competitive destruction forces that, over the long
term, lay siege to most companies. Munger and Buffett are laser-
focused on this issue: Over their long business careers they have
learned, sometimes painfully, that few businesses survive over
multiple generations. Accordingly, they strive to identify and buy
only those businesses with a good chance of beating these tough
odds.
Finally, Charlie seeks to calculate the intrinsic value of the
whole business and, with allowance for potential dilution, etc., to
determine an approximate value per share to compare to market
prices. This latter comparison is the fundamental purpose of the
whole process—comparing value (what you get) with price (what
you pay). On this subject he is famous for his viewpoint that “a
great business at a fair price is superior to a fair business at a
great price.” Warren Buffett often credits Charlie with convincing
him of the wisdom of this approach: “Charlie understood this
early. I was a slow learner.” Charlie’s insight helped Buffett move
from pure Benjamin Graham– style investing to focusing on great
businesses such as The Washington Post, GEICO, Coca-Cola,
Gillette, and others.
Though extremely thorough, Charlie is able to ignore
insigniﬁcant detail and the distractions to which others
sometimes fall victim. Investment variables, just like all other
variables, go through their own process of elimination. By the
time he is ﬁnished with his analysis, he has reduced the
candidate to its most salient elements and achieved a
remarkable degree of conﬁdence about whether or not to act.

## Page 59

The evaluation, ﬁnally, becomes not so much mathematical as
philosophical. Ultimately a “feel” emerges, a function of both the
analysis itself and Charlie’s lifetime of accumulated experience
and skill in recognizing patterns.
At this point, only an exceptionally superior investment
candidate will still be in the running. But Charlie does not
immediately rush out and buy it. Knowing that a necessary
companion to proper valuation is proper timing, he applies yet a
ﬁner screen, a “prior to pulling the trigger” checklist, which is
especially useful in evaluating what he refers to as close calls.
The checklist includes such items as: What are the current price,
volume, and trading considerations? What disclosure timing or
other sensitivities exist? Do contingent exit strategies exist? Are
better uses of capital currently or potentially available? Is
sufﬁcient liquid capital currently on hand or must it be
borrowed? What is the opportunity cost of that capital? And so
on.
Charlie’s exhaustive screening process requires considerable
self-discipline and results in long periods of apparent inactivity.
But, as Charlie says, “Hard work is an essential element in
tracking down and perfecting a strategy, or in executing it.” For
Charlie and Warren, the hard work is continuous, whether it
results in current investing activity or not—and usually it does
not. This habit of committing far more time to learning and
thinking than to doing is no accident. It is the blend of discipline
and patience exhibited by true masters of a craft: an
uncompromising commitment to “properly playing the hand.”
Like world-class bridge player Richard Zeckhauser, Charlie
scores himself not so much on whether he won the hand but
rather on how well he played it. While poor outcomes are
excusable in the Munger– Buffett world—given the fact that some
outcomes are outside of their control—sloppy preparation and

## Page 60

decision-making are never excusable because they are
controllable.
On those relatively few occasions when all the circumstances
are just right and Charlie does invest, he will likely make a large,
decisive bet. He does not pick around the edges, take initial
positions, or make small, speculative investments. Such
behavior implies uncertainty, and Charlie’s moves, few as they
are, are anything but uncertain. As he says, he practices
“extreme patience combined with extreme decisiveness.”
Charlie’s self-conﬁdence is based not on who, or how many,
agree or disagree with him but on his ability to objectively view
and measure himself. This self-mastery affords him rare
objectivity in gauging his actual knowledge, experience, and
correctness of thought. Again, we see the important role played
by the right kinds of temperamental qualities: self-discipline,
patience, calm, independence. Charlie’s level of investment
performance is arguably impossible without them.
What makes a great business model for Charlie? His
recommended reading materials provide some guidance. Guns,
Germs, and Steel, The Selﬁsh Gene, Ice Age, and Darwin’s Blind Spot all
have a certain theme: a focus on the issue of competitive
destruction and an examination of why some entities are
nevertheless able to adapt, survive, and even dominate over
time. When this theme is extrapolated into investment selection,
the preferred Munger business emerges: some thrive by
outcompeting (à la Selﬁsh Gene) and others by out-cooperating (à
la Darwin’s Blind Spot). Once again, we see Charlie’s rich ﬂuency
across a broad range of disciplines at work: How many investors
ever consider, as Charlie routinely does, such a broad and
sophisticated spectrum of factors? To name but a few, he
routinely considers factors such as conversion, i.e., how the laws
of thermo dynamics intersect with laws of economics (for
instance, how paper and petroleum become a newspaper

## Page 61

delivered to a front door); psychological tendencies and
incentives (notably the extreme behavioral pressures they
create, both good and bad); and fundamental sustainability over
time (the constant and often deadly interplay between positive
factors such as moats and the ravages of competitive
destruction). Charlie is possibly without peer when it comes to
the checklist of atypical investment factors he considers and his
deep ﬂuency in the diverse disciplines from which they are
drawn.
AN INVESTING PRINCIPLES CHECKLIST
We have now examined Charlie’s approach to thinking in general
and to investing in particular. In keeping with our intent to
observe how he seems to do it, we will recap his approach by
using the checklist methodology he advocates. (For Charlie’s own
words of wisdom on the value and importance of checklists, see
Talk Five.) Note, however, that the following principles are most
certainly not employed by Charlie in a one-by-one or one-time
fashion as the checklist format might seem to imply. Nor can
they necessarily be prioritized in terms of any apparent or
relative importance. Rather, each must be considered as part of
the complex whole or gestalt of the investment analysis process,
in much the same way that an individual tile is integral to the
larger mosaic in which it appears.
Risk
All investment evaluations should begin by measuring risk, especially
reputational.
Incorporate an appropriate margin of safety.
Avoid dealing with people of questionable character.
Insist upon proper compensation for risk assumed.

## Page 62

Always beware of inﬂation and interest rate exposures.
Avoid big mistakes; shun permanent capital loss.
Independence
“Only in fairy tales are emperors told they are naked.”
Objectivity and rationality require independence of thought.
Remember that just because other people agree or disagree
with you doesn’t make you right or wrong—the only thing that
matters is the correctness of your analysis and judgment.
Mimicking the herd invites regression to the mean (merely
average performance).
Preparation
“The only way to win is to work, work, work, work, and hope to have a
few insights.”
Develop into a lifelong self-learner through voracious reading;
cultivate curiosity and strive to become a little wiser every
day.
More important than the will to win is the will to prepare.
Develop ﬂuency in mental models from the major academic
disciplines.
If you want to get smart, the question you have to keep asking
is “Why, why, why?”
Intellectual humility
Acknowledging what you don’t know is the dawning of wisdom.
Stay within a well-deﬁned circle of competence.
Identify and reconcile disconﬁrming evidence.
Resist the craving for false precision, false certainties, etc.
Above all, never fool yourself, and remember that you are the
easiest person to fool.

## Page 63

Analytic rigor
Use of the scientiﬁc method and effective checklists minimizes errors
and omissions.
Determine value apart from price, progress apart from
activity, wealth apart from size.
It is better to remember the obvious than to grasp the
esoteric.
Be a business analyst, not a market, macroeconomic, or
security analyst.
Consider the totality of risk and effect; look always at potential
second-order and higher-level impacts.
Think forward and backward: Invert, always invert.
Allocation
Proper allocation of capital is an investor’s number one job.
Remember that the highest and best use is always measured
by the next best use (opportunity cost).
Good ideas are rare—when the odds are greatly in your favor,
bet (allocate) heavily.
Don’t fall in love with an investment—be situation-dependent
and opportunity-driven.
Patience
Resist the natural human bias to act.
“Compound interest is the eighth wonder of the world”
(Einstein); never interrupt it unnecessarily.
Avoid unnecessary transactional taxes and frictional costs;
never take action for its own sake.
Be alert for the arrival of luck.
Enjoy the process along with the proceeds, because the
process is where you live.

## Page 64

Decisiveness
When proper circumstances present themselves, act with decisiveness
and conviction.
Be fearful when others are greedy and greedy when others are
fearful.
Opportunity doesn’t come often, so seize it when it does.
Opportunity meeting the prepared mind—that’s the game.
Change
Live with change and accept unremovable complexity.
Recognize and adapt to the true nature of the world around
you; don’t expect it to adapt to you.
Continually challenge and willingly amend your best-loved
ideas.
Recognize reality even when you don’t like it—especially when
you don’t like it.
Focus
Keep things simple and remember what you set out to do.
Remember that reputation and integrity are your most
valuable assets—and can be lost in a heartbeat.
Guard against the effects of hubris and boredom.
Don’t overlook the obvious by drowning in minutiae.
Be careful to exclude unneeded information or slop: “A small
leak can sink a great ship.”
Face your big troubles, don’t sweep them under the rug.
Since human beings began investing, they have been searching
for a magic formula or easy recipe for instant wealth. As you can
see, Charlie’s superior performance doesn’t come from a magic
formula or some business school– inspired system. It comes

## Page 65

from what he calls his “constant search for better methods of
thought,” from a willingness to “prepay” through rigorous
preparation, and from the extra ordinary outcomes of his
multidisciplinary research model. In the end, it comes down to
Charlie’s most basic guiding principles, his fundamental
philosophy of life: Preparation. Discipline. Patience.
Decisiveness. Each attribute is, in turn, lost without the other, but
together they form the dynamic critical mass for a cascading of
positive effects for which Munger is famous (the lollapalooza).
Finally, a word or two on why this overview of Charlie’s
investment philosophy has focused so much on the subject of
what to buy and so little on when to sell. The answer, in Charlie’s
own words, serves as a wonderful summation of the Munger
school of highly concentrated, focused investing described here:
We’re partial to putting out large amounts of money where
we won’t have to make another decision. If you buy
something because it’s undervalued, then you have to
think about selling it when it approaches your calculation
of its intrinsic value. That’s hard. But if you can buy a few
great companies, then you can sit on your ass. That’s a
good thing.
Like his hero, Benjamin Franklin, Charlie Munger
painstakingly developed and perfected unique approaches to
personal and business endeavors. Through these methods, and
through the development and maintenance of sound, lifelong
habits, he has achieved extra ordinary success.

## Page 66

CHAPTER 4
stripe.press/pca-4
Eleven Talks
Charlie Munger is not the least bit shy when it comes to offering
both frank criticism and constructive advice. When he sets his
sights on an issue—be it a corrupt business practice, an
academic failing, or a ﬁnancial scandal—he lets loose with both
barrels. Which is not to say he spends all his time focused on
life’s failings. He is equally at home discussing the values of
lifelong learning or the joys of a successful marriage. But
whatever the topic, Charlie is apt to tell it like it is, which is
exactly what he has done in over two decades of public speaking.
Here, then, are 11 of Charlie’s best talks, including a special
compilation he has prepared exclusively for this book. Enjoy.
1. Harvard School Commencement Speech
2. A Lesson on Elementary, Worldly Wisdom
3. A Lesson on Elementary, Worldly Wisdom, Revisited
4. Practical Thought about Practical Thought?
5. Harvard Law School 50th Reunion Address
6. Investment Practices of Leading Charitable Foundations
7. Philanthropy Roundtable
8. The Great Financial Scandal of 2003
9. Academic Economics
10. USC Gould School of Law Commencement Address

## Page 67

11. The Psychology of Human Misjudgment: A special
compilation talk, with material written by Charlie
exclusively for this book

## Page 68

CHAPTER 4; TALK ONE
stripe.press/pca-5
Harvard SchoolCommencement Speech
JUNE 13, 1986HARVARD SCHOOL, LOS ANGELES
In a vow that students the world over may hope he renounces,
Charlie delivered “the one and only graduation speech I will ever
make” in 1986 at the Harvard School in Los Angeles. The occasion
was the graduation of Philip Munger, the last of five Munger family
sons to matriculate at this prep school (originally an all-boys
institution and now the coeducational school called Harvard-
Westlake).
Despite Charlie’s self-effacing protestations about lacking
“significant public speaking experience,” he demonstrates imposing
rhetorical talents in this short speech. We also get a good taste
of both Charlie’s value system and his wit. Most graduation
speakers choose to lay out a prescription for attaining a happy
life. Charlie, using the inversion principle he recommends in the
speech, compellingly makes the opposite case by setting forth what
a graduate may do to reach a state of misery.
For those of you who want to remain unenlightened and mirthless,
do not, under any circumstances, read this selection.

## Page 69

Now that Headmaster Berrisford has selected one of the oldest
and longest-serving trustees to make a commencement speech,
it behooves the speaker to address two questions in every mind:
1. Why was such a selection made?
2. How long is the speech going to last?
I will answer the ﬁrst question from long experience
alongside Berrisford. He is seeking enhanced reputation for our
school in the manner of the man who proudly displays his horse
that can count to seven. The man knows that counting to seven is
not much of a mathematical feat, but he expects approval
because doing so is creditable, considering the performer is a
horse.
The second question, regarding the length of the speech, I am
not going to answer in advance. It would deprive your upturned
faces of lively curiosity and obvious keen anticipation, which I
prefer to retain, regardless of source.
But I will tell you how my consideration of speech length
created the subject matter of the speech itself. I was puffed up
when invited to speak. While not having signiﬁcant public
speaking experience, I do hold a black belt in chutzpah, and I
immediately considered Demosthenes and Cicero1 as role
models and anticipated trying to earn a compliment like Cicero
gave when asked which was his favorite among the orations of
Demosthenes. Cicero replied, “The longest one.”
However, fortunately for this audience, I also thought of
Samuel Johnson’s2 famous comment when he addressed
Milton’s3 poem Paradise Lost and correctly said, “No one ever
wished it longer.” And that made me consider which of all the 20
Harvard School graduation speeches I had heard that I had
wished longer. There was only one such speech, given by Johnny

## Page 70

Carson,4 specifying Carson’s prescriptions for guaranteed misery
in life. I, therefore, decided to repeat Carson’s speech, but in
expanded form with some added prescriptions of my own. After
all, I am much older than Carson was when he spoke, and I have
failed and been miserable more often and in more ways than was
possible for a charming humorist speaking at a younger age. I
am plainly well qualiﬁed to expand on Carson’s theme.
What Carson said was that he couldn’t tell the graduating
class how to be happy, but he could tell them from personal
experience how to guarantee misery. Carson’s prescription for
sure misery included:
1. Ingesting chemicals in an effort to alter mood or
perception
2. Envy
3. Resentment
I can still recall Carson’s absolute conviction as he told how he
had tried these things on occasion after occasion and had
become miserable every time.
It is easy to understand Carson’s ﬁrst prescription for misery,
ingesting chemicals. I add my voice. The four closest friends of
my youth were highly intelligent, ethical, humorous types,
favored in person and background. Two are long dead, with
alcohol a contributing factor, and a third is a living alcoholic—if
you call that living.
While susceptibility varies, addiction can happen to any of us
through a subtle process where the bonds of degradation are too
light to be felt until they are too strong to be broken. And yet, I
have yet to meet anyone, in over six decades of life, whose life
was worsened by fear and avoidance of such a deceptive pathway
to destruction.

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Envy, of course, joins chemicals in winning some sort of
quantity prize for causing misery. It was wreaking havoc long
before it got bad press in the laws of Moses. If you wish to retain
the contribution of envy to misery, I recommend that you never
read any of the biographies of that good Christian Samuel
Johnson, because his life demonstrates in an enticing way the
possibility and advantage of transcending envy.
Resentment has always worked for me exactly as it worked for
Carson. I cannot recommend it highly enough to you if you
desire misery. Johnson spoke well when he said that life is hard
enough to swallow without squeezing in the bitter rind of
resentment.
For those of you who want misery, I also recommend
refraining from the practice of the Disraeli compromise,
designed for people who ﬁnd it impossible to quit resentment
cold turkey. [Benjamin] Disraeli, as he rose to become one of the
greatest prime ministers, learned to give up vengeance as a
motivation for action, but he did retain some outlet for
resentment by putting the names of people who wronged him on
pieces of paper in a drawer. Then, from time to time, he reviewed
these names and took pleasure in noting the way the world had
taken his enemies down without his assistance.
Well, so much for Carson’s three prescriptions. Here are four
more prescriptions from Munger:
First, be unreliable. Do not faithfully do what you have
engaged to do. If you will only master this one habit, you will
more than counter balance the combined effect of all your
virtues, howsoever great. If you like being distrusted and
excluded from the best human contribution and company, this
prescription is for you. Master this one habit, and you will always
play the role of the hare in the fable, except that instead of being
outrun by one ﬁne turtle, you will be outrun by hordes and

## Page 72

hordes of mediocre turtles, and even some mediocre turtles on
crutches.
I must warn you that if you don’t follow my ﬁrst prescription,
it may be hard to end up miserable even if you start
disadvantaged. I had a roommate in college who was and is
severely dyslexic. But he is perhaps the most reliable man I have
ever known. He has had a wonderful life so far: an outstanding
wife and children, chief executive of a multi billion-dollar
corporation. If you want to avoid a conventional, main-culture,
establishment result of this kind, you simply can’t count on your
other handicaps to hold you back if you persist in being reliable.
I cannot here pass by a reference to a life described as
“wonderful so far” without reinforcing the “so far” aspects of the
human condition by repeating the remark of Croesus,5 once the
richest king in the world. Later, in ignominious captivity, as he
prepared to be burned alive, he said, “Well now do I remember
the words of the historian Solon: ‘No man’s life should be
accounted a happy one until it is over.’”
My second prescription for misery is to learn everything you
possibly can from your own experience, minimizing what you
learn vicariously from the good and bad experiences of others,
living and dead. This prescription is a sure-shot producer of
misery and second-rate achievement.
You can see the results of not learning from others’ mistakes
by simply looking about you. How little originality there is in the
common disasters of mankind: drunk driving deaths, reckless
driving maimings, incurable venereal diseases, conversion of
bright college students into brainwashed zombies as members of
destructive cults, business failures through repetition of obvious
mistakes made by predecessors, various forms of crowd folly,
and so on. I recommend as a memory clue to ﬁnding the way to
real trouble from heedless, unoriginal error the modern saying
“If at ﬁrst you don’t succeed, well, so much for hang gliding.”

## Page 73

The other aspect of avoiding vicarious wisdom is the rule of
not learning from the best work done before yours. The
prescription is to become as non-educated as you reasonably
can.
Perhaps you will better see the type of non-miserable result
you can thus avoid if I render a short historical account. There
once was a man who assiduously mastered the work of his best
predecessors, despite a poor start and very tough time in
analytical geometry. Eventually, his own work attracted wide
attention, and he said of his work, “If I have seen a little farther
than other men, it is because I stood on the shoulders of giants.”
The bones of that man lie buried now, in Westminster Abbey,
under an unusual inscription: “Here lie the remains of all that
was mortal in Sir Isaac Newton.”6
My third prescription to you for misery is to go down and stay
down when you get your ﬁrst, second, or third severe reverse in
the battle of life. Because there is so much adversity out there,
even for the lucky and wise, this will guarantee that, in due
course, you will be permanently mired in misery. Ignore at all
cost the lesson contained in the accurate epitaph written for
himself by Epictetus:7 “Here lies Epictetus, a slave, maimed in
body, the ultimate in poverty, and favored by the gods.”
My ﬁnal prescription to you for a life of fuzzy thinking and
infelicity is to ignore a story they told me when I was very young
about a rustic who said, “I wish I knew where I was going to die,
and then I’d never go there.” Most people smile, as you did, at the
rustic’s ignorance and ignore his basic wisdom. If my experience
is any guide, the rustic’s approach is to be avoided at all cost by
someone bent on misery. To help fail, you should discount as
mere quirk, with no useful message, the method of the rustic,
which is the same one used in Carson’s speech.
What Carson did was to approach the study of how to create X
by turning the question backward—that is, by studying how to

## Page 74

create non-X. The great algebraist Jacobi had exactly the same
approach as Carson and was known for his constant repetition of
one phrase: “Invert, always invert.” It is in the nature of things, as
Jacobi knew, that many hard problems are best solved only when
they are addressed backward. For instance, when almost
everyone else was trying to revise the electromagnetic laws of
[James Clerk] Maxwell8 to be consistent with the motion laws of
Newton, Einstein9 discovered special relativity as he made a
180-degree turn and revised Newton’s laws to ﬁt Maxwell’s.
It is my opinion, as a certiﬁed biography nut, that Charles
Robert Darwin10 would have ranked near the middle of the
Harvard School graduating class of 1986. Yet he is now famous
in the history of science. This is precisely the type of example
you should learn nothing from if bent on minimizing your
results from your own endowment.
Darwin’s result was due in large measure to his working
method, which violated all my rules for misery and particularly
emphasized a backward twist in that he always gave priority
attention to evidence tending to disconﬁrm whatever cherished
and hard-won theory he already had. In contrast, most people
early achieve and later intensify a tendency to process new and
disconﬁrming information so that any original conclusion
remains intact. They become people of whom Philip Wylie
observed, “You couldn’t squeeze a dime between what they
already know and what they will never learn.”
The life of Darwin demonstrates how a turtle may outrun a
hare, aided by extreme objectivity, which helps the objective
person end up like the only player without a blindfold in a game
of pin the tail on the donkey.
If you minimize objectivity, you ignore not only a lesson from
Darwin but also one from Einstein. Einstein said that his
successful theories came from “curiosity, concentration,

## Page 75

perseverance, and self-criticism.” And by self-criticism, he
meant the testing and destruction of his own well-loved ideas.
Finally, minimizing objectivity will help you lessen the
compromises and burden of owning worldly goods, because
objectivity does not work only for great physicists and biologists.
It also adds power to the work of a plumbing contractor in
Bemidji. Therefore, if you interpret being true to yourself as
requiring that you retain every notion of your youth, you will be
safely underway, not only toward maximizing ignorance but also
toward whatever misery can be obtained through unpleasant
experiences in business.
It is ﬁtting that a backward sort of speech end with a
backward sort of toast, inspired by Elihu Root’s11 repeated
accounts of how the dog went to Dover, “leg over leg.” To the class
of 1986: Gentlemen, may each of you rise by spending each day
of a long life aiming low.
TALK ONE REVISITED
As I review in 2006 this talk made in 1986, I would not revise a
single idea. If anything, I now believe even more strongly that 1)
reliability is essential for progress in life and 2) while quantum
mechanics is unlearnable for a vast majority, reliability can be
learned to great advantage by almost anyone.
Indeed, I have often made myself unpopular on elite college
campuses by pushing this reliability theme. What I say is that
McDonald’s is one of our most admirable institutions. Then, as
signs of shock come to surrounding faces, I explain that
McDonald’s, providing ﬁrst jobs to millions of teenagers, many
troubled, over the years, has successfully taught most of them
the one lesson they most need: to show up reliably for
responsible work. Then I usually go on to say that if the elite

## Page 76

campuses were as successful as McDonald’s in teaching sensibly,
we would have a better world.

## Page 77

CHAPTER 4; TALK TWO
stripe.press/pca-6
A Lesson on Elementary,Worldly Wisdom as It Relates toInvestment Management andBusiness
APRIL 14, 1994THE UNIVERSITY OF SOUTHERN CALIFORNIAMARSHALL SCHOOL OF BUSINESS
Well known because it was published in Outstanding Investor Digest12
(May 5, 1995), this talk was given in 1994 to Professor Guilford
Babcock’s business class at the University of Southern California.
Charlie ranges in the talk from education systems to psychology to
the importance of possessing both common and uncommon sense.
Dissecting business management, he brilliantly describes
psychological impacts that can damage or benefit a firm. He also
presents an outstanding set of principles for investment, business
management, and—most importantly, from Charlie’s perspective—
decision-making in everyday life.
Your time investment in reading this talk will be paid back
quickly via the effect it will have on your own decision-making
abilities.

## Page 78

I am going to play a minor trick on you today, because the subject
of my talk is the art of stock picking as a subdivision of the art of
worldly wisdom. That enables me to start talking about worldly
wisdom, a much broader topic that interests me because I think
all too little of it is delivered by modern educational systems, at
least in an effective way. And, therefore, the talk is sort of along
the lines that some behaviorist psychologists call “grandma’s
rule,” after the wisdom of grandma when she said that you have
to eat the carrots before you get the dessert.
The carrot part of this talk is about the general subject of
worldly wisdom, which is a pretty good way 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’re
going to be a great stock picker, you need some general
education. So, emphasizing what I sometimes waggishly call
remedial worldly wisdom, I’m going to start by waltzing you
through a few basic notions.
What is elementary, worldly wisdom? Well, the ﬁrst rule is
that you can’t really know anything if you just remember isolated
facts and try and bang ’em back. If the facts don’t hang together
on a latticework of theory, you don’t have them in a usable form.
You’ve got to have models in your head. And you’ve got to array
your experience—both vicarious and direct—on this latticework
of models. You may have noticed students who just try to
remember and pound back what is remembered. Well, they fail
in school and fail in life. You’ve got to hang experience on a
latticework of models in your head.
What are the models? Well, the ﬁrst rule is that you’ve got to
have multiple models—because if you have just one or two that
you’re using, the nature of human psychology is such that you’ll
torture reality so that it ﬁts your models, or at least you’ll think it
does. You become the equivalent of a chiropractor, who, of
course, is the great boob in medicine. It’s like the old saying, “To

## Page 79

the man with only a hammer, every problem looks like a nail.”
And, of course, that’s the way the chiropractor goes about
practicing medicine. But that’s a perfectly disastrous way to
think and a perfectly disastrous way to operate in the world. So
you’ve got to have multiple models.
And the models have to come from multiple disciplines—
because all the wisdom of the world is not to be found in one
little academic department. That’s why poetry professors, by and
large, are so unwise in a worldly sense. They don’t have enough
models in their heads. So you’ve got to have models across a fair
array of disciplines.
You may say, “My god, this is already getting way too tough.”
But fortunately, it isn’t that tough—because 80 or 90 important
models will carry about 90 percent of the freight in making you a
worldly-wise person. And, of those, only a mere handful really
carry very heavy freight.
So let’s brieﬂy review what kinds of models and techniques
constitute this basic knowledge that everybody has to have
before they proceed to being really good at a narrow art like
stock picking.
First, there’s mathematics. Obviously, you’ve got to be able to
handle numbers and quantities—basic arithmetic. And the great
useful model, after compound interest, is the elementary math
of permutations and combinations. That was taught in my day in
the sophomore year in high school. I suppose by now, in great
private schools, it’s probably down to the eighth grade or so. It’s
very simple algebra. And it was all worked out in the course of
about one year in correspondence between [Blaise] Pascal and
[Pierre de] Fermat.13 They worked it out casually in a series of
letters.
It’s not that hard to learn. What is hard is to get so you use it
routinely almost every day of your life. The Fermat/Pascal
system is dramatically consonant with the way the world works.

## Page 80

And it’s a fundamental truth. So you simply have to have the
technique.
Many educational institutions—although not nearly enough—
have realized this. At Harvard Business School, the great
quantitative thing that bonds the ﬁrst year class together is what
they call decision tree theory. All they do is take high school
algebra and apply it to real life problems. And the students love
it. They’re amazed to ﬁnd that high school algebra works in life.
By and large, as it works out, people can’t naturally and
automatically do this. If you understand elementary psychology,
the reason they can’t is really quite simple: The basic neural
network of the brain is there through broad genetic and cultural
evolution. And it’s not Fermat/Pascal. It uses a very crude,
shortcut type of approximation. It’s got elements of
Fermat/Pascal in it. However, it’s not good. So you have to learn
in a very usable way this very elementary math and use it
routinely in life—just the way that if you want to become a golfer,
you can’t use the natural swing that broad evolution gave you.
You have to learn to have a certain grip and swing in a different
way to realize your full potential as a golfer.
If you don’t get this elementary, but mildly unnatural,
mathematics of elementary probability into your repertoire, then
you go through a long life like a one legged man in an ass kicking
contest. You’re giving a huge advantage to everybody else. One of
the advantages of a fellow like Buffett, whom I’ve worked with all
these years, is that he automatically thinks in terms of decision
trees and the elementary math of permutations and
combinations.
Obviously, you have to know accounting. It’s the language of
practical business life. It was a very useful thing to deliver to
civilization. I’ve heard it came to civilization through Venice,
which, of course, was once the great commercial power in the
Mediterranean. However, double entry bookkeeping was a hell of

## Page 81

an invention. And it’s not that hard to understand. But you have
to know enough about it to understand its limitations—because
although accounting is the starting place, it’s only a crude
approximation. And it’s not very hard to understand its
limitations. For example, everyone can see that you have to more
or less just guess at the useful life of a jet airplane or anything
like that. Just because you express the depreciation rate in neat
numbers doesn’t make it anything you really know.
In terms of the limitations of accounting, one of my favorite
stories involves a very great businessman named Carl Braun
who created the C. F. Braun Engineering Company.14 It designed
and built oil reﬁneries, which is very hard to do. And Braun
would get them to come in on time and not blow up and have
efﬁciencies and so forth. This is a major art.
Braun, being the thorough Teutonic type that he was, had a
number of quirks. One of them was that he took a look at
standard accounting and the way it was applied to building oil
reﬁneries and he said, “This is asinine.” So he threw all of his
accountants out, and he took his engineers and said, “Now we’ll
devise our own system of accounting to handle this process.”
And in due time, accounting adopted a lot of Carl Braun’s
notions. So he was a formidably willful and talented man who
demonstrated both the importance of accounting and the
importance of knowing its limitations.
He had another rule, from psychology—which, if you’re
interested in wisdom, ought to be part of your repertoire, like the
elementary mathematics of permutations and combinations. His
rule for all the Braun Company’s communications was called the
ﬁve Ws: You had to tell who was going to do what, where, when, and
why. And if you wrote a letter or directive in the Braun Company
telling somebody to do something and you didn’t tell him why,
you could get ﬁred. In fact, you would get ﬁred if you did it twice.

## Page 82

You might ask, why is that so important? Well, again, that’s a
rule of psychology. Just as you think better if you array
knowledge on a bunch of models that are basically answers to
the question “Why, why, why?,” if you always tell people why,
they’ll understand it better, they’ll consider it more important,
and they’ll be more likely to comply. Even if they don’t
understand your reason, they’ll be more likely to comply. So
there’s an iron rule that just as you want to start getting worldly
wisdom by asking “Why, why, why?,” in communicating with
other people about everything, you want to include why, why,
why. Even if it’s obvious, it’s wise to stick in the why.
Which models are the most reliable? Well, obviously, the
models that come from hard science and engineering are the
most reliable models on this earth. And engineering quality
control—at least the guts of it that matters to you and me and
people who are not professional engineers—is very much based
on the elementary mathematics of Fermat and Pascal: It costs so
much, and you get so much less likelihood of it breaking if you
spend this much. It’s all elementary high school mathematics.
And an elaboration of that is what [W. Edwards] Deming15
brought to Japan for all of that quality control stuff.
I don’t think it’s necessary for most people to be terribly facile
in statistics. For example, I’m not sure that I can even pronounce
the Gaussian distribution, although I know what it looks like and
I know that events and huge aspects of reality end up distributed
that way. So I can do a rough calculation. But if you ask me to
work out something involving a Gaussian distribution to 10
decimal points, I can’t sit down and do the math. I’m like a poker
player who’s learned to play pretty well without mastering
Pascal. And, by the way, that works well enough. But you have to
understand that bell shaped curve at least roughly as well as I do.
And, of course, the engineering idea of a backup system is a
very powerful idea. The engineering idea of breakpoints, that’s a

## Page 83

very powerful model too. The notion of a critical mass—that
comes out of physics—is a very powerful model.
All of these things have great utility in looking at ordinary
reality. And all of this cost beneﬁt analysis—hell, that’s all
elementary high school algebra. It’s just been dolled up a little bit
with fancy lingo. And you can demonstrate that point quite
simply: There’s not a person in this room viewing the work of a
very ordinary professional magician who doesn’t see a lot of
things happening that aren’t happening and not see a lot of
things happening that are happening.
I suppose the next most reliable models are from biology and
physiology because, after all, all of us are programmed by our
genetic makeup to be much the same.
Then, when you get into psychology, of course, it gets very
much more complicated. But it’s an ungodly important subject if
you’re going to have any worldly wisdom. And the reason why is
that the perceptual apparatus of man has shortcuts in it. The
brain cannot have unlimited circuitry. So someone who knows
how to take advantage of those shortcuts and cause the brain to
miscalculate in certain ways can cause you to see things that
aren’t there.
Now you get into the cognitive function as distinguished from
the perceptual function. And there, you are equally—more than
equally, in fact—likely to be misled. Again, your brain has a
shortage of circuitry and so forth, and it’s taking all kinds of little
automatic shortcuts. So when circumstances combine in certain
ways—or, more commonly, when your fellow man starts acting
like the magician and manipulates you on purpose by causing
you cognitive dysfunction—you’re a patsy. And so, just as a man
working with a tool has to know its limitations, a man working
with his cognitive apparatus has to know its limitations. And this
knowledge, by the way, can be used to control and motivate other
people.

## Page 84

So the most useful and practical part of psychology—which I
personally think can be taught to any intelligent person in a
week—is ungodly important. And nobody taught it to me, by the
way. I had to learn it later in life, one piece at a time. And it was
fairly laborious. It’s so elementary, though, that when it was all
over, I just felt like a total horse’s ass. And yeah, I’d been
educated at Caltech and the Harvard Law School and so forth. So
very eminent places miseducated people like you and me.
The elementary part of psychology—the psychology of
misjudgment, as I call it—is a terribly important thing to learn.
There are about 20 little principles. And they interact, so it gets
slightly complicated. But the guts of it is unbelievably important.
Terribly smart people make totally bonkers mistakes by failing to
pay heed to it. In fact, I’ve done it several times during the last
two or three years in a very important way. You never get totally
over making silly mistakes.
There’s another saying that comes from Pascal that I’ve
always considered one of the really accurate observations in the
history of thought. Pascal said, “The mind of man at one and the
same time is both the glory and the shame of the universe.” And
that’s exactly right. It has this enormous power. However, it also
has these standard misfunctions that often cause it to reach
wrong conclusions. It also makes man extraordinarily subject to
manipulation by others. For example, roughly half of the army of
Adolf Hitler was composed of believing Catholics. Given enough
clever psychological manipulation, what human beings will do is
quite interesting.
Personally, I’ve gotten so that I now use a kind of two track
analysis. First, what are the factors that really govern the
interests involved, rationally considered? And second, what are
the sub conscious inﬂuences where the brain, at a subconscious
level, is automatically doing these things—which, by and large,
are useful but which often misfunction? One approach is

## Page 85

rationality, the way you’d work out a bridge problem: by
evaluating the real interests, the real probabilities, and so forth.
And the other is to evaluate the psychological factors that cause
subconscious conclusions, many of which are wrong.
Now we come to another, somewhat less reliable form of
human wisdom: microeconomics. Here I ﬁnd it quite useful to
think of a free-market economy—or a partly free-market
economy—as sort of the equivalent of an ecosystem.
This is a very unfashionable way of thinking because early in
the days after Darwin came along, people like the robber barons
assumed that the doctrine of the survival of the ﬁttest
authenticated them as deserving power—you know, “I’m the
richest. Therefore, I’m the best. God’s in his heaven,” etc. And
that reaction of the robber barons was 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. Just as in an ecosystem, people who
narrowly specialize can get terribly good at occupying some little
niche. Just as animals ﬂourish in niches, people who specialize
in the business world—and get very good because they specialize
—frequently ﬁnd good economics that they wouldn’t get any
other way.
And once we get into microeconomics, we get into the concept
of advantages of scale. Now we’re getting closer to investment
analysis, because in terms of which businesses succeed and
which businesses fail, advantages of scale are ungodly
important.
For example, one great advantage of scale taught in all of the
business schools of the world is cost reductions along the so
called experience curve. Just doing something complicated in
more and more volume enables human beings, who 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

## Page 86

you get a whole lot of volume through your operation, you get
better at processing that volume. That’s an enormous advantage.
And it has a lot to do with which businesses succeed and fail.
Let’s go through a list—albeit an incomplete one—of possible
advantages of scale. Some come from simple geometry. If you’re
building a great circular tank, obviously, as you build it bigger,
the amount of steel you use in the surface goes up with the
square and the cubic volume goes up with the cube. So as you
increase the dimensions, you can hold a lot more volume per
unit area of steel.
There are all kinds of things like that where the simple
geometry—the simple reality—gives you an advantage of scale.
For example, you can get advantages of scale from TV
advertising. When TV advertising ﬁrst arrived—when talking
color pictures ﬁrst came into our living rooms—it was an
unbelievably powerful thing. And in the early days, we had three
networks that had whatever it was, say 90 percent of the
audience.
Well, if you were Procter & Gamble, you could afford to use
this new method of advertising. You could afford the very
expensive cost of network television because you were selling so
damn many cans and bottles. Some little guy couldn’t. And there
was no way of buying it in part. Therefore, he couldn’t use it. In
effect, if you didn’t have a big volume, you couldn’t use network
TV advertising, which was the most effective technique. So when
TV came in, the branded companies that were already big got a
huge tailwind. Indeed, they prospered and prospered and
prospered until some of them got fat and foolish, which happens
with prosperity, at least to some people.
And your advantage of scale can be an informational
advantage. If I go to some remote place, I may see Wrigley
chewing gum alongside Glotz’s chewing gum. Well, I know that
Wrigley is a satisfactory product whereas I don’t know anything

## Page 87

about Glotz’s. So if one is 40¢ and the other is 30¢, am I going to
take something I don’t know and put it in my mouth—which is a
pretty personal place, after all—for a lousy dime? So, in effect,
Wrigley, simply by being so well known, has advantages of scale
—what you might call an informational advantage.
Another advantage of scale comes from psychology.
Psychologists use the term social proof. We are all inﬂuenced—
subconsciously and, to some extent, consciously—by what we see
others do and approve. Therefore, if everybody’s buying
something, we think it’s better. We don’t like to be the one guy
who’s out of step. Again, some of this is at a subconscious level
and some of it isn’t. Sometimes, we consciously and rationally
think, “Gee, I don’t know much about this. They know more than
I do. Therefore, why shouldn’t I follow them?”
The social proof phenomenon, which comes right out of
psychology, gives huge advantages to scale—for example, with
very wide distribution, which of course is hard to get. One
advantage of Coca Cola is that it’s available almost everywhere in
the world.
Well, suppose you have a little soft drink. Exactly how do you
make it available all over the earth? The worldwide distribution
setup, which is slowly won by a big enterprise, gets 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.
There’s another kind of advantage to scale. In some
businesses, the very nature of things is to sort of cascade toward
the overwhelming dominance of one ﬁrm. The most obvious one
is daily news papers. There’s practically no city left in the United
States, aside from a few very big ones, where there’s more than
one daily newspaper. And, again, that’s a scale thing. Once I get
most of the circulation, I get most of the advertising. And once I
get most of the advertising and circulation, why would anyone

## Page 88

want the thinner paper with less information in it? So it tends to
cascade to a winner-take all situation. And that’s a separate form
of the advantages of-scale phenomenon.
Similarly, all these huge advantages of scale allow greater
specialization within the ﬁrm. Therefore, each person can be
better at what he does. And these advantages of scale are so
great, for example, that when Jack Welch16 came into General
Electric, he just said, “To hell with it. We’re either going to be
number one or number two in every ﬁeld we’re in or we’re going
to be out. I don’t care how many people I have to ﬁre and what I
have to sell. We’re going to be number one or number two or
out.”
That was a very tough minded thing to do, but I think it was a
very correct decision if you’re thinking about maximizing
shareholder wealth. And I don’t think it’s a bad thing to do for a
civilization either, because I think that General Electric is
stronger for having Jack Welch there.
And there are also disadvantages of scale. For example, we—
by which I mean Berkshire Hathaway—are the largest
shareholder in Capital Cities/ABC. And we had trade publications
there that got murdered, where our competitors beat us. And the
way they beat us was by going to a narrower specialization. We’d
have a travel magazine for business travel, so somebody would
create one that was addressed solely at corporate travel
departments. Like an ecosystem, you’re getting a narrower and
narrower specialization.
Well, they got much more efﬁcient. They could tell more to the
guys who ran corporate travel departments. Plus, they didn’t
have to waste the ink and paper mailing out stuff that corporate
travel departments weren’t interested in reading. It was a more
efﬁcient system. And they beat our brains out as we relied on our
broader magazine.

## Page 89

That’s what happened to The Saturday Evening Post and all
those things. They’re gone. What we have now is Motocross, which
is read by a bunch of nuts who like to participate in tournaments
where they turn somersaults on their motorcycles. But they care
about it. For them, it’s the principal purpose of life. A magazine
called Motocross is a total necessity to those people. And its proﬁt
margins would make you salivate. Just think of how narrowcast
that kind of publishing is. So occasionally, scaling down and
intensifying gives you the big advantage. Bigger is not always
better.
The great defect of scale, of course, which makes the game
interesting, so that the big people don’t always win, is that as you
get big, you get the bureaucracy. And with the bureaucracy
comes the territoriality—which is again grounded in human
nature. And the incentives are perverse. For example, if you
worked for AT & T in my day, it was a great bureaucracy. Who in
the hell was really thinking about the shareholder or anything
else? And in a bureaucracy, you think the work is done when it
goes out of your in basket into somebody else’s in basket. But, of
course, it isn’t. It’s not done until AT & T delivers what it’s
supposed to deliver. So you get big, fat, dumb, unmotivated
bureaucracies.
They also tend to become somewhat corrupt. In other words,
if I’ve got a department and you’ve got a department and we kind
of share power running this thing, there’s sort of an unwritten
rule: “If you won’t bother me, I won’t bother you, and we’re both
happy.” So you get layers of management and associated costs
that nobody needs. Then, while people are justifying all these
layers, it takes for ever to get anything done. They’re too slow to
make decisions, and nimbler people run circles around them.
The constant curse of scale is that it leads to big, dumb
bureaucracy—which, of course, reaches its highest and worst
form in government, where the incentives are really awful. That

## Page 90

doesn’t mean we don’t need governments, because we do. But it’s
a terrible problem to get big bureaucracies to behave. So people
go to stratagems. They create little decentralized units and fancy
motivation and training programs. For example, for a big
company, General Electric has fought bureaucracy with amazing
skill. But that’s 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. Of course, that’s Jack Welch.
But bureaucracy is terrible. And as things get very powerful
and very big, you can get some really dysfunctional behavior.
Look at Westinghouse. They blew billions of dollars on a bunch of
dumb loans to real estate developers. They put in some guy
who’d come up by some career path—I don’t know exactly what it
was, but it could have been refrigerators or something—and all of
a sudden, he’s loaning money to real estate developers building
hotels. It’s a very unequal contest. And, in due time, they lost all
those billions of dollars.
CBS provides an interesting example of another rule of
psychology, namely Pavlovian association.17 If people tell you
what you really don’t want to hear, what’s unpleasant, there’s an
almost automatic reaction of antipathy. You have to train
yourself out of it. It isn’t foredestined that you have to be this
way. But you will tend to be this way if you don’t think about it.
Television was dominated by one network, CBS, in its early
days. And [William S.] Paley was a god. But he didn’t like to hear
what he didn’t like to hear, and people soon learned that. So they
told Paley only what he liked to hear. Therefore, he was soon
living in a little cocoon of unreality and everything else was
corrupt—although it was a great business. So the idiocy that crept
into the system was carried along by this huge tide. It was a Mad
Hatter’s tea party the last 10 years under Bill Paley.
And that is not the only example, by any means. You can get
severe misfunction in the high ranks of business. And, of course,

## Page 91

if you’re investing, it can make a hell of a lot of difference. If you
take all the acquisitions that CBS made under Paley after the
acquisition of the network itself, with all his dumb advisers—his
investment bankers, management consultants, and so forth, who
were getting paid very handsomely—it was absolutely terrible.
So life is an everlasting battle between those two forces: to get
these advantages of scale on one side and a tendency to get a lot
like the US Department of Agriculture on the other side, where
they just sit around and so forth. I don’t know exactly what they
do. However, I do know that they do very little useful work.
On the subject of the advantages of economies of scale, I ﬁnd
chain stores quite interesting. Just think about it. The concept of
a chain store was a fascinating invention: You get this huge
purchasing power, which means that you have lower
merchandise costs. You get a whole bunch of little laboratories
out there in which you can conduct experiments. And you get
specialization. If one little guy is trying to buy across 27 different
merchandise categories inﬂuenced by traveling salesmen, he’s
going to make a lot of dumb decisions. But if your buying is done
in headquarters for a huge bunch of stores, you can get very
bright people who know a lot about refrigerators and so forth to
do the buying.
The reverse is demonstrated by the little store where one guy
is doing all the buying. It’s like the old story about the little store
with salt all over its walls. A stranger comes in and says to the
store owner, “You must sell a lot of salt.” And he replies, “No, I
don’t. But you should see the guy who sells me salt.”
So there are huge purchasing advantages. And then there are
the slick systems of forcing everyone to do what works. So a
chain store can be a fantastic enterprise.
It’s quite interesting to think about Walmart18 starting from a
single store in Arkansas against Sears, Roebuck, with its name,
reputation, and all of its billions. How does a guy in Bentonville,

## Page 92

Arkansas, with no money, blow right by Sears, Roebuck? And he
does it in his own lifetime—in fact, during his own late lifetime
because he was already pretty old by the time he started out with
one little store.
He played the chain store game harder and better than
anyone else. [Sam] Walton invented practically nothing. But he
copied everything anybody else ever did that was smart—and he
did it with more fanaticism and better employee manipulation.
So he just blew right by them all.
He also had a very interesting competitive strategy in the
early days. He was like a prizeﬁghter who wanted a great record
so he could be in the ﬁnals and make a big TV hit. So what did he
do? He went out and fought 42 palookas. Right? And the result
was knockout, knockout, knockout—42 times. Walton, being as
shrewd as he was, basically broke other small town merchants in
the early days. With his more efﬁcient system, he might not have
been able to tackle some titan head on at the time. But with his
better system, he could sure as hell destroy those small town
merchants. And he went around doing it time after time after
time. Then, as he got bigger, he started destroying the big boys.
Well, that was a very, very shrewd strategy.
You can say, “Is this a nice way to behave?” Well, capitalism is
a pretty brutal place. But I personally think that the world is
better for having Walmart. I mean, you can idealize small town
life, but I’ve spent a fair amount of time in small towns. And let
me tell you—you shouldn’t get too idealistic about all those
businesses he destroyed. Plus, a lot of people who work at
Walmart are very high grade, bouncy people who 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’s an interesting model of how the
scale of things and fanaticism combine to be very powerful.

## Page 93

And it’s also an interesting model on the other side—how, with
all its great advantages, the disadvantages of bureaucracy did
such terrible damage to Sears, Roebuck. Sears had layers and
layers of people it didn’t need. It was very bureaucratic. It was
slow to think. And there was an established way of thinking. If
you poked your head up with a new thought, the system kind of
turned against you. It was everything in the way of a
dysfunctional big bureaucracy that you would expect.
In all fairness, there was also much that was good about it. But
it just wasn’t as lean and mean and shrewd and effective as Sam
Walton. And, in due time, all Sears’ advantages of scale were not
enough to prevent it from losing heavily to Walmart and other,
similar retailers.
Here’s a model that we’ve had trouble with. Maybe you’ll be
able to ﬁgure it out better. Many markets get down to two or three
big competitors, or ﬁve or six. And in some of those markets,
nobody makes any money to speak of. But in others, everybody
does very well. Over the years, we’ve tried to ﬁgure out why the
competition in some markets gets sort of rational from the
investor’s point of view so that the shareholders do well, while in
other markets there’s destructive competition that destroys
shareholder wealth.
If it’s a pure commodity like airline seats, you can understand
why no one makes any money. As we sit here, just think of what
airlines have given to the world: safe travel, greater experience,
time with your loved ones, you name it. Yet the net amount of
money that’s been made by the shareholders of airlines since
Kitty Hawk is now a negative ﬁgure—a substantial negative
ﬁgure. Competition was so intense that, once it was unleashed by
deregulation, it ravaged shareholder wealth in the airline
business.
Yet in other ﬁelds—like cereals, for example—almost all the
big boys make out. If you’re some kind of a medium grade cereal

## Page 94

maker, you might make 15 percent on your capital. And if you’re
really good, you might make 40 percent. But why are cereals so
proﬁtable, despite the fact that it looks to me like they’re
competing like crazy with promotions, coupons, and everything
else? I don’t fully understand it.
Obviously, there’s a brand identity factor in cereals that
doesn’t exist in airlines. That must be the main factor that
accounts for it. And maybe the cereal makers, by and large, have
learned to be less crazy about ﬁghting for market share—because
if you get even one person who’s hell bent on gaining market
share … For example, if I were Kellogg19 and I decided that I had
to have 60 percent of the market, I think I could take most of the
proﬁt out of cereals. I’d ruin Kellogg in the process. But I think I
could do it.
In some businesses, the participants behave like a demented
Kellogg. In other businesses, they don’t. Unfortunately, I do not
have a perfect model for predicting how that’s going to happen.
For example, if you look around at bottler markets, you’ll ﬁnd
many markets where bottlers of Pepsi and Coke both make a lot
of money and many others where they destroy most of the
proﬁtability of the two franchises. That must get down to the
peculiarities of individual adjustment to market capitalism. I
think you’d have to know the people involved to fully understand
what was happening.
In microeconomics, of course, you’ve got the concept of
patents, trademarks, exclusive franchises,20 and so forth. Patents
are quite interesting. When I was young, I think more money
went into patents than came out. Judges tended to throw them
out based on arguments about what was really invented and
what relied on prior art. That isn’t altogether clear. But they
changed that. They didn’t change the laws, they just changed the
administration, so that it all goes to one patent court. And that

## Page 95

court is now very much more pro patent. So I think people are
now starting to make a lot of money out of owning patents.
Trademarks, of course, have always made people a lot of
money. A trademark system is a wonderful thing for a big
operation if it’s well known.
The exclusive franchise can also be wonderful. If there were
only three television channels awarded in a big city and you
owned one of them, there were only so many hours a day that
you could be on. So you had a natural position in an oligopoly in
the pre cable days. 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.
The great lesson in microeconomics is to discriminate
between when technology is going to help you and when it’s
going to kill you. And most people do not get this straight in their
heads. But a fellow like Buffett does. For example, when we were
in the textile business, which is a terrible commodity business,
we were making low end textiles, which are a real commodity
product. And one day, the people came to Warren and said,
“They’ve invented a new loom that we think will do twice as
much work as our old ones.” And Warren said, “Gee, I hope this
doesn’t work—because if it does, I’m going to close the mill.” And
he meant it.
What was he thinking? He was thinking, “It’s a lousy business.
We’re earning substandard returns and keeping it open just to be
nice to the elderly workers. But we’re not going to put huge
amounts of new capital into a lousy business.” And he knew that
the huge productivity increases that would come from a better
machine introduced into the production of a commodity product
would all go to the beneﬁt of the buyers of the textiles. Nothing
was going to stick to our ribs as owners.
That’s such an obvious concept—that there are all kinds of
wonderful new inventions that give you nothing as owners

## Page 96

except the opportunity to spend a lot more money in a business
that’s still going to be lousy. The money still won’t come to you.
All of the advantages from great improvements are going to ﬂow
through to the customers.
Conversely, if you own the only newspaper in Oshkosh and
they were to invent more efﬁcient ways of composing the whole
news paper, then when you got rid of the old technology and got
new, fancy computers and so forth, all of the savings would come
right through to the bottom line.
In all cases, the people who sell the machinery—and, by and
large, even the internal bureaucrats urging you to buy the
equipment—show you projections with the amount you’ll save at
current prices with the new technology. However, they don’t do
the second step of the analysis, which is to determine how much
is going to stay home and how much is just going to ﬂow through
to the customer. I’ve never seen a single projection incorporating
that second step in my life. And I see them all the time. Rather,
they always read, “This capital outlay will save you so much
money that it will pay for itself in three years.”
So you keep buying things that will pay for themselves in
three years. And after 20 years of doing it, somehow you’ve
earned a return of only about 4 percent per annum. That’s the
textile business. And it isn’t that the machines weren’t better. It’s
just 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 who bought the equipment. It’s such a simple idea. It’s
so basic. And yet it’s so often forgotten.
Then there’s another model from microeconomics that I ﬁnd
very interesting. When technology moves as fast as it does in a
civilization like ours, you get a phenomenon that I call
competitive destruction. You know, you have the ﬁnest buggy
whip factory, and all of a sudden, in comes this little horseless
carriage. And before too many years go by, your buggy whip

## Page 97

business is dead. You either get into a different business or
you’re dead—you’re destroyed. It happens again and again and
again.
And when these new businesses come in, there are huge
advantages for the early birds. When you’re an early bird, there’s
a model that I call surﬁng—when a surfer gets up and catches the
wave and just stays there, he can go a long, long time. But if he
gets off the wave, he becomes mired in shallows. But people get
long runs when they’re right on the edge of the wave, whether it’s
Microsoft or Intel or all kinds of people, including National Cash
Register21 in the early days.
The cash register was one of the great contributions to
civilization. It’s a wonderful story. [John Henry] Patterson was a
small retail merchant who didn’t make any money. One day,
somebody sold him a crude cash register, which 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.
But Patterson, having the kind of mind that he did, didn’t
think, “Oh, good for my retail business.” He thought, “I’m going
into the cash register business.” And, of course, he created
National Cash Register. And he surfed. He got the best
distribution system, the biggest collection of patents, and the
best of everything. He was a fanatic about everything important
as the technology developed.
I have in my ﬁles an early National Cash Register company
report in which Patterson described his methods and objectives.
And a well-educated orangutan could see that buying into a
partnership with Patterson in those early days, given his notions
about the cash register business, was a total 100 percent cinch.
And, of course, that’s exactly what an investor should be looking
for. In a long life, you can expect to proﬁt heavily from at least a

## Page 98

few of those opportunities if you develop the wisdom and will to
seize them. At any rate, surﬁng is a very powerful model.
However, Berkshire Hathaway, by and large, does not invest in
these people who are surﬁng on complicated technology. After
all, we’re cranky and idiosyncratic, as you may have noticed. And
Warren and I don’t feel like we have any great advantage in the
high tech sector. In fact, we feel like we’re at a big disadvantage
in trying to understand the nature of technical developments in
software, computer chips, or what have you. So we tend to avoid
that stuff, based on our personal inadequacies.
Again, that is a very, very powerful idea. Every person is going
to have a circle of competence. And it’s going to be very hard to
enlarge that circle. If I had to make my living as a musician … I
can’t even think of a level low enough to describe where I would
be sorted out to if music were the measuring standard of the
civilization.
So you have to ﬁgure out what your own aptitudes are. If you
play games where other people have the aptitudes and you don’t,
you’re going to lose. And that’s as close to certain as any
prediction you can make. You have to ﬁgure out where you’ve got
an edge. And you’ve got to play within your own circle of
competence.
If you want to be the best tennis player in the world, you may
start out trying and soon ﬁnd out that it’s hopeless—that other
people blow right by you. However, if you want to become the
best plumbing contractor in Bemidji, that is probably doable by
two-thirds of you. It takes a will. It takes the intelligence. But
after a while, you’d gradually know all about the plumbing
business in Bemidji and master the art. That is an attainable
objective, given enough discipline. And people who could never
win a chess tournament or stand in center court in a respectable
tennis tournament can rise quite high in life by slowly
developing a circle of competence, which results partly from

## Page 99

what they were born with and partly from what they slowly
develop through work.
So some edges can be acquired. And the game of life, to some
extent, for most of us, is trying to be something like a good
plumbing contractor in Bemidji. Very few of us are chosen to win
the world’s chess tournaments. Some of you may ﬁnd
opportunities surﬁng along in the new high tech ﬁelds—the
Intels, the Microsofts, and so on. The fact that we don’t think
we’re very good at it and have pretty well stayed out of it doesn’t
mean that it’s irrational for you to do it.
Well, so much for the basic microeconomic models, a little bit
of psychology, a little bit of mathematics, helping create what I
call the general substructure of worldly wisdom. Now, if you want
to go on from carrots to dessert, I’ll turn to stock picking, trying
to draw on this general worldly wisdom as we go.
I don’t want to get into emerging markets, bond arbitrage, and
so forth. I’m talking about nothing but plain vanilla stock
picking. That, believe me, is complicated enough. And I’m
talking about common stock picking.
The ﬁrst question is, what is the nature of the stock market?
And that gets you directly to this efﬁcient-market theory that got
to be the rage—a total rage—long after I graduated from law
school. And it’s rather interesting because one of the greatest
economists of the world is a substantial shareholder in Berkshire
Hathaway and has been from the very early days, after Buffett
was in control. His textbook always taught that the stock market
was perfectly efﬁcient and that nobody could beat it. But his own
money went into Berkshire and made him wealthy. So, like
Pascal in his famous wager, he hedged his bet.
Is the stock market so efﬁcient that people can’t beat it? Well,
the efﬁcient-market theory is obviously roughly right, meaning
that markets are quite efﬁcient and it’s quite hard for anybody to
beat the market by signiﬁcant margins as a stock picker by just

## Page 100

being intelligent and working in a disciplined way. Indeed, the
average result has to be the average result. By deﬁnition,
everybody can’t beat the market. As I always say, the iron rule of
life is that only 20 percent of the people can be in the top ﬁfth.
That’s just the way it is. So the answer is that it’s partly efﬁcient
and partly inefﬁcient.
And, by the way, I have a name for people who went to the
extreme efﬁcient-market theory, which is “bonkers.” It was an
intellectually consistent theory that enabled them to do pretty
mathematics, so I understand its seductiveness to people with
large mathematical gifts. It just had a difﬁculty in that the
fundamental assumption did not tie properly to reality. Again, to
the man with a hammer, every problem looks like a nail. If you’re
good at manipulating higher mathematics in a consistent way,
why not make an assumption that enables you to use your tool?
The model I like—to sort of simplify the notion of what goes on
in a market for common stocks—is the pari mutuel system22 at
the racetrack. If you stop to think about it, a pari mutuel system
is a market. Everybody goes there and bets, and the odds change
based on what’s bet. That’s what happens in the stock market.
Any damn fool can see that a horse carrying a light weight
with a wonderful win rate and a good post position, etc., etc., is
way more likely to win than a horse with a terrible record and
extra weight and so on and so on. But if you look at the damn
odds, the bad horse pays 100 to 1, whereas the good horse pays 3
to 2. Then it’s not clear which is statistically the best bet using
the mathematics of Fermat and Pascal. The prices have changed
in such a way that it’s very hard to beat the system. And then the
track is taking 17 percent off the top. So not only do you have to
outwit all the other bettors, but you’ve got to outwit them by such
a big margin that, on average, you can afford to take 17 percent
of your gross bets off the top and give it to the house before the
rest of your money can be put to work.

## Page 101

Given those mathematics, is it possible to beat the horses
using only one’s intelligence? Intelligence should give some edge
because lots of people who don’t know anything go out and bet
lucky numbers and so forth. Therefore, somebody who really
thinks about nothing but horse performance and is shrewd and
mathematical could have a very considerable edge, in the
absence of the frictional cost caused by the house take.
Unfortunately, what a shrewd horseplayer’s edge does in most
cases is to reduce his average loss over a season of betting from
the 17 percent that he would lose if he got the average result to
maybe 10 percent. However, there are actually a few people who
can beat the game after paying the full 17 percent.
I used to play poker, when I was young, with a guy who made a
substantial living doing nothing but betting on harness races.
Now, harness racing is a relatively inefﬁcient market. You don’t
have the depth of intelligence betting on harness races that you
do on regular races. What my poker pal would do was to think
about harness races as his main profession. And he would bet
only occasionally when he saw some mispriced bet available.
And by doing that, after paying the full handle to the house—
which I presume was around 17 percent—he made a substantial
living.
You have to say that’s rare. However, the market was not
perfectly efﬁcient. And if it weren’t for that big 17 percent
handle, lots of people would regularly be beating lots of other
people at the horse races. It’s efﬁcient, yes. But it’s not perfectly
efﬁcient. And with enough shrewdness and fanaticism, some
people will get better results than others.
The stock market is the same way, except that the house
handle is so much lower. If you take transaction costs—the
spread between the bid and the ask plus the commissions—and if
you don’t trade too actively, you’re talking about fairly low
transaction costs. So, with enough fanaticism and enough

## Page 102

discipline, some of the shrewd people are going to get way better
results than average in the nature of things.
It is not a bit easy. And, of course, 50 percent will end up in
the bottom half, and 70 percent will end up in the bottom 70
percent. But some people will have an advantage. And in a fairly
low-transaction-cost operation, they will get better than average
results in stock picking.
How do you get to be one of those who is a winner—in a
relative sense—instead of a loser? Here again, look at the pari
mutuel system. I had dinner last night by absolute accident with
the president of Santa Anita. He says that there are two or three
bettors who have a credit arrangement with the track, now that
they have off-track betting, who are actually beating the house.
The track is sending money out net after the full handle—a lot of
it to Las Vegas, by the way—to people who are actually winning
slightly, net, after paying the full handle. They’re that shrewd
about something with as much unpredictability as horse racing.
It’s not given to human beings to have such talent that they
can just know everything about everything all the time. But it is
given to human beings who work hard at it—who look and sift the
world for a mispriced bet—that they can occasionally ﬁnd one.
And the wise ones bet heavily when the world offers them that
opportunity. They bet big when they have the odds. And the rest
of the time, they don’t. It’s just that simple.
That is a very simple concept. And to me it’s obviously right,
based on experience not only from the pari mutuel system but
everywhere else. And yet, in investment management,
practically nobody operates that way. We operate that way—I’m
talking about Buffett and Munger. And we’re not alone in the
world. But a huge majority of people have some other crazy
construct in their heads. And instead of waiting for a near cinch
and loading up, they apparently ascribe to the theory that if they
work a little harder or hire more business school students, they’ll

## Page 103

come to know everything about everything all the time. To me,
that’s totally insane.
How many insights do you need? Well, I’d argue that you don’t
need many in a lifetime. If you look at Berkshire Hathaway and
all of its accumulated billions, the top 10 insights account for
most of it. And that’s with a very brilliant man—Warren’s a lot
more able than I am and very disciplined—devoting his lifetime
to it. I don’t mean to say that he’s only had 10 insights. I’m just
saying that most of the money came from 10 insights.
So you can get very remarkable investment results if you
think more like a winning pari mutuel player. Just think of it as a
heavy-odds against game full of bullshit and craziness with an
occasional mispriced something or other. And you’re probably
not going to be smart enough to ﬁnd thousands in a lifetime. And
when you get a few, you really load up. It’s just that simple.
When Warren lectures at business schools, he says, “I could
improve your ultimate ﬁnancial welfare by giving you a ticket
with only 20 slots in it so that you had 20 punches, representing
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.” He says, “Under those rules, you’d really
think carefully about what you did, and you’d be forced to load up
on what you’d really thought about. So you’d do so much better.”
Again, this is a concept that seems perfectly obvious to me.
And to Warren, it seems perfectly obvious. But this is one of the
very few business classes in the United States where anybody
will be saying so. It just isn’t the conventional wisdom.
To me, it’s obvious that the winner has to bet very selectively.
It’s been obvious to me since very early in life. I don’t know why
it’s not obvious to very many other people.
I think the reason why we got into such idiocy in investment
management is best illustrated by a story that I tell about the guy
who sold ﬁshing tackle. I asked him, “My god, they’re purple and

## Page 104

green. Do ﬁsh really take these lures?” And he said, “Mister, I
don’t sell to ﬁsh.”
Investment managers are in the position of that ﬁshing tackle
salesman. They’re like the guy who was selling salt to the guy
who already had too much salt. And as long as the guy will buy
salt, why, they’ll sell salt. But that isn’t what ordinarily works for
the buyer of investment advice.
If you invested Berkshire Hathaway– style, it would be hard to
get paid as an investment manager as well as they’re currently
paid, because you’d be holding a block of Walmart and a block of
Coca-Cola and a block of something else. You’d be sitting on your
ass. And the client would be getting rich. And, after a while, the
client would think, “Why am I paying this guy half a percent a
year on my wonderful passive holdings?”
So what makes sense for the investor is different from what
makes sense for the manager. And, as usual in human affairs,
what determines the behavior are incentives for the decision
maker, and getting the incentives right is a very, very important
lesson.
From all businesses, my favorite case on incentives is Federal
Express.23 The heart and soul of its system, which creates the
integrity of the product, is having all its 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 whole operation can’t
deliver a product full of integrity to Federal Express customers.
And it was always screwed up. They could never get it done on
time. They tried everything—moral suasion, threats, you name it.
And nothing worked. Finally, somebody got the idea to pay all
these people not so much an hour but so much a shift, and when
it’s all done, they can all go home. Well, their problems cleared
up overnight.
So getting the incentives right is a very, very important
lesson. It was not obvious to Federal Express what the solution

## Page 105

was. But maybe now, it will hereafter more often be obvious to
you.
All right, we’ve now recognized that the market is efﬁcient as
a pari mutuel system is efﬁcient—with the favorite more likely
than the long shot to do well in racing but not necessarily give
any betting advantage to those who bet on the favorite.
In the stock market, some railroad that’s beset by better
competitors and tough unions may be available at one third of its
book value. In contrast, IBM in its heyday might be selling at six
times book value. So it’s just like the pari mutuel system. Any
damn fool could plainly see that IBM had better business
prospects than the railroad. But once you put the price into the
formula, it wasn’t so clear anymore what was going to work best
for a buyer choosing between the stocks. So it’s a lot like a pari
mutuel system. And, therefore, it gets very hard to beat.
What style should the investor use as a picker of common
stocks in order to try to beat the market—in other words, to get
an above-average long term result? A standard technique that
appeals to a lot of people is called sector rotation. You simply
ﬁgure out when oils are going to outperform retailers, etc., etc.,
etc. You just 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.
However, I know of no really rich sector rotator. Maybe some
people can do it. I’m not saying they can’t. All I know is that all
the people I know who got rich—and I know a lot of them—did not
do it that way.
The second basic approach is the one that Ben Graham24
used, much admired by Warren and me. As one factor, Graham
had this concept of value to a private owner—what the whole
enterprise would sell for if it were available. And that was
calculable in many cases. Then, if you could take the stock price
and multiply it by the number of shares and get something that

## Page 106

was one third or less of sellout value, he would say that you’ve got
a lot of edge going for you. Even with an elderly alcoholic
running a stodgy business, this signiﬁcant excess of real value
per share working for you means that all kinds of good things
can happen to you. You had a huge margin of safety, as he put it,
by having this big excess value going for you.
But he was, by and large, operating when the world was in
shell shock from the 1930s, which was the worst contraction in
the English speaking world in about 600 years. Wheat in
Liverpool, I believe, got down to something like a 600 year low,
adjusted for inﬂation. People were so shell shocked for a long
time thereafter that Ben Graham could run his Geiger counter
over this detritus from the collapse of the 1930s and ﬁnd things
selling below their working capital per share and so on. And in
those days, working capital actually belonged to the
shareholders. If the employees were no longer useful, you just
sacked them all, took the working capital, and stuck it in the
owners’ pockets. That was the way capitalism then worked.
Nowadays, of course, the accounting is not realistic, because
the minute the business starts contracting, signiﬁcant assets are
not there. Under social norms and the new legal rules of the
civilization, so much is owed to the employees that the minute
the enterprise goes into reverse, some of the assets on the
balance sheet aren’t there anymore.
Now, that might not be true if you run a little auto dealership
yourself. You may be able to run it in a way that there’s no health
plan and this and that so that if the business gets lousy, you can
take your working capital and go home. But IBM can’t, or at least
didn’t. Just look at what disappeared from its balance sheet
when it decided that it had to change size both because the world
had changed techno logically and because its market position
had deteriorated.

## Page 107

And in terms of blowing it, IBM is some example. Those were
brilliant, disciplined people. But there was enough turmoil in
technological change that IBM got bounced off the wave after
surﬁng successfully for 60 years. And that was some collapse—an
object lesson in the difﬁculties of technology and one of the
reasons why Buffett and Munger don’t like technology very
much. We don’t think we’re any good at it, and strange things can
happen.
At any rate, the trouble with what I call the classic Ben
Graham concept is that gradually the world wised up, and those
real obvious bargains disappeared. You could run your Geiger
counter over the rubble, and it wouldn’t click.
But such is the nature of people who have a hammer—to
whom, as I mentioned, every problem looks like a nail—that the
Ben Graham followers responded by changing the calibration on
their Geiger counters. In effect, they started deﬁning a bargain in
a different way. And they kept changing the deﬁnition so that
they could keep doing what they’d always done. And it still
worked pretty well. So the Ben Graham intellectual system was a
very good one.
Of course, the best part of it all was his concept of Mr. Market.
Instead of thinking the market was efﬁcient, Graham treated it
as a manic depressive who comes by every day. And some days
Mr. Market says, “I’ll sell you some of my interest for way less
than you think it’s worth.” And other days, he comes by and says,
“I’ll buy your interest at a price that’s way higher than you think
it’s worth.” And you get the option of deciding whether you want
to buy more, sell part of what you already have, or do nothing at
all.
To Graham, it was a blessing to be in business with a manic-
depressive who gave you this series of options all the time. That
was a very signiﬁcant mental construct. And it’s been very useful
to Buffett, for instance, over his whole adult lifetime. However, if

## Page 108

we’d stayed with classic Graham the way Ben Graham did it, we
would never have had the record we have. And that’s because
Graham wasn’t trying to do what we did.
For example, Graham didn’t want to ever talk to management.
And his reason was that, like the best sort of professor aiming his
teaching at a mass audience, he was trying to invent a system
that anybody could use. And he didn’t feel that the man in the
street could run around and talk to management and learn
things. He also had a concept that management would often
couch the information very shrewdly to mislead. Therefore, it
was very difﬁcult. And that is still true, of course, human nature
being what it is.
And so, having started out as Grahamites—which, by the way,
worked ﬁne—we gradually got what I would call better insights.
And we realized that some company that was selling at two or
three times book value could still be a hell of a bargain because
of momentums implicit in its position, sometimes combined
with an unusual managerial skill plainly present in some
individual or other or some system or other. And once we’d
gotten over the hurdle of recognizing that a thing could be a
bargain based on quantitative measures that would have
horriﬁed Graham, we started thinking about better businesses.
And, by the way, the bulk of the billions in Berkshire
Hathaway have come from the better businesses. Much of the
ﬁrst $200 or $300 million came from scrambling around with
our Geiger counter. But the great bulk of the money has come
from the great businesses. And even some of the early money
was made by being temporarily present in great businesses.
Buffett Partnership, for example, owned American Express and
Disney when they got pounded down.
[Most investment managers are] in a game where the clients
expect them to know a lot about a lot of things. We didn’t have
any clients who could ﬁre us at Berkshire Hathaway. So we didn’t

## Page 109

have to be governed by any such construct. And we came to this
notion of ﬁnding a mispriced bet and loading up when we were
very conﬁdent that we were right. So we’re way less diversiﬁed.
And I think our system is miles better.
However, in all fairness, I don’t think [a lot of money
managers] could successfully sell their services if they used our
system. But if you’re investing for 40 years in some pension
fund, what 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’s all going to work out well in the end? So what if
there’s a little extra volatility? In investment management today,
everybody wants not only to win but to have the path never
diverge very much from a standard path except on the upside.
Well, that is a very artiﬁcial, crazy construct. That is really
hobbling yourself.
Now, investment managers would say, “We have to be that
way. That’s how we’re measured.” And they may be right in terms
of the way the business is now constructed. But from the
viewpoint of a rational consumer, the whole system’s bonkers
and draws a lot of talented people into socially useless activity.
And the Berkshire system is not bonkers. It’s so damned
elementary that even bright people are going to have limited,
really valuable insights in a very competitive world when they’re
ﬁghting against other very bright, hardworking people.
And it makes sense to load up on the very few good insights
you have instead of pretending to know everything about
everything at all times. You’re much more likely to do well if you
start out to do something feasible instead of something that isn’t
feasible. Isn’t that perfectly obvious? How many of you have 56
brilliant insights in which you have equal conﬁdence? Raise your
hands, please. How many of you have two or three insights that
you have some conﬁdence in? I rest my case.

## Page 110

We’ve really made the money out of high quality businesses.
In some cases, we bought the whole business, and in some cases,
we just bought a big block of stock. But when you analyze what
happened, the big money’s been made in the high quality
businesses. And most of the other people who’ve made a lot of
money have done so in high quality businesses.
I’d say that Berkshire Hathaway’s system is adapting to the
nature of the investment problem as it really is. Over the long
term, it’s hard for a stock to earn a much better return than the
business that underlies it earns. If the business earns 6 percent
on capital over 40 years and you hold it for that 40 years, you’re
not going to make much different than a 6 percent return, even if
you originally buy it at a huge discount. Conversely, if a business
earns 18 percent on capital over 20 or 30 years, even if you pay
an expensive looking price, you’ll end up with one hell of a result.
So the trick is getting into better businesses. And that involves all
of these advantages of scale that you could consider momentum
effects.
How do you get into these great companies? One method is
what I’d call the method of ﬁnding them small—get ’em when
they’re little. For example, buy Walmart when Sam Walton ﬁrst
goes public and so forth. A lot of people try to do just that. And
it’s a very beguiling idea. If I were a young man, I might actually
go into it. But it doesn’t work for Berkshire Hathaway anymore
because we’ve got too much money. We can’t ﬁnd anything that
ﬁts our size parameter that way. Besides, we’re set in our ways.
But I regard ﬁnding them small as a perfectly intelligent
approach for somebody to try with discipline. It’s just not
something that I’ve done.
Finding ’em big obviously is very hard because of the
competition. So far, Berkshire’s managed to do it. But can we
continue to do it? What’s the next Coca Cola investment for us?

## Page 111

Well, the answer to that is I don’t know. I think it gets harder for
us all the time.
And ideally—and we’ve done a lot of this—you get into a great
business that also has a great manager, because management
matters. For example, it’s made a hell of a difference to General
Electric that Jack Welch came in instead of the guy who took over
Westinghouse—one hell of a difference. So management matters,
too. And some of it is predictable. I do not think it takes a genius
to understand that Jack Welch was a more insightful person and
a better manager than his peers in other companies. Nor do I
think it took tremendous genius to understand that Disney had
basic momentums in place that are very powerful, and that
[Michael] Eisner and [Frank] Wells25 were very unusual
managers.
So you do get an occasional opportunity to get into a
wonderful business that’s being run by a wonderful manager.
And, of course, that’s hog heaven day. If you don’t load up when
you get those opportunities, it’s a big mistake.
Occasionally, you’ll ﬁnd a human being who’s so talented that
he can do things that ordinary skilled mortals can’t. I would
argue that Simon Marks26—who was second generation in Marks
& Spencer of England—was such a man. Patterson was such a
man at National Cash Register. And Sam Walton was such a man.
These people do come along, and, in many cases, they’re not all
that hard to identify. If they’ve got a reasonable hand—with the
fanaticism and intelligence and so on that these people generally
bring to the party—then management can matter very much.
However, averaged out, betting on the quality of a business is
better than betting on the quality of management. In other
words, if you have to choose one, bet on the business
momentum, not the brilliance of the manager. But very rarely,
you ﬁnd a manager who’s so good that you’re wise to follow him
into what looks like a mediocre business.

## Page 112

Another very simple effect I very seldom see discussed either
by investment managers or anybody else is the effect of taxes. If
you’re going to buy something that compounds for 30 years at 15
percent per annum and you pay one 35 percent tax at the very
end, the way that works out is that after taxes, you keep 13.3
percent per annum.
In contrast, if you bought the same investment but had to pay
taxes every year of 35 percent out of the 15 percent that you
earned, then your return would be 15 percent minus 35 percent
of 15 percent, or only 9.75 percent per year compounded. So the
difference there is over 3.5 percent. And what 3.5 percent does to
the numbers over long holding periods like 30 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 way
income taxes work.
Even with a 10 percent per annum investment, paying a 35
percent tax at the end gives you 8.3 percent after taxes as an
annual compounded result after 30 years. In contrast, if you pay
the 35 percent each year instead of at the end, your annual result
goes down to 6.5 percent. So you add nearly 2 percent of after tax
return per annum if you only achieve an average return by
historical standards from common stock investments in
companies with low dividend payout ratios.
But in terms of business mistakes that I’ve seen over a long
lifetime, I would 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. Warren and I personally don’t drill oil wells. We
pay our taxes. And we’ve done pretty well so far. Anytime
somebody offers you a tax shelter from here on in life, my advice
would be don’t buy it. In fact, anytime anybody offers you
anything with a big commission and a 200 page prospectus,
don’t buy it. Occasionally, you’ll be wrong if you adopt Munger’s

## Page 113

rule. However, over a lifetime, you’ll be a long way ahead—and
you will miss a lot of unhappy experiences that might otherwise
reduce your love for your fellow man.
There are huge advantages for an individual to get into a
position where you make a few great investments and just sit on
your ass: You’re paying less to brokers. You’re listening to less
nonsense. And if it works, the governmental tax system gives you
an extra 1, 2, or 3 percentage points per annum compounded.
And you think that most of you are going to get that much
advantage by hiring investment counselors and paying them 1
percent to run around, incurring a lot of taxes on your behalf?
Lots of luck.
Are there any dangers in this philosophy? Yes. Everything in
life has dangers. Since it’s so obvious that investing in great
companies works, it gets horribly overdone from time to time. In
the “nifty 50” days, everybody could tell which companies were
the great ones. So they got up to 50, 60, and 70 times earnings.
And just as IBM fell off the wave, other companies did too. Thus,
a large investment disaster resulted from too high prices. And
you’ve got to be aware of that danger. So there are risks. Nothing
is automatic and easy. But if you can ﬁnd some fairly priced,
great company and buy it and sit, that tends to work out very,
very well indeed—especially for an individual.
Within the growth stock model, there’s a sub position: There
are actually businesses that you will ﬁnd a few times in a lifetime
where any manager could raise the return enormously just by
raising prices, and yet they haven’t done it. So they have huge
untapped pricing power that they’re not using. That is the
ultimate no brainer.
That existed in Disney. It’s such a unique experience to take
your grandchild to Disneyland. You’re not doing it that often. And
there are lots of people in the country. And Disney found that it
could raise those prices a lot and the attendance stayed right up.

## Page 114

So a lot of the great record of Eisner and Wells was utter
brilliance, but the rest came from just raising prices at
Disneyland and Disney World and through videocassette sales of
classic animated movies.
At Berkshire Hathaway, Warren and I raised the prices of See’s
Candies a little faster than others might have. And, of course, we
invested in Coca Cola, which had some untapped pricing power.
And it also had brilliant management. So a [Roberto] Goizueta
and [Donald] Keough could do much more than raise prices. It
was perfect.
You will get a few opportunities to proﬁt from ﬁnding under -
pricing. There are actually people out there who don’t price
everything as high as the market will easily stand. And once you
ﬁgure that out, it’s like ﬁnding money in the street, if you have
the courage of your convictions.
If you look at Berkshire’s investments where a lot of the
money’s been made and you look for the models, you can see
that we twice bought into two newspaper towns, which have
since become one-newspaper towns. So we made a bet to some
extent. In one of those—The Washington Post27—we bought it at
about 20 percent of the value to a private owner. So we bought it
on a Ben Graham– style basis—at one ﬁfth of obvious value—and,
in addition, we faced a situation where you had both the top
hand in a game that was clearly going to end up with one winner
and a management with a lot of integrity and intelligence. That
one was a real dream. They’re very high-class people, the
Katharine Graham family. That’s why it was a dream—an
absolute, damn dream.
Of course, that came about back in ’73, ’74. And that was
almost like 1932. That was probably a once in 40 years type
denouement in the markets. That investment’s up about 50
times over our cost. If I were you, I wouldn’t count on getting any

## Page 115

investment in your lifetime quite as good as The Washington Post
was in ’73 and ’74.
Let me mention another model. Of course, Gillette28 and Coke
make fairly low priced items and have a tremendous marketing
advantage all over the world. And in Gillette’s case, they keep
surﬁng along new technology, which is fairly simple by the
standards of microchips. But it’s hard for competitors to do. So
they’ve been able to stay constantly near the edge of
improvements in shaving. There are whole countries where
Gillette has more than 90 percent of the shaving market.
GEICO29 is a very interesting model. It’s another one of the
hundred or so models you ought to have in your head. I’ve had
many friends in the sick business ﬁx game over a long lifetime.
And they practically all use the following formula—I call it the
cancer surgery formula. They look at this mess, and they ﬁgure
out if there’s anything sound left that can live on its own if they
cut away everything else. And if they ﬁnd anything sound, they
just cut away everything else. Of course, if that doesn’t work, they
liquidate the business. But it frequently does work.
And GEICO had a perfectly magniﬁcent business—submerged
in a mess, but still working. Misled by success, GEICO had done
some foolish things. They got to thinking that, because they were
making a lot of money, they knew everything. And they suffered
huge losses. All they had to do was to cut out all the folly and go
back to the perfectly wonderful business that was lying there.
And when you think about it, that’s a very simple model. And it’s
repeated over and over again. And, in GEICO’s case, think about
all the money we passively made. It was a wonderful business
combined with a bunch of foolishness that could easily be cut
out. And people were coming in who were temperamentally and
intellectually designed so they were going to cut it out.
That is a model you want to look for. And you may ﬁnd one or
two or three in a long lifetime that are very good. And you may

## Page 116

ﬁnd 20 or 30 that are good enough to be quite useful.
Finally, I’d like to once again talk about investment
management. That is a funny business, because on a net basis,
the whole investment management business together gives no
value added to all buyers combined. That’s the way it has to
work.
Of course, that isn’t true of plumbing, and it isn’t true of
medicine. If you’re going to make your careers in the investment
management business, you face a very peculiar situation. And
most investment managers handle it with psychological denial,
just like a chiropractor. That is the standard method of handling
the limitations of the investment management process. But if
you want to live the best sort of life, I would urge each of you not
to use the psychological denial mode.
I think a select few—a small percentage of the investment
managers—can 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 discipline of calling your shots and loading up if you want to
maximize your chances of becoming one who provides above
average real returns for clients over the long pull.
But I’m just talking about investment managers engaged in
common stock picking. I am agnostic elsewhere. I think there
may well be people who are so shrewd about currencies and this,
that, and the other thing that they can achieve good long term
records operating on a pretty big scale in that way. But that
doesn’t happen to be my milieu. I’m talking about stock picking
in American stocks. I think it’s hard to provide a lot of value
added to the investment management client, but it’s not
impossible.

## Page 117

TALK TWO REVISITED
As I reviewed Talk Two in 2006, I thought it would be improved
by adding 1) an attempt to explain the extreme investment
success of Harvard and Yale in recent years, plus 2) a prediction
about the outcomes for the many pools of capital that will now
try to duplicate the past success of Harvard and Yale by copying
or continuing their methods, plus 3) a brief comment about the
implications for the efﬁcient-market hypothesis as
demonstrated in a 2005 book, Fortune’s Formula by William
Poundstone.
To me, it seems likely that, as Harvard and Yale de-
emphasized conventional unleveraged holding of diversiﬁed US
common stocks, their investment success was boosted by factors
including the four described below:
1. By investing in LBO [leveraged buyout] funds, Harvard and
Yale introduced leverage into their results from owning
interests in US businesses. And the LBO fund structure
gave them a way to make their leveraged business
investments in a manner safer than is possible in a normal
margin account, prone during panics to forced sales.
Decent comparative results often followed in markets with
tolerable general outcomes. And this happened even when
net-after-cost results from investments in the LBO funds
were no better than would have occurred through only
slightly leveraged investment in an index of US stocks.
2. In category after category, Harvard and Yale selected or
directly employed investment managers who were way
above average in ability, providing additional evidence that
investment markets are not perfectly efﬁcient and that

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some good investment results come from abnormal skill or
other abnormal advantage. As one example, Harvard and
Yale, by reason of their own prestige, were able to get into
some of the most proﬁtable high-tech venture capital
funds not available to all other investors. These funds,
using momentum provided by their own past success, had
an opportunity advantage over less well-established
venture capital operations in that the best entrepreneurs,
quite logically, made early presentations to the best-
regarded funds.
3. Harvard and Yale wisely and opportunistically imitated
investment banking ﬁrms by going into several activities
that were then non traditional, like investing in distressed
US corporate bonds and high-coupon foreign bonds and
leveraged ﬁxed income arbitrage, during a period when
many good opportunities were available to skilled
operators in the activities chosen.
4. Finally, the beneﬁts that came to Harvard and Yale in
recent years through leverage and unconventionality were
often, of course, given a large tailwind by a happy
combination of declining interest rates and rising price-
earnings ratios for stocks.
The extreme investment success of Harvard and Yale gives
me both pleasure and pain. My pleasure comes from this
demonstration that academic skill is often useful in worldly
affairs. People like me who were attracted by academia yet have
gone into business naturally respond to such worldly
achievement much like the many modern scientists who relish
the example of Thales of Miletus.30 This scientist of antiquity
made a large proﬁt by leasing most of the olive presses in his

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area just before the occurrence of a particularly bountiful
harvest.
My pain comes from 1) foreseeing a lot of future adversity for
other worthy institutions, driven by envy and salesmen into
enthusiastic imitation of Harvard and Yale, and 2) disapproval of
the conduct of many of the salesmen likely to succeed in pushing
the imitation—something similar to what I fear happened near
the end of the high-tech bubble. At that time, envy of successful
early-stage, high-tech venture capital investors like Stanford,
plus the dubious sales methods of many venture capitalists,
caused about $90 billion to rush into low-quality, imitative early-
stage ventures that by now may have created as much as $45
billion in net losses for late-coming investors.
Moreover, Harvard and Yale may now need new displays of
unconventional wisdom that are different from their last
displays. It is quite counterintuitive to decrease that part of one’s
activity that has recently worked best, but this is often a good
idea. And so also with reducing one’s perception of one’s needs
instead of increasing risks in an attempt to satisfy perceived
needs.
Talk Two was made in 1994, about 12 years before this
addendum was written. And during that 12 years much useful
thought and data collection has supported the idea that neither
securities markets nor pari-mutuel betting systems at race
tracks prevent some venturers from gaining highly satisfactory,
way-above-average results through unusual skill. William
Poundstone’s book Fortune’s Formula collects much of the modern
evidence on this point in a highly entertaining way. Moreover, the
book contains an account of the lolla palooza investment record
of Claude Shannon, pioneer scientist in information theory, that
makes Shannon’s methods look much like those of Charlie
Munger.

## Page 120

WORLDLY WISDOM, UPDATED: Q & A WITH CHARLIE
How do you and Warren evaluate an acquisition candidate?
We’re light on ﬁnancial yardsticks. We apply lots of subjective
criteria: Can we trust management? Can it harm our reputation?
What can go wrong? Do we understand the business? Does it
require capital infusions to keep it going? What is the expected
cash ﬂow? We don’t expect linear growth; cyclicality is ﬁne with
us as long as the price is appropriate.
What should a young person look for in a career?
I have three basic rules—meeting all three is nearly impossible,
but you should try anyway:
Don’t sell anything you wouldn’t buy yourself.
Don’t work for anyone you don’t respect and admire.
Work only with people you enjoy.
I have been incredibly fortunate in my life: With Warren I had
all three.
What overall life advice do you have for young people?
Spend each day trying to be a little wiser than you were when you
woke up. Discharge your duties faithfully and well. Step-by-step
you get ahead, but not necessarily in fast spurts. But you build
discipline by preparing for fast spurts. Slug it out one inch at a
time, day by day, and at the end of the day—if you live long
enough—like most people, you will get out of life what you
deserve.
Life and its various passages can be hard, brutally hard. The
three things I have found helpful in coping with its challenges
are:

## Page 121

Have low expectations.
Have a sense of humor.
Surround yourself with the love of friends and family.
Above all, live with change and adapt to it. If the world didn’t
change, I’d still have a 12 handicap.

## Page 122

CHAPTER 4; TALK THREE
stripe.press/pca-7
A Lesson on Elementary,Worldly Wisdom as It Relates toInvestment Management and
Business Revisited
APRIL 19, 1996STANFORD LAW SCHOOL
This talk was given in 1996 to the students of Professor William C.
Lazier, who was the Nancy and Charles Munger professor of business
at Stanford University Law School.
Because this talk—published in Outstanding Investor Digest on
December 29, 1997, and March 13, 1998—repeats many of the ideas and
much of the language included in other talks, particularly
“Practical Thought about Practical Thought?,” your editor has
abridged certain passages and added comments to maintain the logic
and flow of the speech. Even with the abridgments, this talk
includes many unique ideas, as well as familiar ones expressed in
novel ways.
What I’m going to try to do today is to extend the remarks I made
two years ago at the USC Business School. You were assigned a

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transcript of my USC talk. There’s nothing I said then that I
wouldn’t repeat today. But I want to amplify what I said then.
It’s perfectly clear that if Warren Buffett had never learned
anything new after graduating from the Columbia Business
School, Berkshire would be a pale shadow of its present self.
Warren would have gotten rich, because what he learned from
Ben Graham at Columbia was enough to make anybody rich. But
he wouldn’t have the kind of enterprise Berkshire Hathaway is if
he hadn’t kept learning.
How do you get worldly wisdom? What system do you use to
rise into the tiny top percentage of the world in terms of having
sort of an elementary, practical wisdom?
I’ve long believed that a certain system, which almost any
intelligent person can learn, works way better than the systems
that most people use. As I said at the USC Business School, what
you need is a latticework of mental models in your head. And you
hang your actual experience and your vicarious experience that
you get from reading and so forth on this latticework of powerful
models. And with that system, things gradually get to ﬁt together
in a way that enhances cognition.
[Charlie discusses several of the speciﬁc mental models elaborated in
other talks.]
Your assigned reading for today included the latest annual
letters from Jack Welch and Warren Buffett relating to General
Electric and Berkshire Hathaway, respectively. Jack Welch has a
PhD in engineering, and Warren plainly could have gotten a PhD
in any ﬁeld he wanted to pursue. And both gentlemen are
inveterate teachers. Worldly wisdom is quite academic when you
get right down to it. Look at what General Electric has achieved—
and, for that matter, what Berkshire Hathaway has achieved.

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Of course, Warren had a professor and mentor, Ben Graham,
for whom he had a great affection. Graham was so academic that
when he graduated from Columbia, three different academic
departments invited him into their PhD programs and asked him
to start teaching immediately as part of the PhD program:
literature, Greek and Latin classics, and mathematics.
Graham had a very academic personality. I knew him. He was
a lot like Adam Smith31—very preoccupied, very brilliant. He
even looked like an academic. And he was a good one. And
Graham, without ever really trying to maximize the gaining of
wealth, died rich—even though he was always generous and
spent 30 years teaching at Columbia and authored or coauthored
the best textbooks in his ﬁeld. So I would argue that academia
has a lot to teach about worldly wisdom and that the best
academic values really work.
Of course, when I urge a multidisciplinary approach—that
you’ve got to have the main models from a broad array of
disciplines, and you’ve got to use them all—I’m really asking you
to ignore jurisdictional boundaries. And the world isn’t
organized that way. It discourages the jumping of jurisdictional
boundaries. Big bureaucratic businesses discourage it. And, of
course, academia itself discourages it. All I can say there is that,
in that respect, academia is horribly wrong and dysfunctional.
Some of the worst dysfunctions in businesses come from the
fact that they balkanize reality into little individual departments,
with territoriality and turf protection and so forth. So if you want
to be a good thinker, you must develop a mind that can jump the
jurisdictional boundaries. You don’t have to know it all. Just take
in the best big ideas from all these disciplines. And it’s not that
hard to do.
I might try and demonstrate that point using the card game of
contract bridge. Suppose you want to be good at declarer play in
contract bridge. Well, you know the contract—you know what you

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have to achieve. And you can count up the sure winners you have
by laying down your high cards and your invincible trumps. But
if you’re a trick or two short, how are you going to get the other
needed tricks? Well, there are only six or so different standard
methods. You’ve got long suit establishment. You’ve got ﬁnesses.
You’ve got throw-in plays. You’ve got crossruffs. You’ve got
squeezes. And you’ve got various ways of misleading the defense
into making errors. So it’s a very limited number of models. But
if you only know one or two of those models, then you’re going to
be a horse’s patoot in declarer play. Further more, these things
interact. Therefore, you have to know how the models interact.
Otherwise, you can’t play the hand right.
Similarly, I’ve told you to think forward and backward. Well,
great declarers in bridge think, “How can I take the necessary
winners?” But they think it through backward, too: “What could
possibly go wrong that could cause me to have too many losers?”
Both methods of thinking are useful. So in the game of life, get
the needed models into your head and think it through forward
and backward. What works in bridge will work in life.
That contract bridge is so out of vogue in your generation is a
tragedy. China is way smarter than we are about bridge. They’re
teaching bridge in grade school now. And God knows the Chinese
do well enough when introduced to capitalist civilization. If we
compete with a bunch of people who really know how to play
bridge when our people don’t, it’ll be just one more disadvantage
we don’t need.
Since your academic structure, by and large, doesn’t
encourage minds jumping jurisdictional boundaries, you’re at a
disadvantage because, in that one sense, even though academia’s
very useful to you, you’ve been mistaught. My solution for you is
one that I got at a very early age, from the nursery: the story of
the Little Red Hen.32 The punch line, of course, is: “‘Then I’ll do it
myself,’ said the Little Red Hen.”

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So if your professors won’t give you an appropriate multi -
disciplinary approach—if each wants to overuse his own models
and underuse the important models in other disciplines—you
can correct that folly yourself. Just because he’s a horse’s patoot,
you don’t have to be one too. You can reach out and grasp the
model that better solves the overall problem. All you have to do is
know it and develop the right mental habits. And it’s kind of fun
to sit there and outthink people who are way smarter than you
are because you’ve trained yourself to be more objective and
multidisciplinary. Furthermore, there’s a lot of money in it—as I
can testify from my own personal experience.
[Charlie begins the Coca-Cola business case detailed in Talk Four,
“Practical Thought about Practical Thought?,” and discusses the
importance of ﬂavor.]
One of my favorite business stories comes from Hershey.33
They get their ﬂavor because they make their cocoa butter in old
stone grinders that they started with in the 1800s in
Pennsylvania. And a little bit of the husk of the cocoa bean winds
up in the chocolate. Therefore, they get that odd ﬂavor that
people like in Hershey’s chocolate.
Hershey knew enough when they wanted to expand into
Canada to know they shouldn’t change their winning ﬂavor.
Therefore, they copied their stone grinders. Well, it took them
ﬁve years to duplicate their own ﬂavor. As you can see, ﬂavors
can be quite tricky. Even today, there’s a company called
International Flavors and Fragrances. It’s the only company I
know that does something on which you can’t get a copyright or a
patent but which nevertheless receives a permanent royalty.
They manage to do that by helping companies develop ﬂavors
and aromas in their trademarked products, like shaving cream.

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The slight aroma of shaving cream is very important to
consumption. So all of this stuff is terribly important.
[Continuing the Coca-Cola case study, Charlie explains how our
understanding of graphic depictions of mathematical ideas are rooted
in biology.]
My friend, Dr. Nat Myhrvold, who’s the chief technology ofﬁcer
at Microsoft, is bothered by this. He’s a PhD physicist and knows
a lot of math. And it disturbs him that biology could create a
neural apparatus that could do automatic differential equations
at fast speed, and yet, everywhere he looks, people are total
klutzes at dealing with ordinary probabilities and ordinary
numbers.
By the way, I think Myhrvold’s wrong to be amazed by that.
The so-called ﬁtness landscape of our ancestors forced them to
know how to throw spears, run around, turn corners, and what
have you long before they had to think correctly like Myhrvold.
So I don’t think he should be so surprised. However, the
difference is so extreme that I can understand how he ﬁnds it
incongruous.
At any rate, mankind invented a system to cope with the fact
that we are so intrinsically lousy at manipulating numbers. It’s
called the graph. Oddly enough, it came out of the Middle Ages.
It’s the only intellectual invention of the monks during the
Middle Ages I know of that’s worth a damn. The graph puts
numbers in a form that looks like motion. So it’s using some of
this primitive neural stuff in your system in a way that helps you
understand it. So the Value Line34 graphs are very useful.
The graph I’ve distributed is on log paper, which is based on
the natural table of logarithms. And that’s based on the
elementary mathematics of compound interest, which is one of
the most important models there is on earth. So there’s a reason

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why that graph is in that form. And if you draw a straight line
through data points on a graph on log paper, it will tell you the
rate at which compound interest is working for you. So these
graphs are marvelously useful. I don’t use Value Line’s
predictions because our system works better for us than theirs—
in fact, a lot better. But I can’t imagine not having their graphs
and their data. It’s a marvelous, marvelous product.
[Charlie discusses the importance of trademarks to Coca-Cola’s success
and carries it over to a discussion of food products and Carnation.]
Now, when Carnation35 tried to make a deal for its trademark,
there was this one guy who sold Carnation Fish. So help me God,
that was his trade name. Don’t ask me why. And every time
they’d say, “We’ll pay you $250,000,” he’d say, “I want $400,000.”
And then, four years later, they’d say, “We’ll give you $1 million,”
and he’d say, “I want $2 million.” And they just kept doing that all
the way through. They never did buy the trademark—at least,
they hadn’t bought it the last time I looked.
In the end, Carnation came to him sheepfacedly and said,
“We’d like to put our quality control inspectors into your ﬁsh
plants to make sure that your ﬁsh are perfect, and we’ll pay all
the costs,” which he quickly and smirkily allowed. So he got free
quality control in his ﬁsh plants, courtesy of the Carnation
Company.
This history shows the enormous incentive you create if you
give a guy a trademark. And this incentive is very useful to the
wider civilization. As you see, Carnation got so that it was
protecting products that it didn’t even own. That sort of outcome
is very, very desirable. So there are some very fundamental
microeconomic reasons why even communist countries should
protect trademarks. They don’t all do it, but there are very
powerful reasons why they should. And, by and large, averaged

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out around the world, trademark protection has been pretty
good.
[Charlie applies various mental models to Coca-Cola.]
However, if you don’t have the basic models and the basic
mental methods for dealing with the models, then all you can do
is to sit there twiddling your thumbs as you look at the Value Line
graph. But you don’t have to twiddle your thumbs. You’ve got to
learn 100 models and a few mental tricks and keep doing it all of
your life. It’s not that hard. And the beauty of it is that most
people won’t do it—partly because they’ve been miseducated.
And I’m here trying to help you avoid some of the perils that
might otherwise result from that miseducation.
Okay. We’ve been through some of the general ideas in the
search for worldly wisdom. And now I want to turn to something
even more extreme and peculiar than the talk I’ve already given
you. Of all the models that people ought to have in useful form
and don’t, perhaps the most important lie in the area of
psychology.
I recently had an instructive experience. I just returned from
Hong Kong. I have a pal there who’s a headmaster of one of the
leading schools. He gave me this book called The Language
Instinct, written by Steven Pinker.36 Well, Pinker is a semanticist
professor who rose in the shadow of Noam Chomsky, Linguistics
Institute professor at MIT, who is probably the greatest
semanticist who ever lived. And Pinker says that human
language ability is not just learned—it’s deeply buried, to a
considerable extent, in the genome. It’s not in the genome of the
other animals, including the chimpanzee, to any really useful
extent. It’s a gift that came to humans. And Pinker proves his
point pretty well. Of course, Chomsky’s already proven it. You
have to be pretty ignorant not to realize that a good deal of

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language ability is right there in the human genome. And even
though you have to work like hell to improve it through
education, you start with a big leg up in your genes.
Pinker can’t understand why Chomsky—who, again, is such a
genius—takes the position that the jury’s still out about why this
ability is in the human genome. Pinker, in effect, says, “Like hell,
the jury is still out! The language instinct got into humans in
exactly the same way that everything else got there—through
Darwinian natural selection.”
Well, the junior professor is clearly right, and Chomsky’s
hesitation is a little daft. But if the junior professor and I are
right, how has a genius like Chomsky made an obvious
misjudgment? The answer’s quite clear to me: Chomsky is
passionately ideological. He is an extreme egalitarian leftist who
happens to be a genius. And he’s so smart that he realized that if
he concedes this particular Darwinian point, the implications
threaten his leftist ideology. So he naturally has his conclusion
affected by his ideological bias. And that gets into another lesson
in worldly wisdom: If ideology can screw up the head of
Chomsky, imagine what it does to people like you and me.
Ideology does some strange things and distorts cognition
terribly. If you get a lot of heavy ideology young, and then you
start expressing it, you are really locking your brain into a very
unfortunate pattern. And you are going to distort your general
cognition.
There’s a very interesting history if you take Warren Buffett as
an example of worldly wisdom. Warren adored his father, who
was a wonderful man. But Warren’s father was a very heavy
ideologue—right wing, it happened to be—who hung around with
other very heavy ideologues—right wing, naturally. Warren
observed this as a kid, and he decided that ideology was
dangerous and that he was going to stay a long way away from it.

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And he has throughout his whole life. That has enormously
helped the accuracy of his cognition.
I learned the same lesson in a different way. My father hated
ideology. Therefore, all I had to do was imitate my father and,
thereby, stay on what I regard as the right path. People like [Bob]
Dornan on the right or [Ralph] Nader on the left have obviously
gone a little daft. They’re extreme examples of what ideology will
do to you—particularly violently expressed ideology. Since it
pounds ideas in better than it convinces out, it’s 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
wary of heavy ideology. You can have heavy ideology in favor of
accuracy, diligence, and objectivity. But a heavy ideology that
makes you absolutely sure that the minimum wage should be
raised or that it shouldn’t, and it’s kind of a holy construct where
you know you’re right, makes you a bit nuts.
This is a very complicated system. And life is one damn
relatedness after another. It’s all right to think that, on balance,
you suspect that civilization is better if it lowers the minimum
wage or raises it. Either position is okay. But being totally sure on
issues like that with a strong, violent ideology, in my opinion,
turns you into a lousy thinker. So beware of ideology-based
mental misfunctions.
[Charlie laments how poorly the ﬁeld of psychology deals with incentive-
caused bias.]
Another reason that I mentioned Pinker, the semanticist who
wrote the book that I told you about earlier, is that at the end of
his book, he says, roughly, “I’ve read the psychology textbooks.
And they’re daft.” He says, “This whole subject is misorganized
and mistaught.”

## Page 132

Well, I have far less in the way of qualiﬁcations than Pinker. In
fact, I’ve never taken a single course in psychology. However, I’ve
come to exactly the same conclusion—that the psychology texts,
while they are wonderful in part, are also signiﬁcantly daft.
In fact, just take simple psychological denial. About three
centuries before the birth of Christ, Demosthenes said, “What a
man wishes, that also will he believe.” Well, Demosthenes was
right.
I had a family acquaintance whose much-loved son, who was
brilliant and a star football player, ﬂew off over the ocean and
never came back. Well, his mother thought he was still alive. The
mind will sometimes ﬂip so that the wish becomes the belief. It
will do so at various levels. Individuals vary in how much
psychological denial they get. But miscognition from denial
overwhelmingly pervades the reality that you’re going to have to
deal with. And yet, you won’t ﬁnd an adequate treatment of
simple psychological denial in psychology texts.
So you can’t learn psychology the way your professors teach
it. You’ve got to learn everything they teach, but you’ve got to
learn a lot more that they don’t teach, because they don’t handle
their own subject correctly.
Psychology, to me, as currently organized, is like electro -
magnetism after [Michael] Faraday37 but before Maxwell—a lot
has been discovered, but no one mind has put it all together in
proper form. And it should be done because it wouldn’t be that
hard to do—and it’s enormously important.
Just open a psychology text, turn to the index, and look up
envy. Well, envy made it into one or two or three of the Ten
Commandments. Moses knew all about envy. The old Jews, when
they were herding sheep, knew all about envy. It’s just that
psychology professors don’t know about envy. Books that thick
are teaching a psychology course without envy? And with no
simple psychological denial? And no incentive-caused bias?

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And psychological texts don’t deal adequately with
combinations of factors. I told you earlier to be aware of the
lollapalooza effect, when two or three or more forces are
operating in the same direction. Well, the single most publicized
psychology experiment ever done is the Milgram experiment,38
where they asked people to apply what they had every reason to
believe was heavy electrical torture on innocent fellow human
beings. And they manipulated most of these decent volunteers
into doing the torture. [Stanley] Milgram performed the
experiment right after Hitler had gotten a bunch of believing
Lutherans, Catholics, and so forth to perform unholy acts they
should have known were wrong. Milgram was trying to ﬁnd out
how much authority could be used to manipulate high-grade
people into doing things that were clearly and grossly wrong.
And he got a very dramatic effect. He managed to get high-grade
people to do many awful things. But for years, it was in the
psychology books as a demonstration of authority—how
authority could be used to persuade people to do awful things.
Of course, that’s mere ﬁrst-conclusion bias. That’s not the
complete and correct explanation. Authority is part of it.
However, there were also quite a few other psychological
principles, all operating in the same direction, that achieved that
lollapalooza effect precisely because they acted in combination
toward the same end. People have gradually ﬁgured that out. And
if you read the recent psychology texts at a place like Stanford,
you’ll see that they’ve now managed to get it about two-thirds
right. However, here’s the main experiment in all of psychology,
and even at Stanford, they still leave out some of the important
causes of Milgram’s results.
How can smart people be so wrong? Well, the answer is that
they don’t do what I’m telling you to do—which is to take all the
main models from psychology and use them as a checklist in
reviewing outcomes in complex systems.

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No pilot takes off without going through his checklist: A, B, C,
D … And no bridge player who needs two extra tricks plays a
hand without going down his checklist and ﬁguring out how to do
it. But these psychology professors think they’re so smart that
they don’t need a checklist. But they aren’t that smart. Almost
nobody is. Or maybe nobody is. If they used a checklist, they’d
realize the Milgram experiment harnesses six psychological
principles at least—not three. All they’d have to do is to go down
the checklist to see the ones that they missed. Similarly, without
this system of getting the main models and using them together
in a multi-modular way, you’ll screw up time after time after
time, too.
One reason psychology professors so screw up denial is that
it’s hard to do demonstrative experiments without conduct
forbidden by ethics. To demonstrate how misery creates mental
dysfunction in people, think of what you’d have to do to your
fellow human beings. And you’d have to do it without telling
them about the injury to come. So clearly there are ethical
reasons why it’s practically impossible to do the experiments
necessary to best lay out the ways human misery creates human
mental misfunction.
Most professors solve this problem, in effect, by assuming “If I
can’t demonstrate it with my experiments, then it doesn’t exist.”
However, obviously, that’s asinine. If something is very
important but can’t be perfectly and precisely demonstrated
because of ethical constraints, you can’t just treat it like it doesn’t
exist. You have to do the best you can with it, with such evidence
as is available.
Pavlov himself spent the last 10 years of his life torturing
dogs. And he published. Thus, we have a vast amount of data
about misery-caused mental misfunction in dogs and its
correction. Yet it’s in no introductory psychology book that you’ll
ever see. I don’t know whether they don’t like the fact that Pavlov

## Page 135

tortured dogs or whether B. F. Skinner,39 by overclaiming when
he lapsed into his literary mode, made the drawing of
implications from animal behavior into human behavior
unpopular. However, for some crazy reason or other, the
psychology books are grossly inadequate in dealing with misery-
caused mental misfunction.
You may say, “What difference does all this psychological
ignorance make?” Well, if I’m right, you need these models that
are blanked out by this ignorance. And, furthermore, you need
them in a form whereby if there are 20 constructs, you have all
20. In other words, you shouldn’t be operating with 10. And you
need to use them as a checklist. So you have to go back and put
in your own head what I’d call the psychology of misjudgment in
a form whereby you have all of the important models and you
can use them. And you especially need them when four or ﬁve
forces from these models come together to operate in the same
direction. In such cases, you often get lollapalooza effects—which
can make you rich, or they can kill you. So it’s essential that you
beware of lollapalooza effects.
There’s only one right way to do it: You 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 consequences.
[Charlie discusses the lack of multidisciplinary teaching in the
professions, especially how the ﬁeld of psychology is virtually ignored in
academia.]
You can also learn when you’re playing the game of
persuasion—for a reputable reason—to combine these forces in a
way that makes you more effective. Let me give you an example
of that—of wise psychology of yore. In Captain [James] Cook’s40
day, he took these long voyages. At the time, scurvy was the

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dread of the long voyage. In scurvy, your living gums putrefy in
your mouth, after which the disease gets unpleasant and kills
you. And being on a primitive sailing ship with a bunch of dying
sailors is a very awkward business.
So everybody was terribly interested in scurvy, but they didn’t
know about vitamin C. Well, Captain Cook, being a smart man
with a multiple-models kind of approach, noticed that Dutch
ships had less scurvy than English ships on long voyages. So he
said, “What are the Dutch doing that’s different?” And he noticed
they had all these barrels of sauerkraut. So he thought, “I’m
going on these long voyages, and it’s very dangerous. Sauerkraut
may help.” So he laid in all this sauerkraut, which, incidentally,
happens to contain a trace of vitamin C.
But English sailors were a tough, cranky, and dangerous
bunch in that day. They hated “krauts.” And they were used to
their standard food and booze. So how do you get such English
sailors to eat sauerkraut?
Well, Cook didn’t want to tell ’em that he was doing it in the
hope it would prevent scurvy—because they might mutiny and
take over the ship if they thought that he was taking them on a
voyage so long that scurvy was likely. So here’s what he did:
Ofﬁcers ate at one place where the men could observe them. And
for a long time, he served sauerkraut to the ofﬁcers but not to the
men. And then, ﬁnally, Captain Cook said, “Well, the men can
have it one day a week.” In due course, he had the whole crew
eating sauerkraut.
I regard that as a very constructive use of elementary
psychology. It may have saved God knows how many lives and
caused God knows how much achievement. However, if you don’t
know the right techniques, you can’t use them.
[Charlie discusses psychological effects at play in the marketing of
consumer items such as Coca-Cola, Procter & Gamble products,

## Page 137

Tupperware, etc.]
Worldly wisdom is mostly very, very simple. And what I’m
urging on you is not that hard to do if you have the will to plow
through and do it. And the rewards are awesome—absolutely
awesome. But maybe you aren’t interested in awesome rewards
or avoiding a lot of misery or being more able to serve everything
you love in life. And if that’s your attitude, then don’t pay
attention to what I’ve been trying to tell you, because you’re
already on the right track.
It can’t be emphasized too much that issues of morality are
deeply entwined with worldly wisdom considerations involving
psychology. For example, take the issue of stealing. A very
signiﬁcant fraction of the people in the world will steal if a) it’s
very easy to do and b) there’s practically no chance of being
caught. And once they start stealing, the consistency principle—
which is a big part of human psychology—will soon combine with
operant conditioning to make stealing habitual. So if you run a
business where it’s easy to steal because of your methods, you’re
working a great moral injury on the people who work for you.
Again, that’s obvious. It’s very, very important to create
human systems that are hard to cheat. Otherwise, you’re ruining
your civilization, because these big incentives will create
incentive-caused bias and people will rationalize that bad
behavior is okay. Then, if somebody else does it, now you’ve got
at least two psychological principles: incentive-caused bias plus
social proof. Not only that but you get Serpico41 effects: If enough
people are proﬁting in a general social climate of doing wrong,
then they’ll turn on you and become dangerous enemies if you
try and blow the whistle. It’s very dangerous to ignore these
principles and let slop creep in. Powerful psychological forces
are at work for evil.

## Page 138

How does this relate to the law business? Well, people
graduate from places like Stanford Law School and go into the
legislatures of our nation and, with the best of motives, pass laws
that are easily used by people to cheat. Well, there could hardly
be a worse thing you could do.
Let’s say you have a desire to do public service. As a natural
part of your planning, you think in reverse and ask, “What can I
do to ruin our civilization?” That’s easy. If what you want to do is
to ruin your civilization, just go to the legislature and pass laws
that create systems wherein people can easily cheat. It will work
perfectly.
Take the workers’ compensation system in California. Stress
is real. And its misery can be real. So you want to compensate
people for their stress in the workplace. It seems like a noble
thing to do. But the trouble with such a compensation practice is
that it’s practically impossible to delete huge cheating. And once
you reward cheating, you get crooked lawyers, crooked doctors,
crooked unions, etc. participating in referral schemes. You get a
total miasma of disastrous behavior. And the behavior makes all
the people doing it worse as they do it. So you were trying to help
your civilization, but what you did was create enormous damage,
net. So it’s much better to let some things go uncompensated—to
let life be hard—than to create systems that are easy to cheat.
Let me give you an example: I have a friend who made an
industrial product at a plant in Texas not far from the border. He
was in a low-margin, tough business. He got massive fraud in the
workers’ compensation system, to the point that his premiums
reached double-digit percentages of payroll. And it was not that
dangerous to produce his product. It’s not like he was a
demolition contractor or something.
So he pleaded with the union, “You’ve got to stop this. There’s
not enough money in making this product to cover all of this
fraud.” But by then, everyone’s used to it. “It’s extra income. It’s

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extra money. Everybody does it. It can’t be that wrong. Eminent
lawyers, eminent doctors, eminent chiropractors—if there are
any such things—are cheating.”
And no one could tell them, “You can’t do it anymore.”
Incidentally, that’s Pavlovian mere association, too. When people
get bad news, they hate the messenger. Therefore, it was very
hard for the union representative to tell all of these people that
the easy money was about to stop. That is not the way to advance
as a union representative.
So my friend closed his plant and moved the work to Utah
among a community of believing Mormons. Well, the Mormons
aren’t into workers’ compensation fraud—at least they aren’t in
my friend’s plant. And guess what his workers’ compensation
expense is today? It’s 2 percent of payroll.
This sort of tragedy is caused by letting the slop run. You must
stop slop early. It’s very hard to stop slop and moral failure if you
let it run for a while.
[Charlie describes his notion of deprival-super reaction syndrome as it
relates to gambling and the New Coke debacle of the mid-1980s.]
Of course, as I said before, there is one big consideration that
needs huge and special attention as part of any use of techniques
deliberately harnessing elementary psychological forces, and
that is that once you know how to do it, there are real moral
limits regarding how much you should do it. Not all of what you
know how to do should you use to manipulate people.
Also, if you’re willing to transcend the moral limits and the
person you’re trying to manipulate realizes what you’re doing
because he also understands the psychology, he’ll hate you.
There is wonderfully persuasive evidence of this effect taken
from labor relations, some in Israel. So not only are there moral

## Page 140

objections, but there are also practical objections—big ones in
some cases.
Audience question: How do you incorporate psychology in your
investment decisions? I think it would be more than just
picking products that will appeal to everybody, like Coke.
After all, there are a lot of smart people out there who
obviously think just the way you showed us today. So are you
looking for failure in the thinking of other investors when you
go about picking successful companies?
What makes investment hard, as I said at USC, is that it’s easy to
see that some companies have better businesses than others. But
the price of the stock goes up so high that all of a sudden, the
question of which stock is the best to buy gets quite difﬁcult.
We’ve never eliminated the difﬁculty of that problem. And 98
percent of the time, our attitude toward the market is that we’re
agnostics. We don’t know. Is GM valued properly vis-à-vis Ford?
We don’t know.
We’re always looking for something where we think we have
an insight that gives us a big statistical advantage. Sometimes it
comes from psychology, but often it comes from something else.
And we only ﬁnd a few, maybe one or two a year. We have no
system for having automatic good judgment on all investment
decisions that can be made. Ours is a totally different system. We
just look for no-brainer decisions. As Buffett and I say over and
over again, we don’t leap 7-foot fences. Instead, we look for 1-
foot fences with big rewards on the other side. So we’ve
succeeded by making the world easy for ourselves, not by solving
hard problems.
Based on statistical analysis and insight?

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Well, certainly when we do make a decision, we think that we
have an insight advantage. And it’s true that some of the insight
is statistical in nature. However, again, we ﬁnd only a few of
those. It doesn’t help us merely for favorable odds to exist. They
have to be in a place where we can recognize them. So it takes a
mispriced opportunity that we’re smart enough to recognize.
And that combination doesn’t occur often. But it doesn’t have to.
If you wait for the big opportunity and have the courage and
vigor to grasp it ﬁrmly when it arrives, how many do you need?
For example, take the top 10 business investments Berkshire
Hathaway’s ever made. We would be very rich if we’d never done
anything else—in two lifetimes.
So, once again, we don’t have any system for giving you
perfect investment judgment on all subjects at all times. That
would be ridiculous. I’m just trying to give you a method you can
use to sift reality to obtain an occasional opportunity for rational
reaction. If you take that method into something as competitive
as common stock picking, you’re competing with many brilliant
people. So even with our method, we only get a few
opportunities. Fortunately, that happens to be enough.
Have you been successful in creating an atmosphere where
people below you can do the same things you’re talking about
doing yourself? For example, you talked about the tendency
toward commitment and consistency …
Mostly about the terrible mistakes it causes you to make.
How have you created an atmosphere comfortable enough for
people to abandon that tendency and admit that they’ve made
a mistake? For example, someone here earlier this year from
Intel talked about problems that occurred with their Pentium
chip. One of the most difﬁcult things for them to do was to

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realize they’d been going about it the wrong way and turn
course. And it’s very difﬁcult to do that in a complex structure.
How do you foster that?
Intel and its ilk create a coherent culture where teams solve
difﬁcult problems on the cutting edge of science. That’s radically
different from Berkshire Hathaway. Berkshire is a holding
company. We’ve decentralized all the power, except for natural
headquarters-type capital allocation.
By and large, we’ve chosen people we admire enormously to
have the power beneath us. It’s easy for us to get along with
them, on average, because we love and admire them. And they
create the culture for whatever invention and reality recognition
is going on in their businesses. And included in that reality
recognition is the recognition that previous conclusions were
incorrect.
But we’re a totally different kind of company. It’s not at all
clear to me that Warren or I would be that good at doing what
Andy Grove42 does. We don’t have special competence in that
ﬁeld. We are fairly good at relating to brilliant people we love. But
we have defects. For example, some regard me as absentminded
and opinionated. I might be a mess at Intel. However, both
Warren and I are very good at changing our prior conclusions.
We work at developing that facility because without it, disaster
often comes.
Would you talk a little bit about your seeming predilection
away from investing in high-technology stocks, on your own
part and the part of Berkshire Hathaway? One of the things
I’ve found eye-opening and a little surprising is how the
difﬁculties of running a low-tech business and those of
running a high-tech business aren’t all that different.

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They’re all hard. But why should it be easy to get rich? In a
competitive world, shouldn’t it be impossible for there to be an
easy way for everybody to get rich? Of course they’re all hard.
The reason we’re not in high-tech businesses is that we have a
special lack of aptitude in that area. And yes—a low-tech
business can be plenty hard. Just try to open a restaurant and
make it succeed.
You seem to be suggesting that there’s special aptitude
required in high-tech businesses—that they’re harder. But
aren’t they equally difﬁcult?
The advantage of low-tech stuff for us is that we think we
understand it fairly well. The other stuff we don’t. And we’d
rather deal with what we understand. Why should we want to
play a competitive game in a ﬁeld where we have no advantage—
maybe a disadvantage—instead of in a ﬁeld where we have a
clear advantage?
Each of you will have to ﬁgure out where your talents lie. And
you’ll have to use your advantages. But if you try to succeed in
what you’re worst at, you’re going to have a very lousy career. I
can almost guarantee it. To do otherwise, you’d have to buy a
winning lottery ticket or get very lucky somewhere else.
Warren Buffett has said that the investment Berkshire made
in an airline was a good example of what not to do. What chain
of thinking led to that wrong decision?
We were not buying stock in USAir on the theory that the
common shareholders were certain to prosper, because the
history of the airline business in terms of taking care of
shareholders has been terrible. It was a preferred stock with a

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mandatory redemption. In effect, we were loaning money to
USAir, and we had this equity kicker. We weren’t guessing
whether it would be a great place for the shareholders. We were
guessing whether it would remain prosperous enough to pay off
a credit instrument, carrying a ﬁxed dividend and a mandatory
redemption. And we guessed that the business would not get so
bad that we’d have a credit threat for which we were not being
adequately compensated by the high rate we were getting.
As it happened, USAir went right to the brink of going broke.
It was hanging by a thread for several months. It’s since come
back. And we’ll probably get all our money back plus the whole
coupon. But it was a mistake. [Editor’s note: Berkshire did indeed
come out whole on its USAir investment.]
I don’t want you to think we have any way of learning or
behaving so you won’t make a lot of mistakes. I’m just saying that
you can learn to make fewer mistakes than other people—and
how to ﬁx your mistakes faster when you do make them. But
there’s no way that you can live an adequate life without making
many mistakes. Part of what you must learn is how to handle
mistakes and new facts that change the odds. Life, in part, is like
a poker game, wherein you have to learn to quit sometimes when
holding a much-loved hand.
In fact, one trick in life is to get so you can handle mistakes.
Failure to handle psychological denial is a common way for
people to go broke. You’ve made an enormous commitment to
something. You’ve poured effort and money in. And the more
you put in, the more the whole consistency principle makes you
think, “Now it has to work. If I put in just a little more, then it’ll
work.”
And deprival-super reaction syndrome also comes in: You’re
going to lose the whole thing if you don’t put in a little more.
People go broke that way because they can’t stop, rethink, and
say, “I can afford to write this one off and live to ﬁght again. I

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don’t have to pursue this thing as an obsession, in a way that will
break me.”
Could you talk about the thoughts that went into your decision
to swap your Capital Cities stock for Disney rather than taking
cash? In the media, it was reported that you mentioned
thinking about taking the cash.
Disney’s a perfectly marvelous company, but it’s also very high-
priced. Part of what it does is make ordinary movies, which is not
a business that attracts me at all. However, part of what Disney
has is better than a great gold mine. I mean, those videocassettes
… Disney is an amazing example of autocatalysis.43 They had all
those movies in the can. They owned the copyright. And just as
Coke could prosper when refrigeration came, when the
videocassette was invented, Disney 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
wanted his descendants to sit around and watch that stuff at
home on videocassette. So Disney got this enormous tailwind
from life. And it was billions of dollars’ worth of tailwind.
Obviously, that’s a marvelous model if you can ﬁnd it. You
don’t have to invent anything. All you have to do is to sit there
while the world carries you forward.
Disney’s done a lot of new things right. Don’t misunderstand
me. But a lot of what happened to Disney was like what a friend
of mine said about an ignorant fraternity brother of his who
succeeded in life: “He was a duck sitting on a pond, and they
raised the level of the pond.”
Eisner and Wells were brilliant in how they ran Disney. But
the huge tailwind from videocassette sales on all of the old stuff
that was there when they came in—that was just an automatic
break for the new management. To be fair, they have been

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brilliant about creating new stuff, like Pocahontas and The Lion
King, to catch the same tailwind. But by the time it’s done, The
Lion King alone is going to do plural billions. And by the way,
when I say “when it’s done,” I mean 50 years from now or
something. But plural billions—from one movie?
Could you talk about why you left the law?
I had a huge family. Nancy and I supported eight children. And I
didn’t realize that the law was going to get as prosperous as it
suddenly got. The big money came into law shortly after I left it.
By 1962, I was mostly out, and I was totally out by 1965. So that
was a long time ago.
Also, I preferred making the decisions and gambling my own
money. I usually thought I knew better than the client anyway. So
why should I have to do it his way? So partly it was having an
opinionated personality. And partly it was a desire to get
resources permitting independence.
Also, the bulk of my clients were terriﬁc, but there were one or
two I didn’t enjoy. Plus, I like the independence of a capitalist.
And I’d always had sort of a gambling personality. I like ﬁguring
things out and making bets. So I simply did what came naturally.
Do you ever gamble Las Vegas– style?
I won’t bet $100 against house odds between now and the grave. I
don’t do that. Why should I? I will gamble recreationally with my
pals. And I’ll occasionally play a much better bridge player, like
Bob Hamman, who might be the best card player in the world.
But I know I’m paying for the fun of playing with him. That’s
recreational.

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As for gambling with simple mechanical house odds against
me, why in the world would I ever want to do that, particularly
given how I detest the manipulative culture of legalized
gambling? I don’t like legalized gambling. And I’m not
comfortable in Las Vegas, even though it does now include a
higher percentage of wholesome family recreation. I don’t like to
be with many of the types who hang around card parlors and so
forth.
On the other hand, I do like the manly art of wagering, so to
speak. And I like light social gambling among friends. But I do
not like the professional gambling milieu.
Could you say something about how the mutual fund and
money management business has changed since you got into
it, and the growth of capital markets?
Actually, I didn’t really get into it. I had a little private
partnership for 14 years, up until a little over 20 years ago.
However, I never had enough money from other people to
amount to a hill of beans—at least by current investment
management standards. So I’ve never really been part of the
mutual fund business.
But the money management business has been one of the
great growth businesses in the recent history of the United
States. It’s created many afﬂuent professionals and multi -
millionaires. It’s been a perfect gold mine for people who got in it
early. The growth of pension funds, the value of American
corporations, and the world’s wealth have created a fabulous
profession for many and carried lots of them up to afﬂuence. And
we deal with them in a variety of ways. However, we haven’t been
part of it for many years. We’ve basically invested our own
money for a long, long time.

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Do you expect this bull run to continue?
Well, I’d be amazed if the capitalized value of all American
business weren’t considerably higher 25 years from now. And if
people continue to trade with one another and shufﬂe these
pieces of paper around, then money management may continue
to be a marvelous business for the managers. But except for what
might be called our own money, we’re really not in it.
I was interested in the evolution of your investment strategy
from when you ﬁrst began using the Ben Graham model to the
Berkshire Hathaway model. Would you recommend that
model to a beginning investor—i.e., dumping most of it or all
of it into one opportunity we think is a great one and leaving it
there for decades? Or is that strategy really for a more mature
investor?
Each person has to play the game given his own marginal utility
considerations and in a way that takes into account his own
psychology. If losses are going to make you miserable—and some
losses are inevitable—you might be wise to utilize a very
conservative pattern of investment and saving all your life. So
you have to adapt your strategy to your own nature and your own
talents.
I don’t think there’s a one-size-ﬁts-all investment strategy
that I can give you. Mine works for me. But in part, that’s because
I’m good at taking losses. I can take ’em psychologically. And,
besides, I have very few. The combination works ﬁne.
You and Buffett have said that Berkshire’s stock is overvalued
and you wouldn’t recommend buying it.

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We didn’t say we thought it was overvalued. We just said that we
wouldn’t buy it or recommend that our friends buy it at the
prices then prevailing. But that just related to Berkshire’s
intrinsic value as it was at that time.
If I had the money, I would buy it—because you’ve been saying
that your returns will go down for 20 years …
Well, I hope that your optimism is justiﬁed. But I do not change
my opinion. After all, today we’re in uncharted territory. I
sometimes tell my friends, “I’m doing the best I can. But I’ve
never grown old before. I’m doing it for the ﬁrst time, and I’m not
sure that I’ll do it right.” Warren and I have never been in this
kind of territory—with high valuations and a huge amount of
capital. We’ve never done it before. So we’re learning.
Everything you and Buffett say seems logical. But it sounds
like exactly the same language that Ben Graham was using 30
years ago when he was saying the stock market was
overvalued, when it was at 900.
Oh, I don’t think that we share that with him. Graham, great
though he was as a man, had a screw loose as he tried to predict
outcomes for the stock market as a whole. In contrast, Warren
and I are almost always agnostic about the market.
On the other hand, we have said that common stocks
generally have generated returns of 10 to 11 percent after
inﬂation for many years and that those returns can’t continue for
a very long period. And they can’t. It’s simply impossible. The
wealth of the world will compound at no such rate. Whatever
experience Stanford has had in its portfolio for the last 15 years,
its future experience is virtually certain to be worse. It may still

## Page 150

be okay. But it’s been a hog-heaven period for investors over the
last 15 years. Bonanza effects of such scale can’t last forever.
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.
Where does that leave you 10 years from now?
We’ve said over and over that our future rate of compounding
our shareholders’ wealth is going to go down compared to our
past, and that our size will be an anchor dragging on
performance. And we’ve said over and over again that this is not
an opinion but a promise.
However, let’s suppose that we were able to compound our
present book value at 15 percent per annum from this point.
That would not be so bad and would work out okay for our long-
term shareholder. I’m just saying that we could afford to slow
down some, as we surely will, and still do okay for the long-term
shareholder.
By the way, I’m not promising that we will compound our
present book value at 15 percent per annum.
You talked about how important it was not to have an extreme
ideology. What responsibility, if any, do you think the business
and legal communities have for helping inner-city areas,
spreading the wealth and so on?
I’m all for ﬁxing social problems. I’m all for being generous to the
less fortunate. And I’m all for doing things where, based on a
slight preponderance of the evidence, you guess that it’s likely to
do more good than harm. What I’m against is being very
conﬁdent and feeling that you know, for sure, that your

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particular intervention will do more good than harm, given that
you’re dealing with highly complex systems wherein everything
is interacting with everything else.
So just make sure that what you’re doing …
You can’t make sure. That’s my point.
On the other hand, I did recently reverse the conclusions of
two sets of engineers. How did I have enough conﬁdence in such
a complicated ﬁeld to do that? Well, you might think, “Oh, this
guy is just an egomaniac who’s made some money and thinks he
knows everything.” Well, I may be an egomaniac, but I don’t
think I know everything. But I saw huge reasons in the
circumstances for bias in each set of engineers as each
recommended a course of action very advantageous to itself. And
what each was saying was so consonant with a natural bias that it
made me distrust it. Also, perhaps I knew enough engineering to
know that what they were saying didn’t make sense. Finally, I
found a third engineer who recommended a solution I approved.
And thereafter, the second engineer came to me and said,
“Charlie, why didn’t I think of that?” Which is to his credit. It was
a much better solution, both safer and cheaper.
You must have the conﬁdence to override people with more
credentials than you whose cognition is impaired by incentive-
caused bias or some similar psychological force that is obviously
present. But there are also cases where you have to recognize
that you have no wisdom to add and that your best course is to
trust some expert. In effect, you’ve got to know what you know
and what you don’t know. What could possibly be more useful in
life than that?
You discussed Coke’s mistake. Do you have any thoughts about
where Apple44 went wrong?

## Page 152

Let me give you a very good answer—one I’m copying from Jack
Welch, the CEO of General Electric. He has a PhD in engineering.
He’s a star businessman. He’s a marvelous guy. And recently, in
Warren’s presence, someone asked him, “Jack, what did Apple do
wrong?”
His answer? “I don’t have any special competence that would
enable me to answer that question.” And I’ll give you the very
same answer. That’s not a ﬁeld in which I’m capable of giving you
any special insight.
On the other hand, in copying Jack Welch, I am trying to teach
you something. When you don’t know and you don’t have any
special competence, don’t be afraid to say so.
There’s another type of person I compare to an example from
biology: When 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, which direction to go and how far. So about 40 or
50 years ago, some clever scientist stuck the nectar straight up.
Well, the nectar’s never straight up in the ordinary life of a bee.
The nectar’s out. So the bee ﬁnds the nectar and returns to the
hive. But it doesn’t have the genetic programming to do a dance
that says straight up. So what does it do?
Well, if it were like Jack Welch, it would just sit there. But what
it actually does is to dance this incoherent dance that gums
things up. A lot of people are like that bee. They attempt to
answer a question like that. And that is a huge mistake. Nobody
expects you to know everything about everything. I try to get rid
of people who always conﬁdently answer questions about which
they don’t have any real knowledge. To me, they’re like the bee
dancing its incoherent dance. They’re just screwing up the hive.
As someone who’s been in legal practice and business, how
did you incorporate, or did you incorporate, these models into
your legal practice? And how did it work? I suspect many of us

## Page 153

have seen law ﬁrms that don’t appear to adhere to these kinds
of models.
Well, the models are there. But just as there are perverse
incentives in academia, there are perverse incentives in law
ﬁrms. In fact, in some respects, at the law ﬁrms, it’s much worse.
Here’s another model from law practice: When I was very
young, my father practiced law. One of his best friends, Grant
McFayden, Omaha’s Pioneer Ford dealer, was a client. He was a
perfectly marvelous man, a self-made Irishman who’d run away
uneducated from a farm as a youth because his father beat him.
So he made his own way in the world. He was a brilliant man of
enormous charm and integrity—just a wonderful, wonderful
man.
In contrast, my father had another client who was a blowhard,
an overreaching, unfair, pompous, difﬁcult man. And I must
have been 14 years old or thereabouts when I asked, “Dad, why
do you do so much work for Mr. X, this overreaching blowhard,
instead of working more for wonderful men like Grant
McFayden?”
My father said, “Grant McFayden treats his employees right,
his customers right, and his problems right. And if he gets
involved with a psychotic, he quickly walks over to where the
psychotic is and works out an exit as fast as he can. Therefore,
Grant McFayden doesn’t have enough remunerative law business
to keep you in Coca-Cola. But Mr. X is a walking mineﬁeld of
wonderful legal business.”
This case demonstrates one of the troubles with practicing
law. To a considerable extent, you’re going to be dealing with
grossly defective people. They create an enormous amount of the
remunerative law business. And even when your own client is a
paragon of virtue, you’ll often be dealing with gross defectives on
the other side or even on the bench. That’s partly what drove me

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out of the profession. The rest was my own greed, but my success
in serving greed partly allowed me to make easier the process of
being honorable and sensible. Like Ben Franklin observed, “It’s
hard for an empty sack to stand upright.”
I’d argue that my father’s model when I asked him about the
two clients was totally correct didaction. He taught me the right
lesson. The lesson? As you go through life, sell your services once
in a while to an unreasonable blowhard if that’s what you must
do to feed your family. But run your own life like Grant
McFayden.
That was a great lesson. And he taught it in a very clever way—
because instead of just pounding it in, he told it to me in a way
that required a slight mental reach. I had to make the reach
myself in order to get the idea that I should behave like Grant
McFayden. And because I had to reach for it, he ﬁgured I’d hold it
better. And, indeed, I’ve held it all the way through until today,
through all of these decades. That’s a very clever teaching
method.
There, again, we’re talking about elementary psychology. It’s
elementary literature. Good literature makes the reader reach a
little for understanding. Then it works better. You hold it better.
It’s the commitment and consistency tendency. If you’ve reached
for it, the idea’s pounded in better.
As a lawyer or executive, you’ll want to teach somebody what
my father taught me, or maybe you’ll want to teach them
something else. And you can use lessons like this. Isn’t that a
great way to teach a child? My father used indirection on
purpose. And look at how powerfully it worked—like Captain
Cook’s wise use of psychology. I’ve been trying to imitate Grant
McFayden ever since, for all my life. I may have had a few lapses.
But at least I’ve been trying.

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At the end of your article in OID, you mentioned that only a
select few investment managers actually add value. Since
you’re speaking to an audience of future lawyers, what would
you encourage us to do in order to be able to add value in our
profession?
To the extent you become a person who thinks correctly, you can
add great value. To the extent you’ve learned it so well that you
have enough conﬁdence to intervene where it takes a little
courage, you can add great value. And to the extent that you can
prevent or stop some asininity that would otherwise destroy your
ﬁrm, your client, or something that you care about, you can add
great value.
There are constructive tricks you can use. For example, one
reason why my old classmate Joe Flom of Skadden, Arps has
been such a successful lawyer is that he’s very good at dreaming
up little vivid examples that serve to pound the point home in a
way that really works. It’s enormously helpful when you’re
serving clients or otherwise trying to persuade someone in a
good cause to come up with a little humorous example. The
ability to do that is a knack. So you could argue that the Joe
Floms of the world are almost born with a gift. But he’s honed the
gift. And to one degree or another, all of you were born with the
gift, and you can hone it too.
Occasionally, you get into borderline stuff. For instance,
suppose you’ve got a client who really wants to commit tax fraud.
If he doesn’t push the tax law way beyond the line, he can’t stand
it. He can’t shave in the morning if he thinks there’s been any
cheating he could get by with that he hasn’t done. And there are
people like that. They just feel they aren’t living aggressively
enough.
You can approach that situation in either of two ways: You can
say, “I just won’t work for him,” and duck it. Or you can say,

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“Well, the circumstances of my life require that I work for him.
And what I’m doing for him doesn’t involve my cheating.
Therefore, I’ll do it.” And if you see he wants to do something
really stupid, it probably won’t work to tell him, “What you’re
doing is bad. I have better morals than you.” That offends him.
You’re young. He’s old. Therefore, instead of being persuaded,
he’s more likely to react with “Who in the hell are you to
establish the moral code of the whole world?” But instead, you
can say to him, “You can’t do that without three other people
beneath you knowing about it. Therefore, you’re making yourself
subject to blackmail. You’re risking your reputation. You’re
risking your family, your money,” etc. That is likely to work. And
you’re telling him something that’s true.
Do you want to spend a lot of time working for people where
you have to use methods like that to get them to behave well? I
think the answer is no. But if you’re hooked with it, appealing to
his interest is likely to work better as a matter of human
persuasion than appealing to anything else. That, again, is a
powerful psychological principle with deep biological roots.
I saw that psychological principle totally blown at Salomon.
Salomon’s general counsel knew that the CEO, [John]
Gutfreund,45 should have promptly told the federal authorities all
about Salomon’s trading improprieties, in which Gutfreund
didn’t participate and which he hadn’t caused. And the general
counsel urged Gutfreund to do it. He told Gutfreund, in effect,
“You’re probably not legally required to do that, but it’s the right
thing to do. You really should.” But it didn’t work. The task was
easy to put off because it was unpleasant. So that’s what
Gutfreund did—he put it off.
The general counsel had very little constituency within
Salomon except for the CEO. If the CEO went down, the general
counsel was going down with him. Therefore, his whole career

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was on the line. So to save his career, he needed to talk the
dilatory CEO into doing the right thing.
It would’ve been child’s play to get that job done right. All the
general counsel had to do was to tell his boss, “John, this
situation could ruin your life. You could lose your wealth. You
could lose your reputation.” And it would have worked. CEOs
don’t like the idea of being ruined, disgraced, and ﬁred.
The ex-general counsel of Salomon is brilliant and generous,
and he had the right idea. However, he lost his job because he
didn’t apply a little elementary psychology. He failed to recognize
that what works best in most cases is to appeal to a man’s
interest. But you don’t have to get similarly lousy results when
you face similar situations. Just remember what happened to
Gutfreund and his general counsel. The right lessons are easily
learned if you’ll work at it. And if you do learn them, you can be
especially useful at crucial moments when others fail. And to the
extent that you do become wise, diligent, objective, and
especially able to persuade in a good cause, then you’re adding
value.
Would you discuss how the threat of litigation—shareholder
lawsuits and so forth—and legal complexity in general have
affected decision-making in big business?
Well, every big business screams about its legal costs, screams
about the amount of regulation, screams about the complexity of
its life, screams about the plaintiffs’ bar, particularly the class-
action plaintiffs’ bar. So there’s an absolute catechism on that
where you could just copy the screams from one corporation to
another and you’d hardly have to change a word.
But what causes the screams has, so far, been a godsend for
the law ﬁrms. The big law ﬁrms have had a long updraft. And
they now tend to kind of cluck like an undertaker in a plague. An

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undertaker, of course, would look very unseemly if he were
jumping up and down and playing his ﬁddle during the plague.
So law ﬁrm partners say, “Oh, isn’t it sad—all this complexity, all
this litigation, all this unfairness.”
But, really, they’re somewhat schizophrenic on the subject
because it’s been very good for them. Some recent California
initiatives created some interesting conduct. Part of the defense
bar lobbied quietly against certain propositions and, effectively,
against their clients because they didn’t want their clients to
catch ’em in the process. And the reason they did so was because
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 it—well, that’s an
adult experience and an adult choice that you have to make.
So big corporations adapt. They have more litigation. They
have to have a bigger legal department. They scream about what
they don’t like. But they adapt.
But hasn’t that legal complexity consumed a lot more of
companies’ resources over the last few decades?
The answer is yes. There’s hardly a corporation in America that
isn’t spending more on lawsuits and on compliance with various
regulations than it was 20 years ago. And yes, some of the new
regulation is stupid and foolish. And some was damn well
necessary. And it will ever be thus, albeit with some ebb and ﬂow.
But have you seen or experienced any change in decision-
making at corporations in their being less likely to take on
riskier investments for fear of failure or liability?

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The only place I saw—with another friend, not Warren—was
when I was part owner of the biggest shareholder in a company
that invented a better policeman’s helmet. It was made of Kevlar
or something of that sort. They brought it to us and wanted us to
manufacture it.
As a matter of ideology, we’re very pro-police. I believe
civilization needs a police force—although I don’t believe in
policemen creating too many widows and orphans unnecessarily
either. But we like the idea of a better policeman’s helmet.
However, we took one look at it and said to the people who
invented it, “We’re a rich corporation. We can’t afford to make a
better policeman’s helmet. That’s just how the civilization works.
All risks considered, it can’t work for us. But we want the
civilization to have these. So we don’t maximize what we sell it
for. Get somebody else to make it. Transfer the technology or
whatever to somebody who can do it. But we’re not going to.”
Thus, we didn’t try to disadvantage policemen from getting new
helmets, but we decided not to manufacture helmets ourselves.
There are businesses—given the way the civilization has
developed—where being the only deep pocket around is bad
business. In high school football, for example, a paraplegic or a
quadriplegic will inevitably be created occasionally. And who
with deep pockets can the injured person best sue other than the
helmet manufacturer? Then everyone feels sorry, the injuries
are horrible, and the case is dangerous for the manufacturer. I
think big, rich corporations are seldom wise to make football
helmets in the kind of a civilization we’re in. And maybe it
should be harder to successfully sue helmet makers.
I know two different doctors, each of whom had a sound
marriage. When the malpractice premiums got high enough,
they divorced their wives and transferred most of their property
to their wives. And they continued to practice, only without
malpractice insurance. They were angry at the civilization. They

## Page 160

needed to adapt. And they trusted their wives. So that was that.
And they’ve not carried any malpractice insurance since. People
adapt to a changing litigation climate. They have various ways of
doing it. That’s how it’s always been and how it’s always going to
be.
What I personally hate most are systems that make fraud
easy. Probably way more than half of all the chiropractic income
in California comes from pure fraud. For example, I have a friend
who had a little fender bender, an auto accident, in a tough
neighborhood. And he got two chiropractors’ cards and one
lawyer’s card before he’d even left the intersection. They’re in
the business of manufacturing claims that necks hurt.
In California, I believe the Rand statistics showed that we have
twice as many personal injuries per accident as in many other
states. And we aren’t getting twice as much real injury per
accident. So the other half of that is fraud. People just get so that
they think everybody does it and it’s all right to do. I think it’s
terrible to let that stuff creep in.
If I were running the civilization, compensation for stress in
workers’ comp would be zero—not because there’s no work-
caused stress, but because I think the net social damage of
allowing stress to be compensated at all is worse than what
would happen if a few people who had real work-caused stress
injuries went uncompensated.
I like the Navy system. If you’re a captain in the Navy and
you’ve been up for 24 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 aground, clearly through no
fault of yours, they don’t court-martial you, but your naval career
is over.
You can say, “That’s too tough. That’s not law school. That’s
not due process.” Well, the Navy model is better in its context
than would be the law school model. The Navy model really

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forces people to pay attention when conditions are tough,
because they know that there’s no excuse. Napoleon46 said he
liked luckier generals—he wasn’t into supporting losers. Well, the
Navy likes luckier captains. It doesn’t matter why your ship goes
aground, your career is over. Nobody’s interested in your fault.
It’s just a rule that we happen to have, for the good of all, all
effects considered.
I like some rules like that. I think that the civilization works
better with some of these no-fault rules. But that stuff tends to be
anathema around law schools: “It’s not due process. You’re not
really searching for justice.” Well, I am searching for justice
when I argue for the Navy rule—for the justice of fewer ships
going aground. Considering the net beneﬁt, I don’t care if one
captain has some unfairness in his life. After all, it’s not like he’s
being court-martialed. He just has to look for a new line of work.
And he keeps vested pension rights and so on. So it’s not like it’s
the end of the world.
So I like things like that. However, I’m in a minority.
I’d like to hear you talk a little bit more about judgment. In
your talk, you said we should read the psychology textbooks
and take the 15 or 16 principles that are best of the ones that
make sense …
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 books, and you’ve got a system.
Right. My problem seems to be the prior step, which is
determining which ones are obviously right. And that seems
to me to be the more essential question to ask.

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No, no. You overestimate the difﬁculty. Do you have difﬁculty
understanding that people are heavily inﬂuenced by what other
people think and what other people do, and that some of that
happens on a subconscious level?
No, I don’t. I understand that.
Well, you can go right through the principles. And one after
another, they’re like that. It’s not that hard. Do you have any
difﬁculty with the idea that operant conditioning works—that
people will repeat what worked for them the last time?
It just seems to me like there’s a lot of other things out there,
as well, that also make a lot of sense. The system would
quickly get too complicated, I imagine, as a result of too much
cross talk.
Well, if you’re like me, it’s kind of fun for it to be a little
complicated. If you want it totally easy and totally laid out,
maybe you should join some cult that claims to provide all the
answers. I don’t think that’s a good way to go. I think you’ll just
have to endure the world, as complicated as it is. Einstein has a
marvelous statement on that: “Everything should be made as
simple as possible, but no more simple.”
I’m afraid that’s the way it is. If there are 20 factors and they
interact some, you’ll just have to learn to handle it, because that’s
the way the world is. But you won’t ﬁnd it that hard if you go at it
Darwin-like, step-by-step, with curious persistence. You’ll be
amazed at how good you can get.
You’ve given us about three of the models that you use. I
wondered where you found the other ones. And second, do

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you have an easier way for us to ﬁnd them than going through
a psychology textbook? I’m not averse to doing that, but it
takes longer.
There are a relatively small number of disciplines and a
relatively small number of truly big ideas. And it’s a lot of fun to
ﬁgure it out. Plus, if you ﬁgure it out and do the outlining
yourself, the ideas will stick better than if you memorize ’em
using somebody else’s cram list.
Even better, the fun never stops. I was miseducated horribly,
and I hadn’t bothered to pick up what’s called modern
Darwinism.47 I do a lot of miscellaneous reading, too. But I just
missed it. And in the last year, I suddenly realized I was a total
damned fool and hadn’t picked it up properly. So I went back.
And with the aid of [Richard] Dawkins—Oxford’s great biologist—
and others, I picked it up.
Well, it was an absolute circus for me in my 70s to get the
modern Darwinian synthesis in my head. It’s so awesomely
beautiful and so awesomely right. And it’s so simple once you get
it. So one beauty of my approach is that the fun never stops. I
suppose that it does stop eventually when you’re drooling in the
convalescent home at the end. But at least it lasts a long time.
If I were czar of a law school—although, of course, no law
school will permit a czar; they don’t even want the dean to have
much power—I’d create a course that I’d call Remedial Worldly
Wisdom that would, among other useful things, include a fair
amount of properly taught psychology. And it might last three
weeks or a month. I think you could create a course that was so
interesting, with pithy examples and powerful examples and
powerful principles, that it would be a total circus. And I think
that it would make the whole law school experience work better.
People raise their eyebrows at that idea. “People don’t do that
kind of thing.” They may not like the derision that’s implicit in

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the title Remedial Worldly Wisdom. But the title would be my way
of announcing, “Everybody ought to know this.” And, if you call it
remedial, isn’t that what you’re saying? “This is really basic and
everybody has to know it.”
Such a course would be a perfect circus. The examples are so
legion. I don’t see why people don’t do it. They may not do it
mostly because they don’t want to. But also, maybe they don’t
know how. And maybe they don’t know what it is. But the whole
law school experience would be much more fun if the really
basic ideas were integrated and pounded in with good examples
for a month or so before you got into conventional law school
material. I think the whole system of education would work
better. But nobody has any interest in doing it.
When law schools do reach out beyond traditional material,
they often do it in what looks to me like a pretty dumb way. If you
think psychology is badly taught in America, you should look at
corporate ﬁnance. Modern portfolio theory? It’s demented! It’s
truly amazing.
I don’t know how these things happen. Hard science and
engineering tend to be pretty reliably done. But the minute you
get outside of those areas, a certain amount of inanity seems to
creep into academia—even academia involving people with very
high IQs. But boy, what a school would be like that pounded a lot
of the silliness out. But the right way to pound it out is not to have
some 70-plus-year-old capitalist come in and tell seniors,
“Here’s a little remedial worldly wisdom.” This is not the way to
do it.
On the other hand, a month at the start of law school that
really pounded in the basic doctrines … Many of the legal
doctrines are tied to other doctrines. They’re joined at the hip.
And yet, they teach you those legal doctrines without pointing
out how they’re tied to the other important doctrines. That’s
insanity—absolute insanity.

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Why do we have a rule that judges shouldn’t talk about legal
issues that aren’t before them? In my day, they taught us the rule,
but not in a way giving reasons tied to the guts of undergraduate
courses. It’s crazy that people don’t have those reasons. The
human mind is not constructed so that it works well without
having reasons. You’ve got to hang reality on a theoretical
structure with reasons. That’s the way it hangs together in usable
form so that you’re an effective thinker. And to teach doctrines
either with no reasons or with poorly explained reasons? That’s
wrong.
Another reason why I like the idea of having a course on
remedial worldly wisdom is that it would force more sense on the
professors. It would be awkward for them to teach something
that was contravened by lessons that were obviously correct and
emphasized in a course named Remedial Worldly Wisdom.
Professors doing so would really have to justify themselves.
Is that a totally crazy idea? It may be crazy to expect it to be
done. However, if somebody had done it, would you have found it
useful?
I think it would be a wonderful thing to have. Unfortunately,
when it’s created, we won’t be here anymore. You’re
proposing that this would be good to teach people in a course
form so it would be accessible to them. Is there any way that it
could be more accessible to us—other than having to …
I get requests for pointers to easy learning all the time. I’m trying
to provide a little easy learning today. But one talk like this is not
the right way to do it. The right way to do it would be in a book.
I hope what I’m saying will help you be more effective and
better human beings. And if you don’t get rich, that won’t bother
me. But I’m always asked this question: “Spoon-feed me what
you know.” And, of course, what they’re often saying is “Teach

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me how to get rich with soft white hands faster. And not only let
me get rich faster, but teach me faster, too.”
I don’t have much interest in writing a book myself. Plus, it
would be a lot of work for somebody like me to try and do it in my
70s. And I have plenty else to do in life. So I’m not going to do it.
But it’s a screaming opportunity for somebody. I’d provide funds
to support the writing of an appropriate book if I found someone
with the wisdom and the will to do the job right.
Let me turn to some of the probable reasons for present bad
education. Part of the trouble is caused by the balkanization of
academia. For instance, psychology is most powerful when
combined with doctrines from other academic departments. But
if your psychology professor doesn’t know the other doctrines,
then he isn’t capable of doing the necessary integration. And how
would anyone get to be a psychology professor in the ﬁrst place if
he were good with non-psychology doctrines and constantly
worked non-psychology doctrines into his material? Such a
would-be professor would usually offend his peers and
superiors.
There have been some fabulous psychology professors in the
history of the world. [Robert] Cialdini of Arizona State was very
useful to me, as was B. F. Skinner—for his experimental results, if
divorced from his monomania and utopianism. But averaged
out, I don’t believe that psychology professors in America are
people whose alternative career paths were in the toughest part
of physics. And that may be one of the reasons why they don’t get
it quite right.
The schools of education, even at eminent universities, are
pervaded by psychology. And they’re almost an intellectual
disgrace. It’s not unheard of for academic departments, even at
great institutions, to be quite deﬁcient in important ways. And
including a lot of material labeled as psychological is no cure-all.

## Page 167

And given academic inertia, all academic deﬁciencies are very
hard to ﬁx.
Do you know how they tried to ﬁx psychology at the University
of Chicago? Having tenured professors who were terrible, the
president there actually abolished the entire psychology
department. And Chicago, in due course, will probably bring
back a new and different psychology department. Indeed, by
now, it probably has. Perhaps conditions are now better. And I
must admit that I admire a college president who will do
something like that.
I do not wish 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
things—in irritating peculiarities that can’t be removed from
psychology.
Let me demonstrate by a thought experiment involving a
couple of questions. Are there not many ﬁelds that need a
synthesizing super mind like that of James Clerk Maxwell but are
destined never to attract one? And is academic psychology, by its
nature, one of the most unfortunate of all the would-be attractors
of super minds? I think the answers are yes and yes.
One can see this by considering the case of any of the few
members of each generation who can, as fast as ﬁngers can
move, accurately work through the problem sets in
thermodynamics, electromagnetism, and physical chemistry.
Such a person will be begged by some of the most eminent
people alive to enter the upper reaches of hard science.
Will such a super-gifted person instead choose academic
psychology, wherein lie very awkward realities: a) that the
tendencies demonstrated by social psychology paradoxically
grow weaker as more people learn them, and b) that clinical
(patient-treating) psychology has to deal with the awkward

## Page 168

reality that happiness, physiologically measured, is often
improved by believing things that are not true? The answer, I
think, is plainly no. The super mind will be repelled by academic
psychology, much as Nobel laureate physicist Max Planck48 was
repelled by economics, wherein he saw problems that wouldn’t
yield to his methods.
We talk a lot about trade-offs between the quality of our life
and our professional commitments. Is there time for a
professional life, learning about these models, and doing
whatever else interests you? Do you ﬁnd time to do fun things
besides learning?
I’ve always taken a fair amount of time to do what I really wanted
to do, some of which was merely to ﬁsh or play bridge or play
golf.
Each of us must ﬁgure out his or her own lifestyle. You may
want to work 70 hours a week for 10 years to make partner at
Cravath and thereby obtain the obligation to do more of the
same. Or you may say, “I’m not willing to pay that price.” Either
way, it’s a totally personal decision that you have to make by your
own lights. But whatever you decide, I think it’s a huge mistake
not to absorb elementary worldly wisdom if you’re capable of
doing it because it makes you better able to serve others, it
makes you better able to serve yourself, and it makes life more
fun. So if you have an aptitude for doing it, I think you’d be crazy
not to. Your life will be enriched—not only ﬁnancially, but in a
host of other ways—if you do.
Now, this has been a very peculiar talk for some businessman
to come in and give at a law school—some guy who’s never taken
a course in psychology telling you that all of the psychology
textbooks are wrong. This is very eccentric. But all I can tell you
is that I’m sincere. There’s a lot of simple stuff that many of you

## Page 169

are quite capable of learning. And your lives will work way better,
too, if you do. Plus, learning it is a lot of fun. So I urge you to learn
it.
Are you, in effect, fulﬁlling your responsibility to share the
wisdom that you’ve acquired over the years?
Sure. Look at Berkshire Hathaway. I call it the ultimate didactic
enterprise. Warren’s never going to spend any money. He’s going
to give it all back to society. He’s just building a platform so
people will listen to his notions. Needless to say, they’re very
good notions. And the platform’s not so bad either. But you could
argue that Warren and I are academics in our own way.
Most of what you’ve said is very compelling. And your quest
for knowledge and, therefore, command of the human
condition and money are all laudable goals.
I’m not sure the quest for money is so laudable.
Well then, understandable.
That I’ll take. I don’t sneer, incidentally, at making sales calls or
proofreading bond indentures. If you need the money, it’s fun
earning it. And if you have to try a bunch of cases in the course of
your career, you’ll learn something doing that. You ought to do
something to earn money. Many activities are digniﬁed by the
fact that you earn money.
I understand your skepticism about overly ideological people.
But is there an ideological component to what you do? Is there
something that you’re irrationally passionate about?

## Page 170

Yeah, I’m passionate about wisdom. I’m passionate about
accuracy and some kinds of curiosity. Perhaps I have some
streak of generosity in my nature and a desire to serve values
that transcend my brief life. But maybe I’m just here to show off.
Who knows?
I believe in the discipline of mastering the best that other
people have ever ﬁgured out. I don’t believe in just sitting down
and trying to dream it all up yourself. Nobody’s that smart.
TALK THREE REVISITED
When I gave Talk Three in 1996, I argued that intense political
animosity should be avoided because it causes much mental
malfunction, even in brilliant brains. Since then, political
animosity has increased greatly, both on the left and the right,
with sad effects on the ability of people to recognize reality,
exactly as I would have expected.
Naturally, I don’t like this result. The grain of my emotional
nature is to respond as Archimedes49 might respond if he
complained now to God, “How could you put in those Dark Ages
after I published my formulas?” Or as Mark Twain once
complained, “These are sad days in literature. Homer is dead.
Shakespeare is dead. And I myself am not feeling at all well.”
Fortunately, I am still able to refrain from complaint in the
mode of Mark Twain. After all, I never had more than a shred of
an illusion that any views of mine would much change the world.
Instead, I always knew that aiming low was the best path for me,
so I merely sought 1) to learn from my betters a few practical
mental tricks that would help me avoid some of the worst
miscognitions common in my age cohort, and 2) to pass on my
mental tricks only to a few people who could easily learn from
me because they already almost knew what I was telling them.

## Page 171

Having pretty well accomplished these very limited
objectives, I see little reason to complain now about the un-
wisdom of the world. Instead, what works best for me in coping
with all disappointment is what I call the Jewish method: humor.
As I revisit Talk Three in March 2006, I still like its emphasis
on the desirability of making human systems as cheating-proof
as is practicable, even if this leaves some human misery unﬁxed.
After all, the people who rewarded cheating on a massive scale
leave a trail of super-ruin in their wake, since the bad conduct
spreads by example and is so very hard to reverse.
And I fondly recall Talk Three’s emphasis on both the life-
handling lessons I learned from my father’s friend, Grant
McFayden, and one teaching method I learned from my father. I
owe a lot to these long-dead predecessors, and if you like Poor
Charlie’s Almanack, so do you.

## Page 172

CHAPTER 4; TALK FOUR
stripe.press/pca-8
Practical Thought aboutPractical Thought?
JULY 20, 1996AN INFORMAL TALK
In this talk, Charlie explains how he makes decisions and solves
problems by taking us step-by-step through a diverse set of mental
models. He presents a case study that asks rhetorically how the
listener would go about producing a $2 trillion business from
scratch, using Coca-Cola as his example. Naturally he has his own
solution, apt to strike you as both brilliant and perceptive.
Charlie’s case study leads him to a discussion of academia’s
failures and its record of having produced generations of sloppy
decision-makers. For this problem, he has other solutions.
This talk was delivered in 1996 to a group that has a policy of
not publicizing its programs.
Editor’s warning, as suggested by Charlie: Most people don’t
understand this talk. Charlie says it was an extreme communication
failure when made, and people have since found it difficult to
understand even when read slowly, twice. To Charlie, these outcomes
have “profound educational implications.”

## Page 173

The title of my talk is “Practical Thought about Practical
Thought?,” with a question mark at the end. In a long career, I
have assimilated various ultrasimple general notions that I ﬁnd
helpful in solving problems. Five of these helpful notions I will
now describe. After that, I will present to you a problem of
extreme scale. Indeed, the problem will involve turning start up
capital of $2 million into $2 trillion, a sum large enough to
represent a practical achievement. Then, I will try to solve the
problem, assisted by my helpful general notions. Following that,
I will suggest that there are important educational implications
in my demonstration. I will so ﬁnish because my objective is
educational, my game today being a search for better methods of
thought.
The ﬁrst helpful notion is that it is usually best to simplify
problems by deciding big no-brainer questions ﬁrst.
The second helpful notion mimics Galileo’s50 conclusion that
scientiﬁc reality is often revealed only by math as if math was the
language of God. Galileo’s attitude also works well in messy,
practical life. Without numerical ﬂuency, in the part of life most
of us inhabit, you are like a one-legged man in an ass-kicking
contest.
The third helpful notion is that it is not enough to think
problems through forward. You must also think in reverse, much
like the rustic who wanted to know where he was going to die so
that he’d never go there. Indeed, many problems can’t be solved
forward. And that is why the great algebraist Carl Jacobi so often
said, “Invert, always invert,” and why the Pythagoreans51 thought
in reverse to prove that the square root of two was an irrational
number.
The fourth helpful notion is that the best and most practical
wisdom is elementary academic wisdom. But there is one
extremely important qualiﬁcation: You must think in a
multidisciplinary manner. You must routinely use all the easy-

## Page 174

to-learn concepts from the freshman course in every basic
subject. Where elementary ideas will serve, your problem-
solving must not be limited, as academia and many business
bureaucracies are limited, by extreme balkanization into
disciplines and subdisciplines, with strong taboos against any
venture outside assigned territory. Instead, you must do your
multidisciplinary thinking in accord with Ben Franklin’s
prescription in Poor Richard:52 “If you want it done, go. If not,
send.”
If, in your thinking, you rely entirely on others—often through
purchase of professional advice—whenever outside a small
territory of your own, you will suffer much calamity. And it is not
just difﬁculties in complex coordination that will do you in. You
will also suffer from the reality evoked by the Shavian character
who said, “In the last analysis, every profession is a conspiracy
against the laity.”
Indeed, a Shavian character, for once, understated the horrors
of something [George Bernard] Shaw didn’t like. It is not usually
the conscious malfeasance of your narrow professional adviser
that does you in. Instead, your troubles come from his
subconscious bias. His cognition will often be impaired, for your
purposes, by ﬁnancial incentives different from yours. And he
will also suffer from the psychological defect caught by the
proverb “To a man with a hammer, every problem looks like a
nail.”
The ﬁfth helpful notion is that really big effects, lollapalooza
effects, will often come only from large combinations of factors.
For instance, tuberculosis was tamed, at least for a long time,
only by routine, combined use in each case of three different
drugs. And other lolla palooza effects, like the ﬂight of an
airplane, follow a similar pattern.
It is now time to present my practical problem. And here is
the problem:

## Page 175

It is 1884 in Atlanta. You are brought, along with 20 others
like you, before a rich and eccentric Atlanta citizen named Glotz.
Both you and Glotz share two characteristics: First, you routinely
use in problem-solving the ﬁve helpful notions, and second, you
know all the elementary ideas in all the basic college courses, as
taught in 1996. However, all discoverers and all examples
demonstrating these elementary ideas come from dates before
1884. Neither you nor Glotz knows anything about anything that
has happened after 1884.
Glotz offers to invest $2 million in 1884 dollars, yet take only
half the equity, for a Glotz Charitable Foundation, in a new
corporation organized to go into the non-alcoholic beverage
business and remain in that business only, forever. Glotz wants
to use a name that has somehow charmed him: Coca-Cola.
The other half of the new corporation’s equity will go to the
man who most plausibly demonstrates that his business plan
will cause Glotz’s foundation to be worth a trillion dollars 150
years later, in the money of that later time, 2034, despite paying
out a large part of its earnings each year as a dividend. This will
make the whole new corporation worth $2 trillion, even after
paying out many billions of dollars in dividends.
You have 15 minutes to make your pitch. What do you say to
Glotz?
Here is my solution, my pitch to Glotz, using only the helpful
notions and what every bright college sophomore should know:
Well, Glotz, the big no-brainer decisions that, to simplify our
problem, should be made ﬁrst are as follows: First, we are never
going to create something worth $2 trillion by selling some
generic beverage. Therefore, we must make your name, Coca-
Cola, into a strong, legally protected trademark. Second, we can
get to $2 trillion only by starting in Atlanta, then succeeding in
the rest of the United States, then rapidly succeeding with our
new beverage all over the world. This will require developing a

## Page 176

product that has universal appeal because it harnesses powerful
elemental forces. And the right place to ﬁnd such powerful
elemental forces is in the subject matter of elementary academic
courses.
We will next use numerical ﬂuency to ascertain what our
target implies. We can guess reasonably that by 2034 there will
be about 8 billion beverage consumers in the world. On average,
each of these consumers will be much more prosperous in real
terms than the average consumer of 1884. Each consumer is
composed mostly of water and must ingest about 64 ounces of
water per day. This is eight 8-ounce servings. Thus, if our new
beverage, and other imitative beverages in our new market, can
ﬂavor and otherwise improve only 25 percent of ingested water
worldwide, and we can occupy half of the new world market, we
can sell 2.92 trillion 8-ounce servings in 2034. And if we can
then net 4¢ per serving, we will earn $117 billion. This will be
enough, if our business is still growing at a good rate, to make it
easily worth $2 trillion.
A big question, of course, is whether 4¢ per serving is a
reasonable proﬁt target for 2034. And the answer is yes if we can
create a beverage with strong universal appeal. One hundred
and ﬁfty years is a long time. The dollar, like the Roman
drachma,53 will almost surely suffer monetary depreciation.
Concurrently, real purchasing power of the average beverage
consumer in the world will go way up. His proclivity to
inexpensively improve his experience while ingesting water will
go up considerably faster. Meanwhile, as technology improves,
the cost of our simple product, in units of constant purchasing
power, will go down. All four factors will work together in favor of
our 4¢ per-serving proﬁt target. Worldwide beverage purchasing
power in dollars will probably multiply by a factor of at least 40
over 150 years. Thinking in reverse, this makes our proﬁt per-
serving target, under 1884 conditions, a mere one-fortieth of 4¢

## Page 177

or one-tenth of a cent per serving. This is an easy-to-exceed
target as we start out if our new product has universal appeal.
That decided, we must next solve the problem of invention to
create universal appeal. There are two intertwined challenges of
large scale. First, over 150 years, we must cause a new-beverage
market to assimilate about one-fourth of the world’s water
ingestion. Second, we must so operate that half the new market
is ours while all our competitors combined are left to share the
remaining half. These results are lollapalooza results.
Accordingly, we must attack our problem by causing every
favorable factor we can think of to work for us. Plainly, only a
powerful combination of many factors is likely to cause the
lollapalooza consequences we desire. Fortunately, the solution to
these intertwined problems turns out to be fairly easy if one has
stayed awake in all the freshman courses.
Let us start by exploring the consequences of our simplifying
no-brainer decision that we must rely on a strong trademark.
This conclusion automatically leads to an understanding of the
essence of our business in proper elementary academic terms.
We can see from the introductory course in psychology that, in
essence, we are going into the business of creating and
maintaining conditioned reﬂexes. The Coca-Cola trade name
and trade dress will act as the stimuli, and the purchase and
ingestion of our beverage will be the desired responses.
And how does one create and maintain conditioned reﬂexes?
Well, the psychology text gives two answers: 1) by operant
conditioning and 2) by classical conditioning, often called
Pavlovian conditioning to honor the great Russian scientist. And
since we want a lollapalooza result, we must use both
conditioning techniques, and all we can invent to enhance
effects from each technique.
The operant conditioning part of our problem is easy to solve.
We need only 1) maximize rewards of our beverage’s ingestion

## Page 178

and 2) minimize possibilities that desired reﬂexes, once created
by us, will be extinguished through operant conditioning by
proprietors of competing products.
For operant conditioning rewards, there are only a few
categories we will ﬁnd practical:
1. Food value in calories or other inputs
2. Flavor, texture, and aroma acting as stimuli to
consumption under neural pre programming of man
through Darwinian natural selection
3. Stimulus, as by sugar or caffeine
4. Cooling effect when man is too hot or warming effect when
man is too cool
Wanting a lollapalooza result, we will naturally include
rewards in all the categories.
To start out, it is easy to decide to design our beverage for
consumption cold. There is much less opportunity, without
ingesting a beverage, to counteract excessive heat compared
with excessive cold. Moreover, with excessive heat, much liquid
must be consumed, and the reverse is not true.
It is also easy to decide to include both sugar and caffeine.
After all, tea, coffee, and lemonade are already widely consumed.
And it is also clear that we must be fanatic about determining,
through trial and error, ﬂavor and other characteristics that will
maximize human pleasure while taking in the sugared water and
caffeine we will provide.
And, to counteract possibilities that desired operant-
conditioned reﬂexes, once created by us, will be extinguished by
operant-conditioning-employing competing products, there is
also an obvious answer: We will make it a permanent obsession
in our company that our beverage, as fast as practicable, will at

## Page 179

all times be available everywhere throughout the world. After all,
a competing product, if it is never tried, can’t act as a reward
creating a conﬂicting habit. Every spouse knows that.
We must next consider the Pavlovian conditioning we must
also use. In Pavlovian conditioning, powerful effects come from
mere association. The neural system of Pavlov’s dog causes it to
salivate at the bell it can’t eat. And the brain of man yearns for
the type of beverage held by the pretty woman he can’t have. And
so, Glotz, we must use every sort of decent, honorable Pavlovian
conditioning we can think of. For as long as we are in business,
our beverage and its promotion must be associated in consumer
minds with all other things consumers like or admire.
Such extensive Pavlovian conditioning will cost a lot of
money, particularly for advertising. We will spend big money as
far ahead as we can imagine. But the money will be effectively
spent. As we expand fast in our new-beverage market, our
competitors will face gross disadvantages of scale in buying
advertising to create the Pavlovian conditioning they need. And
this outcome, along with other volume-creates-power effects,
should help us gain and hold at least 50 percent of the new
market everywhere. Indeed, provided buyers are scattered, our
higher volumes will give us very extreme cost advantages in
distribution.
Moreover, Pavlovian effects from mere association will help
us choose the ﬂavor, texture, and color of our new beverage.
Considering Pavlovian effects, we will have wisely chosen the
exotic and expensive-sounding name “Coca-Cola” instead of a
pedestrian name like “Glotz’s Sugared, Caffeinated Water.” For
similar Pavlovian reasons, it will be wise to have our beverage
look pretty much like wine instead of sugared water. So we will
artiﬁcially color our beverage if it comes out clear. And we will
carbonate our water, making our product seem like champagne,
or some other expensive beverage, while also making its ﬂavor

## Page 180

better and imitation harder to arrange for competing products.
And, because we are going to attach so many expensive
psychological effects to our ﬂavor, that ﬂavor should be different
from any other standard ﬂavor so that we maximize difﬁculties
for competitors and give no accidental same-ﬂavor beneﬁt to any
existing product.
What else from the psychology textbook can help our new
business? Well, there is that powerful “monkey see, monkey do”
aspect of human nature that psychologists often call social proof.
Social proof—imitative consumption triggered by mere sight of
consumption—will not only help induce trial of our beverage, it
will also bolster perceived rewards from consumption. We will
always take this powerful social proof factor into account as we
design advertising and sales promotion and as we forego present
proﬁt to enhance present and future consumption. More than
with most other products, increased selling power will come
from each increase in sales.
We can now see, Glotz, that by combining 1) much Pavlovian
conditioning, 2) powerful social proof effects, and 3) a
wonderful-tasting, energy-giving, stimulating, and desirably cold
beverage that causes much operant conditioning, we are going to
get sales that speed up for a long time by reason of the huge
mixture of factors we have chosen. Therefore, we are going to
start something like an autocatalytic reaction in chemistry—
precisely the sort of multifactor-triggered lolla palooza effect we
need.
The logistics and the distribution strategy of our business will
be simple. There are only two practical ways to sell our beverage:
1) as syrup to fountains and restaurants and 2) as a complete
carbonated water product in containers. Wanting lollapalooza
results, we will naturally do it both ways. And, wanting huge
Pavlovian and social proof effects, we will always spend on

## Page 181

advertising and sales promotion, per serving, over 40 percent of
the fountain price for syrup needed to make the serving.
A few syrup-making plants can serve the world. However, to
avoid needless shipping of mere space and water, we will need
many bottling plants scattered over the world. We will maximize
proﬁts if, like early General Electric with light bulbs, we always
set the ﬁrst-sale price, either 1) for fountain syrup or 2) for any
container of our complete product. The best way to arrange this
desirable proﬁt-maximizing control is to make any independent
bottler we need a subcontractor, not a vendee of syrup, and
certainly not a vendee of syrup under a perpetual franchise
specifying a syrup price frozen forever at its starting level.
Being unable to get a patent or copyright on our super-
important ﬂavor, we will work obsessively to keep our formula
secret. We will make a big hoopla over our secrecy, which will
enhance Pavlovian effects. Eventually, food chemical
engineering will advance so that our ﬂavor can be copied with
near exactitude. But by that time, we will be so far ahead, with
such strong trademarks and complete, “always available”
worldwide distribution, that good ﬂavor copying won’t bar us
from our objective. Moreover, the advances in food chemistry
that help competitors will almost surely be accompanied by
technological advances that will help us, including refrigeration,
better transportation, and, for dieters, the ability to insert a
sugar taste without inserting sugar’s calories. Also, there will be
related beverage opportunities we will seize.
This brings us to a ﬁnal reality check for our business plan.
We will, once more, think in reverse like Jacobi. What must we
avoid because we don’t want it? Four answers seem clear:
First, we must avoid the protective, cloying, stop-
consumption effects of aftertaste that are a standard part of
physiology, developed through Darwinian evolution to enhance
the replication of man’s genes by forcing a generally helpful

## Page 182

moderation on the gene carrier. To serve our ends, on hot days, a
consumer must be able to drink container after container of our
product with almost no impediment from aftertaste. We will ﬁnd
a wonderful no-aftertaste ﬂavor by trial and error and will
thereby solve this problem.
Second, we must avoid ever losing even half of our powerful
trademarked name. It will cost us mightily, for instance, if our
sloppiness should ever allow the sale of any other kind of “cola,”
for instance a “Peppy Cola.” If there is ever a Peppy Cola, we will
be the proprietor of the brand.
Third, with so much success coming, we must avoid bad
effects from envy, which is given a prominent place in the Ten
Commandments because envy is so much a part of human
nature. The best way to avoid envy, as recognized by Aristotle,54
is to plainly deserve the success we get. We will be fanatic about
product quality, quality of product presentation, and
reasonableness of prices, considering the harmless pleasure we
will provide.
Fourth, after our trademarked ﬂavor dominates our new
market, we must avoid making any huge and sudden change in
our ﬂavor. Even if a new ﬂavor performs better in blind taste
tests, changing to that new ﬂavor would be a foolish thing to do.
This follows because, under such conditions, our old ﬂavor will
be so entrenched in consumer preference by psychological
effects that a big ﬂavor change would do us little good, and it
would do immense harm by triggering in consumers the
standard deprival-superreaction syndrome that makes “take-
aways” so hard to get in any type of negotiation and helps make
most gamblers so irrational. Moreover, such a large ﬂavor change
would allow a competitor, by copying our old ﬂavor, to take
advantage of both 1) the hostile consumer super reaction to
deprival and 2) the huge love of our original ﬂavor created by our
previous work.

## Page 183

Well, that is my solution to my own problem of turning $2
million into $2 trillion even after paying out billions of dollars in
dividends. I think it would have won with Glotz in 1884 and
should convince you more than you expected at the outset. After
all, the correct strategies are clear after being related to
elementary academic ideas brought into play by the helpful
notions.
How consistent is my solution with the history of the real
Coca-Cola Company? Well, as late as 1896, 12 years after the
ﬁctional Glotz was to start vigorously with $2 million in 1884
dollars, the real Coca-Cola Company had a net worth under
$150,000 and earnings of about zero. And thereafter, the real
Coca-Cola Company did lose half its trademark and did grant
perpetual bottling franchises at ﬁxed syrup prices. And some of
the bottlers were not very effective and couldn’t easily be
changed. And the real Coca-Cola Company, with this system, did
lose much pricing control that would have improved results, had
it been retained.
Yet, even so, the real Coca-Cola Company followed so much of
the plan given to Glotz that it is now worth about $125 billion and
will have to increase its value at only 8 percent per year until
2034 to reach a value of $2 trillion. And it can hit an annual
physical volume target of 2.92 trillion servings if servings grow
until 2034 at only 6 percent per year, a result consistent with
much past experience and leaving plenty of plain-water
ingestion for Coca-Cola to replace after 2034. So I would guess
that the ﬁctional Glotz, starting earlier and stronger and avoiding
the worst errors, would have easily hit his $2 trillion target. And
he would have done it well before 2034.
This brings me, at last, to the main purpose of my talk. Large
educational implications exist, if my answer to Glotz’s problem is
roughly right and if you make one more assumption I believe
true—that most PhD educators, even psychology professors and

## Page 184

business school deans, would not have given the same simple
answer I did. And if I am right in these two ways, this would
indicate that our civilization now keeps in place a great many
educators who can’t satisfactorily explain Coca-Cola, even in
retrospect, and even after watching it closely all their lives. This
is not a satisfactory state of affairs.
Moreover—and this result is even more extreme—the brilliant
and effective executives who, surrounded by business school and
law school graduates, have run the Coca-Cola Company with
glorious success in recent years also did not understand
elementary psychology well enough to predict and avoid the New
Coke ﬁasco, which dangerously threatened their company. That
people so talented, surrounded by professional advisers from
the best universities, should thus demonstrate a huge gap in
their education is also not a satisfactory state of affairs.
Such extreme ignorance, in both the high reaches of
academia and the high reaches of business, is a lollapalooza
effect of a negative sort, demonstrating grave defects in
academia. Because the bad effect is a lollapalooza, we should
expect to ﬁnd intertwined, multiple academic causes. I suspect
at least two such causes:
First, academic psychology, while it is admirable and useful
as a list of ingenious and important experiments, lacks
intradisciplinary synthesis. In particular, not enough attention is
given to lollapalooza effects coming from combinations of
psychological tendencies. This creates a situation reminding one
of a rustic teacher who tries to simplify schoolwork by rounding
pi to an even 3. And it violates Einstein’s injunction that
“everything should be made as simple as possible, but no more
simple.” In general, psychology is laid out and misunderstood, as
electromagnetism would now be misunderstood if physics had
produced many brilliant experimenters like Michael Faraday
and no grand synthesizer like James Clerk Maxwell.

## Page 185

Second, there is a truly horrible lack of synthesis blending
psychology and other academic subjects. But only an
interdisciplinary approach will correctly deal with reality—in
academia as with the Coca-Cola Company.
In short, academic psychology departments are immensely
more important and useful than other academic departments
think. And at the same time, the psychology departments are
immensely worse than most of their inhabitants think. It is, of
course, normal for self-appraisal to be more positive than
external appraisal. Indeed, a problem of this sort may have given
you your speaker today. But the size of this psychology
department gap is preposterously large. In fact, the gap is so
enormous that one very eminent university, Chicago, simply
abolished its psychology department, perhaps with an
undisclosed hope of later creating a better version.
In such a state of affairs, many years ago and with much that
was plainly wrong already present, the New Coke ﬁasco
occurred. Therein, Coke’s executives came to the brink of
destroying the most valuable trademark in the world. The
academically correct reaction to this immense and well-
publicized ﬁasco would have been the sort of reaction Boeing
would display if three of its new airplanes crashed in a single
week. After all, product integrity is involved in each case, and the
plain educational failure was immense.
But almost no such responsible Boeing-like reaction has
come from academia. Instead, academia, by and large, continues
in its balkanized way to tolerate psychology professors who
misteach psychology, non-psychology professors who fail to
consider psychological effects obviously crucial in their subject
matter, and professional schools that carefully preserve
psychological ignorance coming in with each entering class and
are proud of their inadequacies.

## Page 186

Even though this regrettable blindness and lassitude is now
the normal academic result, are there exceptions providing hope
that disgraceful shortcomings of the education establishment
will eventually be corrected? Here, my answer is a very
optimistic yes.
For instance, consider the recent behavior of the economics
department of the University of Chicago. Over the last decade,
this department has enjoyed a near monopoly of the Nobel
Prizes in economics, largely by getting good predictions out of
free-market models postulating man’s rationality. And what is
the reaction of this department after winning so steadily with its
rational-man approach? Well, it has just invited into a precious
slot amid its company of greats a wise and witty Cornell
economist, Richard Thaler.55 And it has done this because Thaler
pokes fun at much that is holy at the University of Chicago.
Indeed, Thaler believes, with me, that people are often massively
irrational in ways predicted by psychology that must be taken
into account in microeconomics.
In so behaving, the University of Chicago is imitating Darwin,
who spent much of his long life thinking in reverse as he tried to
disprove his own hardest-won and best-loved ideas. And so long
as there are parts of academia that keep alive its best values by
thinking in reverse like Darwin, we can conﬁdently expect that
silly educational practices will eventually be replaced by better
ones, exactly as Carl Jacobi might have predicted.
This will happen because the Darwinian approach, with its
habitual objectivity taken on as a sort of hair shirt, is a mighty
approach indeed. No less a ﬁgure than Einstein said that one of
the four causes of his achievement was self-criticism, ranking
right up there alongside curiosity, concentration, and
perseverance.
And, to further appreciate the power of self-criticism,
consider where lies the grave of that very “ungifted”

## Page 187

undergraduate, Charles Darwin. It is in Westminster Abbey, right
next to the headstone of Isaac Newton, perhaps the most gifted
student who ever lived, honored on that headstone in eight Latin
words constituting the most eloquent praise in all graveyard
print: “Hic depositum est, quod mortale fuit Isaaci
Newtoni”—“Here lies that which was mortal of Isaac Newton.”
A civilization that so places a dead Darwin will eventually
develop and integrate psychology in a proper and practical
fashion that greatly increases skills of all sorts. But all of us who
have dollops of power and see the light should help the process
along. There is a lot at stake. If, in many high places, a universal
product as successful as Coca-Cola is not properly understood
and explained, it can’t bode well for our competency in dealing
with much else that is important.
Of course, those of you with 50 percent of net worth in Coca-
Cola stock, occurring because you tried to invest 10 percent after
thinking like I did in making my pitch to Glotz, can ignore my
message about psychology as too elementary for useful
transmission to you. But I am not so sure that this reaction is
wise for the rest of you. The situation reminds me of the old-time
Warner & Swasey ad that was a favorite of mine: “The company
that needs a new machine tool and hasn’t bought it is already
paying for it.”
TALK FOUR REVISITED
In this talk I attempted to demonstrate large, correctable, and
important cognitive failures in US academia and business. After
all, I argued: 1) If academia and business functioned with best
practicable results, most denizens would be able to explain the
success of the Coca-Cola Company through parsimonious use of
basic concepts and problem-solving techniques, yet 2) as the

## Page 188

New Coke ﬁasco and its aftermath indicated, neither academia
nor business had a respectable grasp of the simple realities
causing the success of Coca-Cola.
As matters worked out, my 1996 talk failed to get through to
almost all people hearing it. Then later, between 1996 and 2006,
even when the talk’s written version was slowly read twice by
very intelligent people who admired me, its message likewise
failed. In almost all cases the message did not get through in any
constructive way. On the other hand, no one said to me that the
talk was wrong. Instead, people were puzzled brieﬂy, then moved
on.
Thus my failure as a communicator was even more extreme
than the cognitive failure I was trying to explain. Why?
The best explanation, I now think, is that I displayed gross
folly as an amateur teacher. I attempted too much. I have always
avoided all people who want to converse at length about the
“meaning of meaning.” Yet I chose as my title “Practical Thought
about Practical Thought?” This was a start into tough territory.
Then I worked out a long, complex interplay of ﬁve generalized,
powerful problem-solving tricks with basic ideas from a great
many disciplines. I particularly included psychology, about
which I wanted to demonstrate that there is much lamentable
ignorance, even among highly educated people, some of whom
teach psychology. My demonstration, naturally, relied on correct
psychology as part of my would-be demonstration. This was
logically sound. But if psychological ignorance is widespread,
why would most of my hearers recognize that my version of
psychology was correct? Thus, for most hearers, I did the rough
equivalent of trying to explain some hard-to-comprehend ideas
by simply deﬁning those ideas as equivalent to themselves.
And this was not the outer limit of my teaching folly. After I
knew that the written version of my talk was hard to understand,
I consented to an order of talks in Poor Charlie’s Almanack wherein

## Page 189

my psychology talk was Talk Eleven, inserted many pages after
Talk Four. Instead, I should have recognized that the order of the
two talks should be reversed, considering that Talk Four
assumed that readers had already mastered basic psychology,
the subject of Talk Eleven. Then, ﬁnally, I preferred to maintain
the original, unhelpful order of the two talks. I did this because I
like closing the book with my most recent organization of
psychology into a sort of checklist that has long been helpful to
me.
Readers, if they wish, can correct somewhat for the teaching
defects that I have stubbornly retained. That is, they can re read
Talk Four after mastering the ﬁnal talk. If they are willing to
endure this ordeal, I predict that at least some of them will ﬁnd
the result worth the effort.

## Page 190

CHAPTER 4; TALK FIVE
stripe.press/pca-9
The Need for More Multi -disciplinary Skills fromEducational Profes sionals:Implications
APRIL 24, 199850TH REUNION OF HARVARD LAW SCHOOLCLASS OF 1948
Having ranted in the previous speech about all that is wrong in
academia, Charlie holds forth here on the solutions. Delivered in
1998 at the 50th reunion of his Harvard Law School class, this talk
focuses on a hugely complicated issue—the narrowness of elite
education—and segments it into elements whose solutions, when taken
together, form a satisfactory answer to the problem.
Through a series of rhetorical questions, Charlie posits that
professionals such as attorneys, to their own detriment, lack
multi disciplinary skills. From his own extensive multidisciplinary
studies, he recognizes that there are “subconscious mental
tendencies” that keep people from broadening their own horizons
sufficiently. Nonetheless, he brings unique and memorable solutions
to the problem.
This talk—a favorite of your editor—clearly demonstrates
Charlie’s “uncommon common sense.” He says, “When it really
matters, as with pilots and surgeons, educational systems employ
highly effective structures. Yet they don’t employ these same well-
understood structures in other areas of learning that are also
important. If superior structures are known and available, why

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don’t educators more broadly utilize them? What could be more
simple?”
Today I am going to engage in a game reminding us of our old
professors: Socratic solitaire. I will ask and brieﬂy answer ﬁve
questions:
1. Do broadscale professionals need more multidisciplinary
skill?
2. Was our education sufﬁciently multidisciplinary?
3. In elite, broadscale soft science, what is the essential
nature of practicable, best-form multidisciplinary
education?
4. In the last 50 years, how far has elite academia progressed
toward attainable best-form multidisciplinarity?
5. What educational practices would make progress faster?
We start with the question: Do broadscale professionals need
more multidisciplinary skill?
To answer the ﬁrst question, we must ﬁrst decide whether
more multidisciplinarity will improve professional cognition.
And to decide what will cure bad cognition, it will help to know
what causes it. One of Bernard Shaw’s characters explained
professional defects as follows: “In the last analysis, every
profession is a conspiracy against the laity.”
There is a lot of truth in Shaw’s diagnosis, as was early
demonstrated when, in the 16th century, the dominant
profession, the clergy, burned William Tyndale56 at the stake for
translating the Bible into English.

## Page 192

But Shaw plainly understates the problem in implying that a
conscious, self-interested malevolence is the main culprit. More
important, there are frequent, terrible effects in professionals
from intertwined subconscious mental tendencies, two of which
are exceptionally prone to cause trouble: 1) incentive-caused
bias, a natural cognitive drift toward the conclusion that what is
good for the professional is good for the client and the wider
civilization; and 2) man-with-a-hammer tendency, with the
name taken from the proverb “To a man with only a hammer,
every problem tends to look pretty much like a nail.”
One partial cure for man-with-a-hammer tendency is
obvious: If a man has a vast set of skills over multiple disciplines,
he, by deﬁnition, carries multiple tools and therefore will limit
bad cognitive effects from man-with-a-hammer tendency.
Moreover, when he is multidisciplinary enough to absorb from
practical psychology the idea that all his life he must ﬁght bad
effects from both the tendencies I mentioned, both within
himself and from others, he has taken a constructive step on the
road to worldly wisdom.
If A is narrow professional doctrine and B consists of the big,
extra-useful concepts from other disciplines, then clearly the
professional possessing A plus B will usually be better off than
the poor possessor of A alone. How could it be otherwise? And
thus, the only rational excuse for not acquiring more B is that it
is not practical to do so, given the man’s need for A and the other
urgent demands in his life. I will later try to demonstrate that
this excuse for unidisciplinarity, at least for our most gifted
people, is usually unsound.
My second question is so easy to answer that I won’t give it
much time. Our education was far too unidisciplinary.
Broadscale problems, by deﬁnition, cross many academic
disciplines. Accordingly, using a unidisciplinary attack on such
problems is like playing a bridge hand by counting trumps while

## Page 193

ignoring all else. This is bonkers, sort of like the Mad Hatter’s tea
party. But nonetheless, too much that is similar remains present
in professional practice and, even worse, has long been
encouraged in isolated departments of soft science, deﬁned as
everything less fundamental than biology.
Even in our youth, some of the best professors were horriﬁed
by bad effects from the balkanization of academia into insular,
turf-protecting enclaves, wherein notions were maintained by
leaps of faith plus exclusion of nonbelievers. Alfred North
Whitehead,57 for one, long ago sounded an alarm in strong
language when he spoke of “the fatal unconnectedness of
academic disciplines.” And since then, elite educational
institutions, agreeing more and more with Whitehead, have
steadily fought unconnectedness by bringing in more multi -
disciplinarity, causing some awesome plaudits to be won in our
time by great unconnectedness ﬁghters at the borders of
academic disciplines, for instance Harvard’s E. O. Wilson and
Caltech’s Linus Pauling.58 Modern academia now gives more
multidisciplinarity than we received and is plainly right to do so.
The natural third question then becomes: What is now the
goal? What is the essential nature of best-form
multidisciplinarity in elite education? This question, too, is easy
to answer. All we have to do is examine our most successful
narrow-scale education, identify essential elements, and scale
up those elements to reach the sensible solution.
To ﬁnd the best educational narrow-scale model, we have to
look not at unthreatened schools of education and the like, too
much driven by our two counterproductive psychological
tendencies and other bad inﬂuences, but instead look where
incentives for effective education are strongest and results are
most closely measured. This leads us to a logical place: the
hugely successful education now mandatory for pilots. Yes, I am

## Page 194

suggesting today that mighty Harvard would do better if it
thought more about pilot training.
In piloting, as in other professions, one great hazard is a bad
effect from man-with-a-hammer tendency. We don’t want a pilot,
ever, to respond to a hazard as if it was hazard X just because his
mind contains only a hazard X model. And so, for that and other
reasons, we train a pilot in a strict six-element system:
1. His formal education is wide enough to cover practically
everything useful in piloting.
2. His knowledge of practically everything needed by pilots is
not taught just well enough to enable him to pass one test
or two; instead, all his knowledge is raised to practice-
based ﬂuency, even in handling two or three intertwined
hazards at once.
3. Like any good algebraist, he is made to think sometimes in
a forward fashion and sometimes in reverse, and so he
learns when to concentrate mostly on what he wants to
happen and also when to concentrate mostly on avoiding
what he does not want to happen.
4. His training time is allocated among subjects so as to
minimize damage from his later malfunctions, and so what
is most important in his performance gets the most
training coverage and is raised to the highest ﬂuency
levels.
5. Checklist routines are always mandatory for him.
6. Even after original training, he is forced into a special
knowledge maintenance routine: regular use of the aircraft
simulator to prevent atrophy through long disuse of skills
needed to cope with rare and important problems.

## Page 195

The need for this clearly correct six-element system, with its
large demands in a narrow-scale ﬁeld where stakes are high, is
rooted in the deep structure of the human mind. Therefore, we
must expect that the education we need for broadscale problem-
solving will keep all these elements but with awesomely
expanded coverage for each element. How could it be otherwise?
Thus it follows, as the night the day, that in our most elite
broadscale education, wherein we are trying to make silk purses
out of silk, we need for best results to have multidisciplinary
coverage of immense amplitude, with all needed skills raised to
an ever-maintained practice-based ﬂuency, including
considerable power of synthesis at boundaries between
disciplines, with the highest ﬂuency levels being achieved where
they are most needed, with forward and reverse thinking
techniques being employed in a manner reminding one of
inversion in algebra, and with checklist routines being a
permanent part of the knowledge system. There can be no other
way, no easier way, to broadscale worldly wisdom. Thus the task,
when ﬁrst identiﬁed in its immense breadth, seems daunting,
verging on impossible.
But the task, considered in full context, is far from impossible
when we consider three factors:
First, the concept of “all needed skills” lets us recognize that
we don’t have to raise everyone’s skill in celestial mechanics to
that of [Pierre-Simon] Laplace59 and also ask everyone to achieve
a similar skill level in all other knowledge. Instead, it turns out
that the truly big ideas in each discipline, learned only in
essence, carry most of the freight. And they are not so numerous,
nor are their interactions so complex, that a large and
multidisciplinary understanding is impossible for many, given
large amounts of talent and time.
Second, in elite education, we have available the large
amounts of talent and time that we need. After all, we are

## Page 196

educating the top 1 percent in aptitude, using teachers who, on
average, have more aptitude than the students. And we have
roughly 13 long years in which to turn our most promising 12-
year-olds into starting professionals.
Third, thinking by inversion and thorough use of checklists is
easily learned, in broadscale life as in piloting.
Moreover, we can believe in the attainability of broad multi -
disciplinary skill for the same reason the fellow from Arkansas
gave for his belief in baptism: “I’ve seen it done.” We all know of
individuals, modern Ben Franklins, who have 1) achieved a
massive multidisciplinary synthesis with less time in formal
education than is now available to our numerous brilliant young,
and 2) thus become better performers in their own disciplines,
not worse, despite diversion of learning time to matter outside
the normal coverage of their own disciplines.
Given the time and talent available and examples of
successful masters of multiple disciplines, what is shown by our
present failure to minimize bad effects from man-with-a-
hammer tendency is only that you can’t win big in
multidisciplinarity in soft-science academia if you are so
satisﬁed with the status quo, or so frightened by the difﬁculties of
change, that you don’t try hard enough to win big.
Which brings us to our fourth question: Judged with reference
to an optimized, feasible multidisciplinary goal, how much has
elite soft-science education been corrected after we left?
The answer is that many things have been tried as corrections
in the direction of better multidisciplinarity. And, after allowing
for some counterproductive results, there has been some
considerable improvement, net. But much desirable correction
is still undone and lies far ahead.
For instance, soft-science academia has increasingly found it
helpful when professors from different disciplines collaborate or
when a professor has been credentialed in more than one

## Page 197

discipline. But a different sort of correction has usually worked
best, namely augmentation, or a “take what you wish” practice
that encourages any discipline to simply assimilate whatever it
chooses from other disciplines. Perhaps it has worked best
because it bypassed academic squabbles rooted in the tradition
and territoriality that had caused the unidisciplinary folly for
which correction was now sought.
In any event, through increased use of take what you wish,
many soft-science disciplines reduced folly from man-with-a-
hammer tendency. For instance, led by our classmate Roger
Fisher,60 the law schools brought in negotiation, drawing on
other disciplines. Over 3 million copies of Roger’s wise and
ethical negotiation book have now been sold, and his life’s
achievement may well be the best, ever, from our whole class.
The law schools also brought in a lot of sound and useful
economics, even some good game theory to enlighten antitrust
law by better explaining how competition really works.
Economics, in turn, took in from a biologist the tragedy of the
commons model, thus correctly ﬁnding a wicked invisible foot in
coexistence with Adam Smith’s angelic invisible hand. These
days, there is even some behavioral economics, wisely seeking
aid from psychology.
However, an extremely permissive practice like take what you
wish was not destined to have 100 percent admirable results in
soft science. Indeed, in some of its worst outcomes, it helped
changes like the assimilation of Freudianism in some literature
departments; the importation into many places of extremist
political ideologies of the left or right that had, for their
possessors, made regaining objectivity almost as unlikely as
regaining virginity; and the importation into many law and
business schools of hard-form, efﬁcient-market theory by
misguided would-be experts in corporate ﬁnance, one of whom
kept explaining Berkshire Hathaway’s investing success by

## Page 198

adding standard deviations of luck until, at six standard
deviations, he encountered enough derision to force a change in
explanation.
Moreover, even when it avoided such lunacies, take what you
wish had some serious defects. For instance, takings from more
fundamental disciplines were often done without attribution,
sometimes under new names, with little attention given to rank
in a fundamentalness order for absorbed concepts. Such
practices 1) act like a lousy ﬁling system that must impair the
successful use and synthesis of absorbed knowledge, and 2) do
not maximize in soft science the equivalent of Linus Pauling’s
systematic mining of physics to improve chemistry. There must
be a better way.
This brings us, ﬁnally, to our last question: In elite soft
science, what practices would hasten our progress toward
optimized disciplinarity? Here, again, there are some easy
answers:
First, many more courses should be mandatory, not optional.
And this, in turn, requires that the people who decide what is
mandatory must possess large, multidisciplinary knowledge
maintained in ﬂuency. This conclusion is as obvious in the
training of the would-be broadscale problem-solver as it is in the
training of the would-be pilot. For instance, both psychology
mastery and accounting mastery should be required as
outcomes in legal education. Yet in many elite places, even today,
there are no such requirements. Often, such is the narrowness of
mind of the program designers that they neither see what is
needed and missing nor are able to ﬁx deﬁciencies.
Second, there should be much more problem-solving practice
that crosses several disciplines, including practice that mimics
the function of the aircraft simulator in preventing loss of skills
through disuse.

## Page 199

Let me give an example, roughly remembered, of this sort of
teaching by a very wise but untypical Harvard Business School
professor many decades ago. This professor gave a test involving
two unworldly old ladies who had just inherited a New England
shoe factory making branded shoes and beset with serious
business problems described in great detail. The professor then
gave the students ample time to answer with written advice to
the old ladies. In response to the answers, the professor gave
every student an undesirable grade except for one student who
was graded at the top by a wide margin.
What was the winning answer? It was very short and roughly
as follows: “This business ﬁeld and this particular business, in
its particular location, present crucial problems that are so
difﬁcult that unworldly old ladies cannot wisely try to solve them
through hired help. Given the difﬁculties and unavoidable
agency costs, the old ladies should promptly sell the shoe factory,
probably to the competitor who would enjoy the greatest
marginal utility advantage.”
Thus, the winning answer relied not on what the students had
most recently been taught in business school but instead on
more fundamental concepts, like agency costs and marginal
utility, lifted from undergraduate psychology and economics. Ah,
my fellow members of the Harvard Law Class of 1948—if only we
had been much more often tested like that, just think of what
more we might have accomplished!
Incidentally, many elite private schools now wisely use such
multidisciplinary methods in seventh grade science, while at the
same time many graduate schools have not yet seen the same
light. This is one more sad example of Whitehead’s fatal
unconnectedness in education.
Third, most soft-science professional schools should increase
their use of the best business periodicals, like The Wall Street
Journal, Forbes, Fortune, etc. Such periodicals are now quite good

## Page 200

and perform the function of the aircraft simulator if used to
prompt practice in relating events to multidisciplinary causes,
often intertwined. And sometimes the periodicals even
introduce new models for causes instead of merely refreshing
old knowledge. Also, it is not just slightly sound to have the
student practice in school what he must practice lifelong after
formal education is over if he is going to maximize his good
judgment. I know no person in business, respected for veriﬁed
good judgment, whose wisdom maintenance system does not
include use of such periodicals. Why should academia be
different?
Fourth, in ﬁlling scarce academic vacancies, professors of
super strong, passionate political ideology, whether on the left or
right, should usually be avoided. So also for students. Best-form
multi disciplinarity requires an objectivity such passionate
people have lost, and a difﬁcult synthesis is not likely to be
achieved by minds in ideological fetters. In our day, some
Harvard Law professors could and did point to a wonderful
example of just such ideology-based folly. This, of course, was
the law school at Yale, which was then viewed by many at
Harvard as trying to improve legal education by importing a
particular political ideology as a dominant factor.
Fifth, soft science should more intensely imitate the
fundamental organizing ethos of hard science, deﬁned as the
fundamental four-discipline combination of math, physics,
chemistry, and engineering. This ethos deserves more imitation.
After all, hard science has, by a wide margin, the best record for
both 1) avoiding unidisciplinary folly and 2) making user-
friendly a big patch of multidisciplinary domain, with frequent,
good results like those of physicist Richard Feynman61 when he
so quickly found in cold O-rings the cause of our greatest space
shuttle disaster.

## Page 201

Previous extensions of the ethos into softer fare have worked
well. For instance, biology, starting 150 years ago with a
descriptive mess not much related to deep theory, has gradually
absorbed the fundamental organizing ethos with marvelous
results, as new generations have come to use better thinking
methods containing models that answer the question “Why?”
And there is no clear reason why the ethos of hard science can’t
also help in disciplines far less fundamental than biology.
Here, as I interpret it, is this fundamental organizing ethos I
am talking about:
1. You must both rank and use disciplines in order of
fundamentalness.
2. You must, like it or not, master to tested ﬂuency and
routinely use the truly essential parts of all four
constituents of the fundamental four-discipline
combination, with particularly intense attention given to
disciplines more fundamental than your own.
3. You may never practice either cross-disciplinary
absorption without attribution or departure from a
principle of economy that forbids explaining in any other
way anything readily explainable from more fundamental
material in your own or any other discipline.
4. But when the step 3 approach doesn’t produce much new
and useful insight, you should hypothesize and test to
establishment new principles, ordinarily by using methods
similar to those that created successful old principles. But
you may not use any new principle inconsistent with an
old one unless you can now prove that the old principle is
not true.

## Page 202

You will note that, compared with much current practice in
soft science, the fundamental organizing ethos of hard science is
more severe. This reminds one of pilot training, and this
outcome is not a coincidence. Reality is talking to anyone who
will listen. Like pilot training, the ethos of hard science does not
say “Take what you wish” but “Learn it all to ﬂuency, like it or
not.” And rational organization of multidisciplinary knowledge is
forced by making mandatory 1) full attribution for cross-
disciplinary takings and 2) mandatory preference for the most
fundamental explanation.
This simple idea may appear too obvious to be useful, but
there is an old two-part rule that often works wonders in
business, science, and elsewhere: 1) Take a simple, basic idea
and 2) take it very seriously. And as some evidence for the value
of taking very seriously the fundamental organizing ethos, I offer
the example of my own life.
I came to Harvard Law School very poorly educated, with
desultory work habits and no college degree. I was admitted over
the objection of Warren Abner Seavey through the intervention
of family friend Roscoe Pound. I had taken one silly course in
biology in high school, brieﬂy learning, mostly by rote, an
obviously incomplete theory of evolution, portions of the
anatomy of the paramecium and frog, plus a ridiculous concept
of “protoplasm” that has since disappeared.
To this day, I have never taken any course, anywhere, in
chemistry, economics, psychology, or business. But I early took
elementary physics and math and paid enough attention to
somehow assimilate the fundamental organizing ethos of hard
science, which I thereafter pushed further and further into softer
and softer fare as my organizing guide and ﬁling system in a
search for whatever multidisciplinary worldly wisdom it would
be easy to get.

## Page 203

Thus, my life became a sort of accidental educational
experiment with respect to the feasibility and utility of a very
gross academic extension of the fundamental organizing ethos
by a man who also learned well what his own discipline had to
teach.
What I found, in my extended attempts to complete by
informal means my stunted education, was that, plugging along
with only ordinary will but with the fundamental organizing
ethos as my guide, my ability to serve everything I loved was
enhanced far beyond my deserts. Large gains came in places that
seemed unlikely as I started out, sometimes making me like the
only one without a blindfold in a high-stakes game of pin the tail
on the donkey. For instance, I was productively led into
psychology, where I had no plans to go, creating large advantages
that deserve a story on another day.
Today, I have no more story. I have ﬁnished my talk by
answering my own questions as best I could in a brief time. What
is most interesting to me in my answers is that, while everything
I have said is non-original and has long been obvious to the point
of banality to many sound and well-educated minds, all the evils
I decry remain grossly over-present in the best of our soft-
science educational domains, wherein virtually every professor
has a too-unidisciplinary habit of mind, even while a better
model exists just across the aisle in his own university.
To me, this ridiculous outcome implies that the soft-science
departments tolerate perverse incentives. Wrong incentives are
a major cause because, as Dr. [Samuel] Johnson so wisely
observed, truth is hard to assimilate in any mind when opposed
by interest. And if institutional incentives cause the problem,
then a remedy is feasible, because incentives can be changed.
I have tried to demonstrate today, and indeed by the example
of my life, that it is neither inevitable nor advantageous for soft-
science educational domains to tolerate as much unidisciplinary

## Page 204

wrong headedness as they now do. Please remember the word Dr.
Johnson used to describe maintenance of academic ignorance
that is removable through diligence: To Dr. Johnson, such
conduct was “treachery.”
And if duty will not move improvement, advantage is also
available. There will be immense worldly rewards, for law
schools and other academic domains as for Charlie Munger, in a
more multi disciplinary approach to many problems, common or
uncommon. And more fun, as well as more accomplishment.
The happier mental realm I recommend is one from which no
one willingly returns. A return would be like cutting off one’s
hands.
TALK FIVE REVISITED
As I review Talk Five in 2006, I would not change a word. And I
continue to believe that my ideas are important. In my attitude I
may be displaying too much similarity to my long-dead relative,
Reverend Theodore Munger, former chaplain of Yale. Theodore
published a collection of his sermons, laying out proper conduct
with a strong, ex cathedra tone. Then, late in life, he published a
ﬁnal edition, reporting in his foreword that he had made no
changes at all and was now producing the new edition only
because the extreme popularity of his sermons had caused
excessive wear in the original printing plates.

## Page 205

CHAPTER 4; TALK SIX
stripe.press/pca-10
Investment Practices of LeadingCharitable Foundations
OCTOBER 14, 1998SPEECH TO THE FOUNDATION FINANCIAL OFFICERS GROUP AT MIRAMARSHERATON HOTEL, SANTA MONICA, CALIFORNIA, SPONSORED BY THE CONRADHILTON FOUNDATION, THE AMATEUR ATHLETIC FOUNDATION, THE J. PAULGETTY TRUST, AND RIO HONDO MEMORIAL FOUNDATION
This speech, delivered in October 1998 to the Foundation Financial
Officers Group in Santa Monica, helps account for Charlie’s line
“It’s sad but true: Not everybody loves me.” In the talk, he
attacks the accepted and practiced orthodoxy of his audience with
sharp humor, though always without malice. Charlie has a deep and
abiding belief in philanthropy, as is demonstrated by his own
generous giving, and he seeks here to save the philanthropic
community from itself.
Charlie believes foundations should serve as societal exemplars,
which means they must discourage wasteful, nonproductive practices.
He posits a choice for his audience: the model of genius statesman
Ben Franklin or that of disgraced fund manager Bernie Cornfeld.
Referring to his days as a limited partnership manager, Charlie
employs, as is typical, self-deprecation and self-reflection:
“Early Charlie Munger is a horrible career model for the young.” If
Charlie can emerge from that state successfully, he seems to be
saying, so can the wayward foundation managers in his audience.

## Page 206

I am speaking here today because my friend John Argue62 asked
me. And John well knew that I—who, unlike many other speakers
on your agenda, have nothing to sell any of you—would be
irreverent about much current investment practice in large
institutions, including charitable foundations. Therefore, any
hostility my talk will cause should be directed at John Argue, who
comes from the legal profession and may even enjoy it.
It was long the norm at large charitable foundations to invest
mostly in unleveraged, marketable domestic securities, mostly
equities. The equities were selected by one or a very few
investment counseling organizations. But in recent years, there
has been a drift toward more complexity. Some foundations,
following the lead of institutions like Yale, have tried to become
much better versions of Bernie Cornfeld’s63 “fund of funds.” This
is an amazing development. Few would have predicted that long
after Cornfeld’s fall into disgrace, major universities would be
leading foundations into Cornfeld’s system.
Now, in some foundations, there are not few but many
investment counselors, chosen by an additional layer of
consultants who are hired to decide which investment
counselors are best, help in allocating funds to various
categories, make sure that foreign securities are not neglected in
favor of domestic securities, check the validity of claimed
investment records, ensure that claimed investment styles are
scrupulously followed, and help augment an already large
diversiﬁcation in a way that conforms to the latest notions of
corporate ﬁnance professors about volatility and “beta.”
But even with this amazingly active, would-be polymathic
new layer of consultants choosing consultants, the individual
investment counselors, in picking common stocks, still rely to a
considerable extent on a third layer of consultants.
The third layer consists of the security analysts employed by
investment banks. These security analysts receive enormous

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salaries, sometimes set in seven ﬁgures after bidding wars. The
hiring investment banks recoup these salaries from two sources:
1) commissions and trading spreads borne by security buyers,
some of which are rebated as “soft dollars” to money managers,
plus 2) investment banking charges paid by corporations that
appreciate the enthusiastic way their securities are being
recommended by the security analysts.
There is one thing sure about all this complexity, including its
touches of behavior lacking the full punctilio of honor: Even
when nothing but unleveraged stock picking is involved, the total
cost of all the investment management, plus the frictional costs
of fairly often getting in and out of many large investment
positions, can easily reach 3 percent of foundation net worth per
annum if foundations, urged on by consultants, add new activity
year after year. This full cost doesn’t show up in conventional
accounting. But that is because accounting has limitations and
not because the full cost isn’t present.
Next, we come to time for a little arithmetic: It is one thing
each year to pay the croupiers 3 percent of starting wealth when
the average foundation is enjoying a real return, say, of 17
percent before the croupiers’ take. But it is not written in the
stars that foundations will always gain 17 percent gross, a
common result in recent years. And if the average annual gross
real return from indexed investment in equities goes back, say,
to 5 percent over some long future period, and the croupiers’
take turns out to remain the waste it has always been, even for
the average intelligent player, then the average intelligent
foundation will be in a prolonged, uncomfortable shrinking
mode. After all, 5 percent minus 3 percent minus 5 percent in
donations leaves an annual shrinkage of 3 percent.
All the equity investors, in total, will surely bear a
performance disadvantage per annum equal to the total
croupiers’ costs they have jointly elected to bear. This is an

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inescapable fact of life. And it is also inescapable that exactly half
of the investors will get a result below the median result after the
croupiers’ take, which median result may well be somewhere
between unexciting and lousy.
Human nature being what it is, most people assume away
worries like those I raise. After all, centuries before Christ,
Demosthenes noted, “What a man wishes, he will believe.” And
in self-appraisals of prospects and talents, it is the norm, as
Demosthenes predicted, for people to be ridiculously over-
optimistic. For instance, a careful survey in Sweden showed that
90 percent of automobile drivers considered themselves above
average. And people who are successfully selling something, as
investment counselors do, make Swedish drivers sound like
depressives. Virtually every investment expert’s public
assessment is that he is above average, no matter what the
evidence to the contrary.
But you may think, “My foundation, at least, will be above
average. It is well endowed, hires the best, and considers all
investment issues at length and with objective professionalism.”
And to this I respond that an excess of what seems like
professionalism will often hurt you horribly, precisely because
the careful procedures themselves often lead to overconﬁdence
in their outcome.
General Motors recently made just such a mistake, and it was
a lollapalooza. Using fancy consumer surveys—its excess of
professionalism—it concluded not to put a fourth door in a truck
designed to serve as the equivalent of a comfortable ﬁve-
passenger car. Its competitors, more basic, had actually seen ﬁve
people enter and exit cars. Moreover, they had noticed that
people were used to four doors in a comfortable ﬁve-passenger
car and that biological creatures ordinarily prefer effort
minimization in routine activities and don’t like removals of
long-enjoyed beneﬁts. There are only two words that come

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instantly to mind in reviewing General Motors’ horrible decision,
which has blown many hundreds of millions of dollars, and one
of those words is “oops.”
Similarly, the hedge fund known as Long-Term Capital
Management64 recently collapsed through overconﬁdence in its
highly leveraged methods, despite IQs of its principals that must
have averaged 160. Smart, hardworking people aren’t exempted
from professional disasters from overconﬁdence. Often, they just
go aground in the more difﬁcult voyages they choose, relying on
their self-appraisals that they have superior talents and
methods.
It is, of course, irritating that extra care in thinking is not all
good but also introduces extra error. But most good things have
undesired side effects, and thinking is no exception. The best
defense is that of the best physicists, who systematically criticize
themselves to an extreme degree, using a mindset described by
Nobel laureate Richard Feynman as follows: “The ﬁrst principle
is that you must not fool yourself, and you’re the easiest person
to fool.”
But suppose that an abnormally realistic foundation, thinking
like Feynman, fears a poor future investment outcome because it
is unwilling to assume that its unleveraged equities will
outperform equity indexes, minus all investment costs, merely
because the foundation has adopted the approach of becoming a
fund of funds, with much investment turnover and layers of
consultants who consider themselves above average. What are
this fearful foundation’s options as it seeks improved prospects?
There are at least three modern choices:
1. The foundation can both dispense with its consultants and
reduce its investment turnover as it changes to indexed
investment in equities.

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2. The foundation can follow the example of Berkshire
Hathaway, and thus get total annual croupier costs below
one-tenth of 1 percent of principal per annum, by
investing with virtually total passivity in a very few much-
admired domestic corporations. And there is no reason
why some outside advice can’t be used in this process. All
the fee payer has to do is suitably control the high talent in
investment counseling organizations so that the servant
becomes the useful tool of its master, instead of serving
itself under the perverse incentives of a sort of Mad
Hatter’s tea party.
3. The foundation can supplement unleveraged investment
in marketable equities with investment in limited
partnerships that do some combination of the following:
unleveraged investment in high-tech corporations in their
infancy; leveraged investments in corporate buyouts;
leveraged relative value trades in equities; and leveraged
convergence trades and other exotic trades in all kinds of
securities and derivatives.
For the obvious reasons given by purveyors of indexed
equities, I think choice 1, indexing, is a wiser choice for the
average foundation than what it is now doing in unleveraged
equity investment. And particularly so, as its present total
croupier costs exceed 1 percent of principal per annum.
Indexing can’t work well forever if almost everybody turns to it.
But it will work all right for a long time.
Choice 3, investment in fancy limited partnerships, is largely
beyond the scope of this talk. I will only say that the Munger
Foundation does not so invest, and brieﬂy mention two
considerations bearing on LBO funds.

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The ﬁrst consideration bearing on LBO funds is that buying
100 percent of corporations with much ﬁnancial leverage and
two layers of promotional carry—one for the management and
one for the general partners in the LBO fund—is no sure thing to
outperform equity indexes in the future if equity indexes
perform poorly in the future. In substance, an LBO fund is a
better way of buying equivalents of marketable equities on
margin, and the debt could prove disastrous if future marketable
equity performance is bad. And particularly so if the bad
performance comes from generally bad business conditions.
The second consideration is increasing competition for LBO
candidates. For instance, if the LBO candidates are good service
corporations, General Electric can now buy more than $10
billion’s worth per year in GE’s credit corporation, with 100
percent debt ﬁnancing at an interest rate only slightly higher
than the US government is paying. This sort of thing is not
ordinary competition but super-competition. And there are now
very many LBO funds, both large and small, mostly awash in
money and with general partners highly incentivized to buy
something. In addition, there is increased buying competition
from corporations other than GE using some combination of
debt and equity.
In short, in the LBO ﬁeld, there is a buried covariance with
marketable equities—toward disaster in generally bad business
conditions—and competition is now extreme.
Given time limitations, I can say no more about limited
partnerships, one of which I once ran. This leaves for extensive
discussion only foundation choice 2, more imitation of the
investment practices of Berkshire Hathaway in maintaining
marketable equity portfolios with virtually zero turnover and
with only a very few stocks chosen. This brings us to the
question of how much investment diversiﬁcation is desirable at
foundations.

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I have more than skepticism regarding the orthodox view that
huge diversiﬁcation is a must for those wise enough, so that
indexation is not the logical mode for equity investment. I think
the orthodox view is grossly mistaken.
In the United States, a person or institution with almost all
wealth invested long-term in just three ﬁne domestic
corporations is securely rich. And why should such an owner
care if, at any time, most other investors are faring somewhat
better or worse? Particularly when he rationally believes, like
Berkshire, that his long-term results will be superior by reason
of his lower costs, required emphasis on long-term effects, and
concentration in his most preferred choices.
I go even further. I think it can be a rational choice, in some
situations, for a family or a foundation to remain 90 percent
concentrated in one equity. Indeed, I hope the Mungers follow
roughly this course. And I note that the [Robert] Woodruff65
foundations have, so far, proven extremely wise to retain an
approximately 90 percent concentration in the founder’s Coca-
Cola stock. It would be interesting to calculate just how all
American foundations would have fared if they had never sold a
share of founder’s stock. Very many, I think, would now be much
better off.
But, you may say, the diversiﬁers simply took out insurance
against a catastrophe that didn’t occur. And I reply: There are
worse things than some foundation’s losing relative clout in the
world, and rich institutions, like rich individuals, should do a lot
of self-insurance if they want to maximize long-term results.
Furthermore, all the good in the world is not done by
foundation donations. Much more good is done through the
ordinary business operations of the corporations in which the
foundations invest. And some corporations do much more good
than others do in a way that gives investors therein better-than-
average long-term prospects. And I don’t consider it foolish,

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stupid, evil, or illegal for a foundation to greatly concentrate
investment in what it admires or even loves. Indeed, Ben
Franklin required just such an investment practice for the
charitable endowment created by his will.
One other aspect of Berkshire’s equity investment practice
deserves comparative mention. So far, there has been almost no
direct foreign investment at Berkshire and much foreign
investment at foundations.
Regarding this divergent history, I wish to say that I agree with
Peter Drucker66 that the culture and legal systems of the United
States are especially favorable to shareholder interests
compared to other interests and compared to most other
countries. Indeed, there are many other countries where any
good going to public shareholders has a very low priority and
almost every other constituency stands higher in line.
This factor, I think, is under-weighed at many investment
institutions, probably because it does not easily lead to
quantitative thinking using modern ﬁnancial technique. But
some important factor doesn’t lose share of force just because
some “expert” can better measure other types of force.
Generally, I tend to prefer over direct foreign investment
Berkshire’s practice of participating in foreign economies
through the likes of Coca-Cola and Gillette.
To conclude, I will make one controversial prediction and one
controversial argument.
The controversial prediction is that, if some of you make your
investment style more like Berkshire Hathaway’s, in a long-term
retro spect, you will be unlikely to have cause for regret, even if
you can’t get Warren Buffett to work for nothing. Instead,
Berkshire will have cause for regret as it faces more intelligent
investment competition. But Berkshire won’t actually regret any
disadvantage from your enlightenment. We only want what

## Page 214

success we can get despite encouraging others to share our
general views about reality.
My controversial argument is an additional consideration
weighing against the complex, high-cost investment modalities
becoming ever more popular at foundations. Even if, contrary to
my suspicions, such modalities should turn out to work pretty
well, most of the money-making activity would contain
profoundly antisocial effects. This would be so because the
activity would exacerbate the current harmful trend in which
ever more of the nation’s ethical young brainpower is attracted
into lucrative money management and its attendant modern
frictions, as distinguished from work providing much more value
to others. Money management does not create the right
examples. Early Charlie Munger is a horrible career model for
the young because not enough was delivered to civilization in
return for what was wrested from capitalism. And other, similar
career models are even worse. Rather than encourage such
models, a more constructive choice at foundations is long-term
investment concentration in a few domestic corporations that
are wisely admired.
Why not thus imitate Ben Franklin? After all, old Ben was very
effective in doing public good. And he was a pretty good investor,
too. Better his model, I think, than Bernie Cornfeld’s. The choice
is plainly yours to make.
TALK SIX REVISITED
A lot of water has passed under the bridge since this talk was
made in 1998. And what has happened by 2006 is that we now
see much more of the conduct I criticized.
In particular, frictional costs for stock market investors have
increased markedly, and there has been an increase in the share

## Page 215

of young brainpower becoming, with respect to investments,
what the tout is with respect to horse racing tracks. Indeed, I
recently heard Warren Buffett say that if present investment
trends spread to racetracks, most bettors will try to improve
results by always bringing along a well-paid personal tout.
However, at the same time that lovers of frictional costs have
been spending more on what they love, there has also been an
increase in holdings of stocks that track market indexes in a
manner imposing negligible costs. This cost-averse, index-
mimicking group does not grow fast enough to prevent an
increase in total frictional costs, but more stockholding is slowly
being converted to the passive, indexed mode.

## Page 216

CHAPTER 4; TALK SEVEN
stripe.press/pca-11
Breakfast Meeting of thePhilanthropy Roundtable
NOVEMBER 10, 2000PHILANTHROPY ROUNDTABLE, PASADENA, CALIFORNIA
This speech was delivered in November 2000 to the Philanthropy
Roundtable67 in Pasadena. Startling Charlie’s family and friends,
Jody Curtis of Foundation News and Commentary characterized Charlie
as “a friendly old uncle, one with a jolly sense of humor at that.”
Charlie’s goal, as was the case in the previous speech, was to
save foundations from their own mistakes by getting them to invest
effectively, with minimum waste. Charlie warns foundations that
they often act unwisely because of “a failure to understand their
own investment operations, related to the larger system” of which
they’re a part.
Never one to pull punches, he boldly and bluntly challenges his
listeners to cure the ignorance that is jeopardizing their
foundations and those who depend on them. Charlie coins the term
“febezzlement”—the functional equivalent of embezzlement—to explain
how wealth is stripped away by layers of unnecessary investment
managers and consultants.
I am here today to talk about so-called wealth effects from rising
prices for US common stocks.

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I should concede, at the outset, that wealth effects are part of
the academic discipline of economics and that I have never taken
a single course in economics, nor tried to make a single dollar,
ever, from foreseeing macroeconomic changes. Nonetheless, I
have concluded that most PhD economists under-appraise the
power of the common stock-based wealth effect under current
extreme conditions.
Everyone now agrees on two things. First, spending proclivity
is inﬂuenced in an upward direction when stock prices go up,
and in a downward direction when stock prices go down. Second,
the proclivity to spend is terribly important in macroeconomics.
However, the professionals disagree about the size and timing
of wealth effects and how they interact with other effects,
including the obvious complication that increased spending
tends to drive up stock prices while stock prices are concurrently
driving up spending. Also, of course, rising stock prices increase
corporate earnings even when spending is static, for instance by
reducing pension cost accruals, after which stock prices tend to
rise more. Thus wealth effects involve mathematical puzzles that
are not nearly so well worked out as physics theories and never
can be.
The wealth effect from rising US stock prices is particularly
interesting right now for two reasons. First, there has never been
an advance so extreme in the price of widespread stock holdings,
and with stock prices going up so much faster than GNP, the
related wealth effect must now be bigger than was common
before. Second, what has happened in Japan over roughly the
last 10 years has shaken up academic economics, as it obviously
should, creating strong worries about recession from wealth
effects in reverse.
In Japan, with much ﬁnancial corruption, there was an
extreme rise in stock and real estate prices for a very long time,
accompanied by extreme real economic growth compared to the

## Page 218

United States. Then, asset values crashed, and the Japanese
economy stalled out at a very suboptimal level. After this, Japan,
a modern economy that had learned all the would-be corrective
Keynesian68 and monetary tricks, pushed these tricks hard and
long. Japan, for many years, not only ran an immense
government deﬁcit but also reduced interest rates to a place
within hailing distance of zero and kept them there. Nonetheless,
the Japanese economy, year after year, stays stalled, as Japanese
proclivity to spend stubbornly resists all the tricks of the
economists, and Japanese stock prices stay down.
This Japanese experience is a disturbing example for
everyone, and if something like it happened here, it would leave
shrunken charitable foundations feeling clobbered by fate. Let us
hope, as is probably the case, that the sad situation in Japan is
caused in some large part by social-psychological effects and
corruption peculiar to Japan. In such case, our country may be at
least half as safe as is widely assumed.
Well, grant that spending proclivity, as inﬂuenced by stock
prices, is now an important subject, and that the long Japanese
recession is disturbing. How big are the economic inﬂuences of
US stock prices?
A median conclusion of the economics professionals, based
mostly on data collected by the Federal Reserve System, would
probably be that the wealth effect on spending from stock prices
is not all that big. After all, even now, real household net worth,
excluding pensions, is probably up by less than 100 percent over
the last 10 years and remains a pretty modest ﬁgure per
household, while market value of common stock is probably not
yet one-third of aggregate household net worth, excluding
pensions. Moreover, such household wealth in common stocks is
almost incredibly concentrated, and the super rich don’t
consume in proportion to their wealth. Leaving out pensions, the
top 1 percent of households probably hold about 50 percent of

## Page 219

common stock value, and the bottom 80 percent probably hold
about 4 percent.
Based on such data, plus unexciting past correlation between
stock prices and spending, it is easy for a professional economist
to conclude, say, that even if the average household spends
incrementally at a rate of 3 percent of asset values in stock,
consumer spending would have risen less than 0.5 percent per
year over the last 10 years as a consequence of the huge,
unprecedented, long-lasting, consistent boom in stock prices.
I believe that such economic thinking widely misses
underlying reality right now. To me, such thinking looks at the
wrong numbers and asks the wrong questions. Let me, the
ultimate amateur, boldly try to do a little better, or at least a little
differently.
For one thing, I have been told, probably correctly, that
Federal Reserve data collection, due to practical obstacles,
doesn’t properly take into account pension effects, including
effects from 401(k) and similar plans. Assume some 63-year-old
dentist has $1 million in GE stock in a private pension plan. The
stock goes up in value to $2 million, and the dentist, feeling
ﬂush, trades in his very old Chevrolet and leases a new Cadillac
at the giveaway rate now common. To me, this is an obvious large
wealth effect in the dentist’s spending. To many economists,
using Federal Reserve data, I suspect the occasion looks like
proﬂigate dissaving by the dentist. To me, the dentist, and many
others like him, seems to be spending a lot more because of a
very strong pension-related wealth effect. Accordingly, I believe
that the present-day wealth effect from pension plans is far from
trivial and much larger than it was in the past.
For another thing, the traditional thinking of economists
often does not take into account implications from the idea of
“bezzle.” Let me repeat: bezzle, B-E-Z-Z-L-E. The word “bezzle” is
a contraction of the word “embezzle,” and it was coined by

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Harvard economics professor John Kenneth Galbraith69 to stand
for the increase in any period of undisclosed embezzlement.
Galbraith coined the “bezzle” word because he saw that
undisclosed embezzlement, per dollar, has a very powerful
stimulating effect on spending. After all, the embezzler spends
more because he has more income, and his employer spends as
before because he doesn’t know any of his assets are gone.
But Galbraith did not push his insight on. He was content to
stop with being a stimulating gadﬂy. So I will now try to push
Galbraith’s “bezzle” concept to the next logical level.
As Keynes showed, in a native economy relying on earned
income, when the seamstress sells a coat to the shoemaker for
$20, the shoemaker has $20 less to spend and the seamstress
has $20 more to spend. There is no lollapalooza effect on
aggregate spending. But when the government prints another
$20 bill and uses it to buy a pair of shoes, the shoemaker has
another $20 and no one feels poorer. And when the shoemaker
next buys a coat, the process goes on and on, not to an inﬁnite
increase, but with what is now called the Keynesian multiplier
effect, a sort of lollapalooza effect on spending.
Similarly, an undisclosed embezzlement has stronger
stimulative effects per dollar on spending than a same-sized
honest exchange of goods. Galbraith, being Scottish, liked the
bleakness of life demonstrated by his insight. After all, the
Scottish enthusiastically accepted the idea of preordained,
unﬁxable infant damnation. But the rest of us don’t like
Galbraith’s insight. Nevertheless, we have to recognize that
Galbraith was roughly right.
No doubt Galbraith saw the Keynesian multiplier– type
economic effects promised by increases in bezzle. But he
stopped there. After all, bezzle could not grow very big because
the discovery of massive theft was nearly inevitable and sure to
have reverse effects in due course. Thus, the increase in private

## Page 221

bezzle could not drive economies up and up, and on and on, at
least for a considerable time, like government spending.
Deterred by the apparent smallness of economic effects from
his insight, Galbraith did not ask the next logical question: Are
there important functional equivalents of bezzle that are large
and not promptly self-destructive?
My answer to this question is yes. I will next describe only
one. I will join Galbraith in coining new words: ﬁrst, “febezzle,” to
stand for the functional equivalent of bezzle; second,
“febezzlement,” to describe the process of creating febezzle; and
third, “febezzlers,” to describe persons engaged in febezzlement.
Then, I will identify an important source of febezzle right in this
room. You people, I think, have created a lot of febezzle through
your foolish investment management practices in dealing with
your large holdings of common stock.
If a foundation or other investor wastes 3 percent of assets per
year in unnecessary, nonproductive investment costs in
managing a strongly rising stock portfolio, it still feels richer,
despite the waste, while the people getting the wasted 3 percent,
febezzlers though they are, think they are virtuously earning
income. The situation is functioning like undisclosed
embezzlement without being self-limited. Indeed, the process
can expand for a long while by feeding on itself. And all the
while, what looks like spending from the earned income of the
receivers of the wasted 3 percent is, in substance, spending from
a disguised wealth effect from rising stock prices.
This room contains many people pretty well stricken by
expired years, in my generation or the one following. We tend to
believe in thrift and avoiding waste as good things, a process that
has worked well for us. It is paradoxical and disturbing to us that
economists have long praised foolish spending as a necessary
ingredient of a successful economy. Let us call foolish
expenditures “foolexures.” And now you holders of old values are

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hearing one of your own add to the case for foolexures the case
for febezzlements, the functional equivalent of embezzlements.
This may not seem like a nice way to start a new day. Please be
assured that I don’t like febezzlements. It is just that I think
febezzlements are widespread and have powerful economic
effects. And I also think that one should recognize reality even
when one doesn’t like it—indeed, especially when one doesn’t
like it. Also, I think one should cheerfully endure paradox that
one can’t remove by good thinking. Even in pure mathematics,
they can’t remove all paradox, and the rest of us should also
recognize we are going to have to endure a lot of paradox, like it
or not.
Let me also take this occasion to state that my previous notion
of 3 percent of assets per annum in waste in much of
institutional investment management related to stocks is quite
likely too low in a great many cases. A friend, after my talk to
foundation ﬁnancial ofﬁcers, sent me a summary of a study
about mutual fund investors. The study concluded that the
typical mutual fund investor gained at 7.25 percent per year in a
15-year period when the average stock fund gained at 12.8
percent per year, presumably after expenses. Thus, the real
performance lag for investors was over 5 percent of assets per
year in addition to whatever percentage per year the mutual
funds, after expenses, lagged behind stock market averages.
If this mutual fund study is roughly right, it raises huge
questions about foundation wisdom in changing investment
managers all the time as mutual fund investors do. If the extra
lag reported in the mutual fund study exists, it is probably
caused in considerable measure by folly in the constant removal
of assets from lagging portfolio managers being forced to
liquidate stock holdings, followed by the placement of removed
assets with new investment managers that have high-pressure,
asset-gaining hoses in their mouths and clients whose

## Page 223

investment results will not be improved by the super-rapid
injection of new funds.
I am always having trouble like that caused by this new
mutual fund study. I describe something realistically that looks
so awful that my description is disregarded as extreme satire
instead of reality. Next, new reality tops the horror of my
disbelieved description by some large amount. No wonder
Munger notions of reality are not widely welcome. This may be
my last talk to charitable foundations.
Now, toss in with febezzlement in investment management
about $750 billion in ﬂoating, ever-growing, ever-renewing
wealth from employee stock options, and you get lot more
common stock-related wealth effect driving consumption, with
some of the wealth effect from employee stock options being, in
substance, febezzle effect, facilitated by the corrupt accounting
practice now required by standard practice.
Next, consider that each 100-point advance in the S & P adds
about $1 trillion in stock market value, and throw in some sort of
Keynesian-type multiplier effect related to all febezzlement. The
related macroeconomic wealth effects, I believe, become much
larger than is conventionally supposed.
And aggregate wealth effect from stock prices can get very
large indeed. It is an unfortunate fact that great and foolish
excess can come into prices of common stocks in the aggregate.
They are valued partly like bonds, based on roughly rational
projections of use value in producing future cash. But they are
also valued partly like Rembrandt paintings, purchased mostly
because their prices have gone up so far. This situation,
combined with big wealth effects, at ﬁrst up and later down, can
conceivably produce much mischief.
Let us try to investigate this by a thought experiment. One of
the big British pension funds once bought a lot of ancient art,
planning to sell it 10 years later, which it did, at a modest proﬁt.

## Page 224

Suppose all pension funds purchased ancient art, and only
ancient art, with all their assets. Wouldn’t we eventually have a
terrible mess on our hands, with great and undesirable
macroeconomic consequences? And wouldn’t the mess be bad if
only half of all pension funds were invested in ancient art? And if
half of all stock value became a consequence of mania, isn’t the
situation much like the case wherein half of pension assets are
ancient art?
My foregoing acceptance of the possibility that stock value in
aggregate can become irrationally high is contrary to the hard-
form efﬁcient-market theory that many of you once learned as
gospel from your mistaken professors of yore. Your mistaken
professors were too much inﬂuenced by “rational man” models
of human behavior from economics and too little by “foolish
man” models from psychology and real-world experience. Crowd
folly—the tendency of humans, under some circumstances, to
resemble lemmings—explains much foolish thinking of brilliant
men and much foolish behavior, like the investment
management practices of many foundations represented here
today. It is sad that today each institutional investor apparently
fears most of all that its investment practices will be different
from the practices of the rest of the crowd.
Well, this is enough uncredentialed musing for one breakfast
meeting. If I am at all right, our present prosperity has had a
stronger boost from common stock price– related wealth effects,
some of them disgusting, than has been the case in many former
booms. If so, what was greater on the upside in the recent boom
could also be greater on the downside at some time of future
stock price decline. Incidentally, the economists may well
conclude, eventually, that when stock market advances and
declines are regarded as long-lasting, there is more downside
force on optional consumption per dollar of stock market decline
than there is upside force per dollar of stock market rise. I

## Page 225

suspect that economists would believe this already if they were
more willing to take assistance from the best ideas outside their
own discipline, or even to look harder at Japan.
Remembering Japan, I also want to raise the possibility that
there are, in the very long term, virtue effects in economics—for
instance, that widespread corrupt accounting will eventually
create bad long-term consequences as a sort of obverse effect
from the virtue-based boost double-entry bookkeeping gave to
the heyday of Venice. I suggest that when the ﬁnancial scene
starts reminding you of Sodom and Gomorrah, you should fear
practical consequences even if you like to participate in what is
going on.
Finally, I believe that the implications for charitable
foundations of my conclusions today, combined with the
conclusions in my former talk to foundation ﬁnancial ofﬁcers, go
way beyond implications for investment techniques. If I am right,
almost all US foundations are unwise through failure to
understand their own investment operations related to the larger
system. If so, this is not good. A rough rule in life is that an
organization foolish in one way in dealing with a complex system
is all too likely to be foolish in another. So the wisdom of
foundation donations may need as much improvement as
investment practices of foundations. And here we have two more
old rules to guide us. One rule is ethical, and the other is
prudential.
The ethical rule is from Samuel Johnson, who believed that
maintenance of easily removable ignorance by a responsible
ofﬁceholder was treacherous malfeasance in meeting moral
obligation. The prudential rule is that underlying the old Warner
& Swasey advertisement for machine tools: “The man who needs
a new machine tool and hasn’t bought it is already paying for it.”
The Warner & Swasey rule also applies, I believe, to thinking
tools. If you don’t have the right thinking tools, you and the

## Page 226

people you seek to help are already suffering from your easily
removable ignorance.
TALK SEVEN REVISITED
This talk in November 2000 turned out to be pretty timely
because stock market unpleasantness thereafter greatly
increased, particularly for high-tech stocks. But, as nearly as I
can tell, there has been absolutely no theoretical reaction from
anyone who heard or read the talk. I still believe everything I said
about signiﬁcant macro-economic effects from febezzlement
through excessive investment costs. But no one trained in
economics has ever tried to engage with me on this subject.
Undeterred by this apathy, I am now going to push my
reasoning one notch further by laying out a thought experiment
extrapolating the combined reasoning of Talks Six and Seven to
an assumed higher level of investment costs.
Assume that 2006 stock prices rise by 200 percent while
corporate earnings do not rise, at which point all the sensibly
distributable earnings of all US corporations combined amount
to less than the total of all stockholder investment costs, because
such costs rise proportionally with stock prices.
Now, so long as this situation continues, no money at all, net
of investment costs, is going out of all corporations to all
corporate owners combined. Instead, frictional cost imposers get
more than all sensibly distributable corporate earnings. And at
the end of any year, the corporate owners in aggregate can get
money by reason of their stockholding only by making stock
sales to providers of “new money,” who, considering high
continuing investment costs for themselves and others, must
expect that stock prices will keep rising indeﬁnitely while all

## Page 227

stock owners, combined, are getting nothing, net, except by
selling stock to more new money.
To many imposers of frictional investment costs, this peculiar
state of affairs would seem ideal, with more than 100 percent of
sensibly distributable corporate earnings going to precisely the
right sort of people, instead of being wasted on the shareholders.
And some economists would regard the result as good because it
came about in a market. But to me it would resemble a weird and
disturbing combination of 1) a gambling casino imposing an
unreasonably greedy take for the house, plus 2) a form of Ponzi-
like scheme, similar to the market for expensive art, in which
participation would be unsuitable for pension funds, etc., plus 3)
a bubble of speculation that would eventually burst, probably
with unfortunate macroeconomic consequences. And what the
situation would not look like is a state of affairs likely to function
well in guiding the capital development of the surrounding
civilization.
Such a state of affairs, or even a lesser version, would, I think,
reduce the reputation of our country, and deservedly so.

## Page 228

CHAPTER 4; TALK EIGHT
stripe.press/pca-12
The Great Financial Scandal of2003
SUMMER 2000AN ACCOUNT BY CHARLES T. MUNGER
This parable and morality play gives Charlie a chance to vent his
anger at the accounting profession’s role in corporate malfeasance.
Handwritten by Charlie when he was vacationing in the summer of
2000, the speech is an eerie prediction of the scandals that
surfaced well before his predicted date of 2003 and that continue
today to be an important issue.
The early Quant Tech appears to be loosely based on C. F. Braun
Engineering, a firm whose brilliant founder, Carl F. Braun, and
business practices Charlie greatly admired. (The firm was
ultimately sold to the Kuwaiti government, so the later Quant Tech
is not modeled in any way on C. F. Braun Engineering.)
Charlie chronicles how leadership change in a very successful
company can consign the firm to mediocrity—or worse, to disrepute
and failure. When new management adopts modern financial
engineering techniques, especially the use of stock options that
aren’t expensed, all is lost.
Shakespeare’s Henry VI said, “The first thing we do, let’s kill
all the lawyers.” Charlie, an attorney, might reject that idea, but
accountants? Well …

## Page 229

The great ﬁnancial scandal erupted in 2003 with the sudden,
deserved disgrace of Quant Technical Corporation, always called
Quant Tech. By this time, Quant Tech was the country’s largest
pure engineering ﬁrm, having become so as a consequence of
the contributions of its legendary founder, engineer Albert
Berzog Quant.
After 2003, people came to see the Quant Tech story as a sort
of morality play divided into two acts. Act I, the era of the great
founding engineer, was seen as a golden age of sound values. Act
II, the era of the founder’s immediate successors, was seen as the
age of false values, with Quant Tech becoming, in the end, a sort
of latter-day Sodom or Gomorrah.
In fact, as this account will make clear, the change from good
to evil did not occur all at once when Quant Tech’s founder died
in 1982. Much good continued after 1982, and serious evil had
existed for many years prior to 1982 in the ﬁnancial culture in
which Quant Tech had to operate.
The Quant Tech story is best understood as a classic sort of
tragedy in which a single ﬂaw is inexorably punished by
remorseless Fate. The ﬂaw was the country’s amazingly peculiar
accounting treatment for employee stock options. The victims
were Quant Tech and its country. The history of the Great
Financial Scandal, as it actually happened, could have been
written by Sophocles.70
As his life ended in 1982, Albert Berzog Quant delivered to his
successors and his Maker a wonderfully prosperous and useful
company. The sole business of Quant Tech was designing, for
fees, all over the world, a novel type of super clean and
superefﬁcient small power plant that improved electricity
generation.
By 1982, Quant Tech had a dominant market share in its
business and was earning $100 million on revenues of $1 billion.
Its costs were virtually all costs to compensate technical

## Page 230

employees engaged in design work. Direct employee
compensation cost amounted to 70 percent of revenues. Of this
70 percent, 30 percent was base salaries and 40 percent was
incentive bonuses being paid out under an elaborate system
designed by the founder. All compensation was paid in cash.
There were no stock options because the old man considered the
accounting treatment required for stock options to be “weak,
corrupt, and contemptible,” and he no more wanted bad
accounting in his business than he wanted bad engineering.
Moreover, the old man believed in tailoring his huge incentive
bonuses to precise performance standards established for
individuals or small groups instead of allowing what he
considered undesirable compensation outcomes, both high and
low, such as he believed occurred under other companies’ stock
option plans.
Yet even under the old man’s system, most of Quant Tech’s
devoted longtime employees were becoming rich, or sure to get
rich. This was happening because the employees were buying
Quant Tech stock in the market, just like non employee
shareholders. The old man had always ﬁgured that people smart
enough and self-disciplined enough to design power plants could
reasonably be expected to take care of their own ﬁnancial affairs
in this way. He would sometimes advise an employee to buy
Quant Tech stock, but more paternalistic than that he would not
become.
By the time the founder died in 1982, Quant Tech was debt-
free and, except as a reputation enhancer, really didn’t need any
shareholders’ equity to run its business, no matter how fast
revenues grew. However, the old man believed with Ben Franklin
that “it is hard for an empty sack to stand upright,” and he
wanted Quant Tech to stand upright. Moreover, he loved his
business and his coworkers, and he always wanted to have on
hand large amounts of cash equivalents so as to be able to

## Page 231

maximize work-out or work-up chances if an unexpected
adversity or opportunity came along. And so, in 1982, Quant
Tech had on hand $500 million in cash equivalents, amounting
to 50 percent of revenues.
Possessing a strong balance sheet and a productive culture
and also holding a critical mass of expertise in a rapidly
changing and rapidly growing business, Quant Tech, using the
old man’s methods, by 1982 was destined for 20 years ahead to
maintain proﬁts at 10 percent of revenues while revenues
increased at 20 percent per year. After these 20 years,
commencing in 2003, Quant Tech’s proﬁt margin would hold for
a very long time at 10 percent while revenue growth would slow
down to 4 percent per year. But no one at Quant Tech knew
precisely when its inevitable period of slow revenue growth
would begin.
The old man’s dividend policy for Quant Tech was simplicity
itself: He never paid a dividend. Instead, all earnings simply
piled up in cash equivalents.
Every truly sophisticated investor in common stocks could
see that the stock of cash-rich Quant Tech provided a splendid
investment opportunity in 1982, when it sold at a mere 15 times
earnings and, despite its brilliant prospects, had a market
capitalization of only $1.5 billion. This low market capitalization,
despite brilliant prospects, existed in 1982 because other
wonderful common stocks were also then selling at 15 times
earnings or less as a natural consequence of high interest rates
then prevailing, plus disappointing investment returns that had
occurred over many previous years for holders of typical
diversiﬁed portfolios of common stocks.
One result of Quant Tech’s low market capitalization in 1982
was that it made Quant Tech’s directors uneasy and dissatisﬁed
right after the old man’s death. A wiser board would then have
bought in Quant Tech’s stock very aggressively, using up all cash

## Page 232

on hand and also borrowing funds to use in the same way.
However, such a decision was not in accord with conventional
corporate wisdom in 1982. And so the directors made a
conventional decision. They recruited a new CEO and CFO from
outside Quant Tech, in particular from a company that had a
conventional stock option plan for employees and also possessed
a market capitalization at 20 times reported earnings, even
though its balance sheet was weaker than Quant Tech’s and its
earnings were growing more slowly than earnings at Quant Tech.
Incident to the recruitment of the new executives, it was made
plain that Quant Tech’s directors wanted a higher market
capitalization as soon as feasible.
The newly installed Quant Tech ofﬁcers quickly realized that
the company could not wisely either drive its revenues up at an
annual rate higher than the rate in place or increase Quant
Tech’s proﬁt margin. The founder had plainly achieved an
optimum in each case. Nor did the new ofﬁcers dare tinker with
an engineering culture that was working so well. Therefore, the
new ofﬁcers were attracted to employing what they called
“modern ﬁnancial engineering,”71 which required prompt use of
any and all arguably lawful methods for driving up reported
earnings, with big, simple changes to be made ﬁrst.
By a strange irony of fate, the accounting convention for stock
options that had so displeased Quant Tech’s founder now made
the new ofﬁcers’ job very easy, and would ultimately ruin Quant
Tech’s reputation. There was now an accounting convention in
the United States that, provided employees were ﬁrst given
options, required that when easily marketable stock was issued
to employees at a below-market price, the bargain element for
the employees, although roughly equivalent to cash, could not
count as a compensation expense in determining a company’s
reported proﬁts. This amazingly peculiar accounting convention
had been selected by the accounting profession, over the

## Page 233

objection of some of its wisest and most ethical members,
because corporate managers, by and large, preferred that their
gains from exercising options covering their employers’ stock
not be counted as an expense in determining their employers’
earnings.
The accounting profession, in making its amazingly peculiar
decision, had simply followed the injunction so often followed by
persons quite different from prosperous, entrenched
accountants. The injunction was that normally followed by
insecure and powerless people: “Whose bread I eat, his song I
sing.” Fortunately, the income tax authorities did not have the
same amazingly peculiar accounting idea as the accounting
profession. Elementary common sense prevailed, and the
bargain element in stock option exercises was treated as an
obvious compensation expense, deductible in determining
income for tax purposes.
Quant Tech’s new ofﬁcers, ﬁnancially shrewd as they were,
could see at a glance that, given the amazingly peculiar
accounting convention and the sound income tax rules in place,
Quant Tech had a breathtakingly large opportunity to increase
its reported proﬁts by taking very simple action. The fact that so
large a share of Quant Tech’s annual expense was incentive
bonus expense provided a modern ﬁnancial engineering
opportunity second to none.
For instance, it was mere child’s play for the executives to
realize that if in 1982 Quant Tech had substituted employee
stock option exercise proﬁts for all its incentive bonus expenses
of $400 million, while using bonus money saved plus option
prices paid to buy back all shares issued in option exercises, and
keeping all else the same, the result would have been to drive
Quant Tech’s 1982 reported earnings up by 400 percent, to $500
million from $100 million, while shares outstanding remained
exactly the same! And so it seemed that the obviously correct

## Page 234

ploy for the ofﬁcers was to start substituting employee stock
option exercise proﬁts for incentive bonuses. Why should a
group of numerate engineers care whether their bonuses were in
cash or virtually perfect equivalents of cash? Arranging such
substitutions, on any schedule desired, seemed like no difﬁcult
chore.
However, it was also mere child’s play for the new ofﬁcers to
realize that a certain amount of caution and restraint would be
desirable in pushing their new ploy. Obviously, if they pushed
their new ploy too hard in any single year, there might be
rebellion from Quant Tech’s accountants or undesirable hostility
from other sources. This, in turn, would risk killing a goose with
a vast ability to deliver golden eggs, at least to the ofﬁcers. After
all, it was quite clear that their ploy would be increasing reported
earnings only by adding to real earnings an element of phony
earnings—phony in the sense that Quant Tech would enjoy no
true favorable economic effect (except a temporary fraud-type
effect similar to that from overcounting closing inventory) from
that part of reported earnings increases attributable to use of the
ploy. The new CEO privately called the desirable, cautious
approach “wisely restrained falsehood.”
Plainly, the new ofﬁcers saw, it would be prudent to shift
bonus payments to employee stock option exercise proﬁts in
only a moderate amount per year over many years ahead. They
privately called the prudent plan they adopted their “dollop-by-
dollop system,” which they believed had four obvious
advantages:
First, a moderate dollop of phony earnings in any single year
would be less likely to be noticed than a large dollop.
Second, the large long-term effect from accumulating many
moderate dollops of phony earnings over the years would also
tend to be obscured in the dollop-by-dollop system. As the CFO
pithily and privately said, “If we mix only a moderate minority

## Page 235

share of turds with the raisins each year, probably no one will
recognize what will ultimately become a very large collection of
turds.”
Third, the outside accountants, once they had blessed a few
ﬁnancial statements containing earnings increases, only a
minority share of which were phony, would probably ﬁnd it
unendurably embarrassing not to bless new ﬁnancial statements
containing only the same phony proportion of reported earnings
increases.
Fourth, the dollop-by-dollop system would tend to prevent
disgrace, or something more seriously harmful, for Quant Tech’s
ofﬁcers. With virtually all corporations except Quant Tech having
ever-more liberal stock option plans, the ofﬁcers could always
explain that a moderate dollop of shift toward compensation in
option-exercise form was needed to help attract or retain
employees. Indeed, given corporate culture and stock market
enthusiasm likely to exist as a consequence of the strange
accounting convention for stock options, this claim would often
be true.
With these four advantages, the dollop-by-dollop system
seemed so clearly desirable that it only remained for Quant
Tech’s ofﬁcers to decide how big to make their annual dollops of
phony earnings. This decision, too, turned out to be easy. The
ofﬁcers ﬁrst decided upon three reasonable conditions they
wanted satisﬁed:
First, they wanted to be able to continue their dollop-by-
dollop system without major discontinuities for 20 years.
Second, they wanted Quant Tech’s reported earnings to go up
by roughly the same percentage each year throughout the whole
20 years, because they believed that ﬁnancial analysts
representing institutional investors would value Quant Tech’s
stock higher if reported annual earnings growth never
signiﬁcantly varied.

## Page 236

Third, to protect credibility for reported earnings, they never
wanted to strain the credulity of investors by reporting, even in
their 20th year, that Quant Tech was earning more than 40
percent of revenues from designing power plants.
With these requirements, the math was easy, given the
ofﬁcers’ assumption that Quant Tech’s non-phony earnings and
revenues were both going to grow at 20 percent per year for 20
years. The ofﬁcers quickly decided to use their dollop-by-dollop
system to make Quant Tech’s reported earnings increase by 28
percent per year instead of the 20 percent that would have been
reported by the founder.
And so, the great scheme of modern ﬁnancial engineering
went forward toward tragedy at Quant Tech. And few
disreputable schemes of man have ever worked better in
achieving what was attempted. Quant Tech’s reported earnings,
certiﬁed by its accountants, increased regularly at 28 percent
per year. No one criticized Quant Tech’s ﬁnancial reporting
except a few people widely regarded as impractical, overly
theoretical, misanthropic cranks. It turned out that the founder’s
policy of never paying dividends, which was continued, greatly
helped in preserving credibility for Quant Tech’s reports that its
earnings were rising steadily at 28 percent per year. With cash
equivalents on hand so remarkably high, the Pavlovian mere-
association effects that so often impair reality recognition served
well to prevent detection of the phony element in the reported
earnings.
It was therefore natural, after the dollop-by-dollop system had
been in place for a few years, for Quant Tech’s ofﬁcers to yearn to
have Quant Tech’s reported earnings per share keep going up at
28 percent per year while cash equivalents grew much faster
than they were then growing. This turned out to be a snap. By
this time, Quant Tech’s stock was selling at a huge multiple of
reported earnings, and the ofﬁcers simply started causing some

## Page 237

incremental stock option exercises that were not matched either
by reductions in cash bonuses paid or by repurchases of Quant
Tech’s stock.
This change, the ofﬁcers easily recognized, was a very helpful
revision of their original plan. Not only was detection of the
phony element in the reported earnings made much more
difﬁcult as cash accumulation greatly accelerated, but also a
signiﬁcant amount of Ponzi scheme or chain-letter effect was
being introduced into Quant Tech, with real beneﬁts for present
shareholders, including the ofﬁcers.
At this time, the ofﬁcers also ﬁxed another ﬂaw in their
original plan. They saw that as Quant Tech’s reported earnings,
containing an increasing phony element, kept rising at 28
percent, Quant Tech’s income taxes as a percentage of reported
pre tax earnings kept going lower and lower. This plainly
increased their chances of attracting undesired questions and
criticism. This problem was soon eliminated. Many power plants
in foreign nations were built and owned by governments, and it
proved easy to get some foreign governments to raise Quant
Tech’s design fees, provided that in each case slightly more than
the fee increase was paid back in additional income taxes to the
foreign government concerned.
Finally, for 2002, Quant Tech reported $16 billion in earnings
on $47 billion in revenue that now included a lot more revenue
from interest on cash equivalents than would have been present
without net issuances of new stock over the years. Cash
equivalents on hand now amounted to an astounding $85 billion,
and somehow it didn’t seem impossible to most investors that a
company virtually drowning in so much cash could be earning
the $16 billion it was reporting. The market capitalization of
Quant Tech at its peak early in 2003 became $1.4 trillion, about
90 times earnings reported for 2002.

## Page 238

However, all man’s desired geometric progressions, if a high
rate of growth is chosen, at last come to grief on a ﬁnite earth.
And the social system for man on earth is fair enough,
eventually, that almost all massive cheating ends in disgrace.
And in 2003, Quant Tech failed in both ways.
By 2003, Quant Tech’s real earning power was growing at only
4 percent per year after sales growth had slowed to 4 percent.
There was now no way for Quant Tech to escape causing a big
disappointment for its shareholders, now largely consisting of
institutional investors. This disappointment triggered a
shocking decline in the price of Quant Tech stock, which went
down suddenly by 50 percent. This price decline, in turn,
triggered a careful examination of Quant Tech’s ﬁnancial
reporting practices, which, at long last, convinced nearly
everyone that a very large majority of Quant Tech’s reported
earnings had long been phony earnings, and that massive and
deliberate misreporting had gone on for a great many years. This
triggered even more price decline for Quant Tech stock until in
mid-2003 the market capitalization of Quant Tech was only $140
billion, down 90 percent from its peak only six months earlier.
A quick 90 percent decline in the price of the stock of such an
important company that was previously so widely owned and
admired caused immense human suffering, considering the $1.3
trillion in market value that had disappeared. And naturally, with
Quant Tech’s deserved disgrace, the public and political reaction
included intense hatred and revulsion directed at Quant Tech,
even though its admirable engineers were still designing the
nation’s best power plants.
Moreover, the hatred and revulsion did not stop with Quant
Tech. It soon spread to other corporations, some of which plainly
had undesirable ﬁnancial cultures different from Quant Tech’s
only in degree. The public and political hatred, like the behavior
that had caused it, soon went to gross excess and fed upon itself.

## Page 239

Financial misery spread far beyond investors into a serious
recession like that of Japan in the 1990s following the long
period of false Japanese accounting.
There was huge public antipathy to professions following the
Great Scandal. The accounting profession, of course, got the
most blame. The rulemaking body for accountants had long
borne the acronym FASB, and now nearly everyone said this
stood for “Financial Accounts Still Bogus.”
Economics professors, likewise, drew much criticism for
failing to blow the whistle on false accounting and for not
sufﬁciently warning about the eventual bad macroeconomic
effects of widespread false accounting. So great was the
disappointment with conventional economists that Harvard’s
John Kenneth Galbraith received the Nobel Prize in economics.
After all, he had once predicted that massive, undetected
corporate embezzlement would have a wonderfully stimulating
effect on the economy. And people could now see that something
very close to what Galbraith had predicted had actually
happened in the years preceding 2003 and had thereafter helped
create a big, reactive recession.
With Congress and the SEC so heavily peopled by lawyers, and
with lawyers having been so heavily involved in drafting
ﬁnancial disclosure documents now seen as bogus, there was a
new lawyer joke every week. One such was: “The butcher says,
‘The reputation of lawyers has fallen dramatically,’ and the
checkout clerk replies, ‘How do you fall dramatically off a
pancake?’”
But the hostility to established professions did not stop with
accountants, economists, and lawyers. There were many adverse
“rub-off” effects on the reputations of professionals who had
always performed well, like engineers, who did not understand
the ﬁnancial fraud that their country had made a conventional

## Page 240

requirement. In the end, much that was good about the country
and needed for its future felicity was widely and unwisely hated.
At this point, action came from a Higher Realm. God himself,
who reviews all, changed His decision schedule to bring to the
fore the sad case of the Great Financial Scandal of 2003. He
called in his chief detective and said, “Smith, bring in for harsh
but fair judgment the most depraved of those responsible for this
horrible outcome.”
But when Smith brought in a group of security analysts who
had long and uncritically touted the stock of Quant Tech, the
Great Judge was displeased. “Smith,” he said, “I can’t come down
hardest on low-level cognitive error, much of it subconsciously
caused by the standard incentive systems of the world.”
Next, Smith brought in a group of SEC commissioners and
powerful politicians. “No, no,” said the Great Judge, “these
people operate in a virtual maelstrom of regrettable forces and
can’t reasonably be expected to meet the behavioral standard
you seek to impose.”
Now the chief detective thought he had gotten the point. He
next brought in the corporate ofﬁcers who had practiced their
version of modern ﬁnancial engineering at Quant Tech. “You are
getting close,” said the Great Judge, “but I told you to bring in the
most depraved. These ofﬁcers will, of course, get strong
punishment for their massive fraud and disgusting stewardship
of the great engineer’s legacy. But I want you to bring in the
miscreants who will soon be in the lowest circle in Hell, the ones
who so easily could have prevented all this calamity.”
At last, the chief detective truly understood. He remembered
that the lowest circle of Hell was reserved for traitors. And so he
now brought in from Purgatory a group of elderly persons who,
in their days on earth, had been prominent partners in major
accounting ﬁrms.

## Page 241

“Here are your traitors,” said the chief detective. “They
adopted the false accounting convention for employee stock
options. They occupied high positions in one of the noblest
professions, which, like yours, help make society work right by
laying down the right rules. They were very smart and securely
placed, and it is inexcusable that they deliberately caused all this
lying and cheating that was so obviously predictable. They well
knew what they were doing was disastrously wrong, yet they did
it anyway. Owing to the press of business in Your Judicial
System, you made a mistake at ﬁrst in punishing them so lightly.
But now you can send them into the lowest circle in Hell.”
Startled by the vehemence and presumption, the Great Judge
paused. Then He quietly said, “Well done, my good and faithful
servant.”
This account is not an implied prediction about 2003. It is a
work of ﬁction. Except in the case of Professor Galbraith, any
resemblance to real persons or companies is accidental. It was
written in an attempt to focus possibly useful attention on
certain modern behaviors and belief systems.
TALK EIGHT REVISITED
I had a lot of fun composing this account in the summer of 2000.
But I was serious as I tried to show how standard accounting
treatment for stock options was functionally equivalent to
simpler types of promotional fraud.
To me, a profession and a nation that allow unsound
accounting for management cost are leaning in the same moral
direction as the group that leaves most of the steel out of the
concrete in erecting high-rise apartment buildings. Moreover,
the unsound accounting is more virulent than the murderous
construction practice. After all, the defective constructors have a

## Page 242

harder time rationalizing their deplorable behavior, and
therefore the bad accounting will more easily spread than the
defective construction. Which is exactly what happened, as
defective accounting for stock options became ubiquitous.
There has been some good news since Talk Eight was
delivered. The accounting profession now requires that some
provision for stock option cost be charged against earnings.
However, by the time stock options are exercised, the total cost
charged is usually far less than total cost incurred. Moreover, the
part of the cost that is charged to earnings is often manipulated
downward by dubious techniques.
What this accounting saga constitutes is one more sad
example of evil rewarded dying hard, as a great many people
conclude that something can’t be evil if they are proﬁting from it.

## Page 243

CHAPTER 4; TALK NINE
stripe.press/pca-13
Academic Economics: Strengthsand Faults after ConsideringInterdisciplinary Needs
OCTOBER 3, 2003HERB KAY UNDERGRADUATE LECTURE, UNIVERSITY OF CALIFORNIA, SANTABARBARA ECONOMICS DEPARTMENT
The editor of this book spent 12 consecutive hours with Charlie on
the day he delivered this speech at the University of California at
Santa Barbara. Our schedule that day: a two-hour drive each way
from Los Angeles, lunch, pre-talk meetings, the talk itself, a
post-talk reception, and finally dinner at the home of Jeff Henley,
chief financial officer (and now chairman) of Oracle. Despite then
being within a few months of his 80th birthday, Charlie performed
like a tireless virtuoso. His sharpness, stamina, and good humor
during that long day were astounding and inspiring.
What Charlie laid forth on that occasion might be considered the
Grand Unified Theory of the Munger approach. The talk incorporates
the many ideas that Charlie discussed in his previous talks and
presents them, checklist-style, as a coherent philosophy.
Charlie’s audience, the economics department of this major
university, was the perfect group on which to unleash this lament—
and remediation proposals besides—about the lack of
multidisciplinarianism in the soft sciences.

## Page 244

I have outlined some remarks in a rough way, and after I’m
ﬁnished talking from that outline, I’ll take questions as long as
anybody can endure listening, until they drag me away to
wherever else I’m supposed to go.
As you might guess, I agreed to do this because the subject of
getting the soft sciences so they talk better to each other has
been one that has interested me for decades. And, of course,
economics is, in many respects, the queen of the soft sciences.
It’s expected to be better than the rest. It’s my view that
economics is better at the multidisciplinary stuff than the rest of
soft science. It’s also my view that it’s still lousy, and I’d like to
discuss this failure in this talk.
As I talk about strengths and weaknesses in academic
economics, one interesting fact you are entitled to know is that I
never took a course in economics. And with this striking lack of
credentials, you may wonder why I have the chutzpah to be up
here giving this talk. The answer is I have a black belt in
chutzpah. I was born with it. Some people, like some of the
women I know, have a black belt in spending. They were born
with that. But what they gave me was a black belt in chutzpah.
I come from two peculiar strands of experience that may have
given me some useful economic insights. One is Berkshire
Hathaway, and the other is my personal educational history.
Berkshire, of course, has ﬁnally gotten interesting. When Warren
took over Berkshire, the market capitalization was about $10
million. Forty-something years later, there are not many more
shares outstanding now than there were then, and the market
capitalization is about $100 billion, $10,000 for one. And since
that has happened, year after year, in kind of a grind-ahead
fashion with very few failures, it eventually drew some attention,
indicating that maybe Warren and I knew something useful in
microeconomics.

## Page 245

For a long time, there was a Nobel Prize–winning economist
who explained Berkshire Hathaway’s success as follows:
First, he said Berkshire beat the market in common stock
investing through one sigma of luck because nobody could beat
the market except by luck. This hard-form version of efﬁcient-
market theory was taught in most schools of economics at the
time. People were taught that nobody could beat the market.
Next, the professor went to two sigmas, and three sigmas, and
four sigmas, and when he ﬁnally got to six sigmas of luck, people
were laughing so hard he stopped doing it.
Then, he reversed the explanation 180 degrees. He said, “No,
it was still six sigmas, but it was six sigmas of skill.” Well, this
very sad history demonstrates the truth of Benjamin Franklin’s
observation in Poor Richard’s Almanack: “If you would persuade,
appeal to interest and not to reason.” The man changed his silly
view when his incentives made him change it and not before.
I watched the same thing happen at the Jules Stein Eye
Institute at UCLA. I asked at one point, “Why are you treating
cataracts only with a totally obsolete cataract operation?” And
the man said to me, “Charlie, it’s such a wonderful operation to
teach.” When he stopped using that operation, it was because
almost all the patients had voted with their feet. Again, appeal to
interest and not to reason if you want to change conclusions.
Well, Berkshire’s whole record has been achieved without
paying one ounce of attention to the efﬁcient-market theory in
its hard form, and not one ounce of attention to the descendants
of that idea, which came out of academic economics and went
into corporate ﬁnance and morphed into such obscenities as the
capital asset pricing model, which we also paid no attention to. I
think you’d have to believe in the tooth fairy to believe that you
could easily outperform the market by 7 percentage points per
annum just by investing in high-volatility stocks.

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Yet, believe it or not, like the Jules Stein doctor, people once
believed this stuff. And the belief was rewarded, and it spread.
And many people still believe it. But Berkshire never paid any
attention to it. Now I think the world is coming our way, and the
idea of perfection in all market outcomes is going the way of the
dodo.
It was always clear to me that the stock market couldn’t be
perfectly efﬁcient, because as a teenager I’d been to the
racetrack in Omaha, where they had the pari-mutuel system.
And it was quite obvious to me that if the house take, the
croupier’s take, was 17 percent, some people consistently lost a
lot less than 17 percent of all their bets and other people
consistently lost more than 17 percent of all their bets. So the
pari-mutuel system in Omaha had no perfect efﬁciency. And so I
didn’t accept the argument that the stock market was always
perfectly efﬁcient in creating rational prices.
Indeed, there have been some documented cases since of
people getting so good at understanding horses and odds that
they actually are able to beat the house in offtrack betting. There
aren’t many people who can do that, but there are a few people in
America who can.
Next, my personal education history is interesting because its
deﬁciencies and my peculiarities eventually created advantages.
For some odd reason, I had an early and extreme
multidisciplinary cast of mind. I couldn’t stand reaching for a
small idea in my own discipline when there was a big idea right
over the fence in somebody else’s discipline. So I just grabbed in
all directions for the big ideas that would really work. Nobody
taught me to do that; I was just born with that yen.
I also was born with a huge craving for synthesis. And when it
didn’t come easily, which was often, I would rag the problem, and
then, when I failed, I would put it aside, and I’d come back to it
and rag it again. It took me 20 years to ﬁgure out how and why

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cult conversion methods worked. But the psychology
departments haven’t ﬁgured it out yet, so I’m ahead of them.
But anyway, I have this tendency to want to rag the problems.
Because WWII caught me, I drifted into some physics, and the
Air Corps sent me to Caltech, where I did a little more physics as
part of being made into a meteorologist. And there, at a very
young age, I absorbed what I call the fundamental full attribution
ethos of hard science. That was enormously useful to me. Let me
explain that ethos.
Under this ethos, you’ve got to know all the big ideas in all the
disciplines more fundamental than your own. You can never
make any explanation that can be made in a more fundamental
way in any other way than the most fundamental way. And you
always take them with full attribution to the most fundamental
ideas that you are required to use. When you’re using physics,
you say you’re using physics. When you’re using biology, you say
you’re using biology. And so on and so on. I could early see that
that ethos would act as a ﬁne organizing system for my thought.
And I strongly suspected that it would work really well in the soft
sciences as well as the hard sciences, so I just grabbed it and
used it all through my life in soft science as well as hard science.
That was a very lucky idea for me.
Let me explain how extreme that ethos is in hard science.
There is a constant, one of the fundamental constants in physics,
known as Boltzmann’s constant.72 You probably all know it very
well. The interesting thing about Boltzmann’s constant is that
[Ludwig] Boltzmann didn’t discover it. So why is Boltzmann’s
constant now named for Boltzmann? Well, the answer is that
Boltzmann derived that constant from basic physics in a more
fundamental way than the poor forgotten fellow who found the
constant in the ﬁrst place in some less fundamental way.
The ethos of hard science is so strong in favor of reductionism
to the more fundamental body of knowledge that you can wash

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the discoverer right out of history when somebody else handles
his discovery in a more fundamental way. I think that is correct. I
think Boltzmann’s constant should be named for Boltzmann.
At any rate, in my history and Berkshire’s history, Berkshire
went on and on into considerable economic success while
ignoring the hard-form efﬁcient-markets doctrine once very
popular in academic economics and ignoring the descendants of
that doctrine in corporate ﬁnance, where the results became
even sillier than they were in economics. This naturally
encouraged me.
Finally, with my peculiar history, I’m also bold enough to be
here today because, at least when I was young, I wasn’t a total
klutz. For one year at the Harvard Law School, I was ranked
second in a very large group, and I always ﬁgured that, while
there were always a lot of people much smarter than I was, I
didn’t have to hang back totally in the thinking game.
Let me begin by discussing the obvious strengths of academic
economics. The ﬁrst obvious strength—and this is true of a lot of
places that get repute—is that it was in the right place at the right
time. Two hundred years ago, aided by the growth of technology
and the growth of other developments in civilization, the real
output per capita of the civilized world started going up at about
2 percent per annum, compounded. Before that, for the previous
thousands of years, it had gone up at a rate that hovered just a
hair’s breadth above zero. And, of course, economics grew up
amid this huge success. Partly it helped the success, and partly it
explained it. So, naturally, academic economics grew. And lately,
with the collapse of all the communist economies, as the free-
market economies or partially free-market economies
ﬂourished, that added to the reputation of economics.
Economics has been a very favorable place to be if you’re in
academia.

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Economics was always more multidisciplinary than the rest of
soft science. It just reached out and grabbed things as it needed
to. And that tendency to just grab whatever you need from the
rest of knowledge if you’re an economist has reached a fairly
high point in N. Gregory Mankiw’s73 new textbook.
I checked out that textbook. I must have been one of the few
businessmen in America who bought it immediately when it
came out because it had gotten such a big advance. I wanted to
ﬁgure out what the guy was doing where he could get an advance
that great. So this is how I happened to rifﬂe through Mankiw’s
freshman textbook. And there I found laid out as principles of
economics: Opportunity cost is a superpower, to be used by all
people who have any hope of getting the right answer. Also,
incentives are superpowers. And lastly, the tragedy of the
commons model, popularized by my longtime friend, UCSB’s
Garrett Hardin.74 Hardin caused the delightful introduction into
economics, alongside Smith’s beneﬁcent invisible hand, of
Hardin’s wicked, evildoing invisible foot. Well, I thought that the
Hardin model made economics more complete, and I knew when
Hardin introduced me to his model, the tragedy of the commons,
that it would be in the economics textbooks eventually. And lo
and behold, it ﬁnally made it about 20 years later. And it’s right
for Mankiw to reach out into other disciplines and grab Hardin’s
model, and anything else that works well.
Another thing that helped economics is that, from the
beginning, it attracted the best brains in soft science. Its
denizens also interacted more with the practical world than was
at all common in soft science and the rest of academia, and that
resulted in very creditable outcomes like the three Cabinet
appointments of economics PhD George Shultz75 and the Cabinet
appointment of Larry Summers. So this has been a very favored
part of academia.

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Also, economics early on attracted some of the best writers of
language in the history of the earth. You start out with Adam
Smith. Adam Smith was so good a thinker and so good a writer
that, in his own time, Immanuel Kant, then the greatest
intellectual in Germany, simply announced that there was
nobody in Germany to equal Adam Smith. Well, Voltaire, being
an even pithier speaker than Kant, which wouldn’t be that hard,
immediately said, “Oh, well, France doesn’t have anybody who
can even be compared to Adam Smith.”
So economics started with some very great men and great
writers. And then there have been later great writers like John
Maynard Keynes, whom I quote all the time and who has added a
great amount of illumination to my life. And ﬁnally, even in the
present era, if you take Paul Krugman and read his essays, you
will be impressed by his ﬂuency. I can’t stand his politics; I’m on
the other side. But I love this man’s essays. I think Paul Krugman
is one of the best essayists alive. So economics has constantly
attracted these fabulous writers. And they are so good that they
have this enormous inﬂuence far outside their economic
discipline, and that’s very uncommon in other academic
departments.
Okay, now it’s time to extend criticism instead of praise. We’ve
recognized that economics is better than other soft science
academic departments in many ways, and one of the glories of
civilization. Now it’s only fair that we outline a few things that are
wrong with academic economics.

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ONE
Fatal unconnectedness, leading to man-with-a-hammer
syndrome, often causing overweighing of what can be
counted
I think I’ve got eight—no, nine—objections, some being logical
subdivisions of a big general objection. The big general objection
to economics was the one early described by Alfred North
Whitehead when he spoke of the fatal unconnectedness of
academic disciplines, wherein each professor didn’t even know
the models of the other disciplines, much less try to synthesize
those disciplines with his own. I think there’s a modern name for
this approach that Whitehead didn’t like, and that name is
“bonkers.” This is a perfectly crazy way to behave. Yet
economics, like much else in academia, is too insular.
The nature of this failure is that it creates what I always call
man-with-a-hammer syndrome. That’s taken from the folk
saying “To the man with only a hammer, every problem looks
pretty much like a nail.” That works marvelously to gum up all
professions and all departments of academia and, indeed, most
practical life.
The only antidote for being an absolute klutz due to the
presence of a man-with-a-hammer syndrome is to have a full kit
of tools. You don’t have just a hammer, you’ve got all the tools.
And you’ve got to have one more trick: You’ve got to use those
tools checklist-style, because you’ll miss a lot if you just hope
that the right tool is going to pop up unaided whenever you need
it. But if you’ve got a full list of tools and go through them in your
mind, checklist-style, you will ﬁnd a lot of answers that you won’t
ﬁnd any other way. So limiting this big general objection that so
disturbed Alfred North Whitehead is very important, and there
are mental tricks that help do the job.

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A special version of this man-with-a-hammer syndrome is
terrible not only in economics but practically everywhere else,
including business. It’s really terrible in business. You’ve got a
complex system, and it spews out a lot of wonderful numbers
that enable you to measure some factors. But there are other
factors that are terribly important, yet there’s no precise
numbering you can put to these factors. You know they’re
important, but you don’t have the numbers. Well, practically
everybody 1) overweighs the stuff that can be numbered because
it yields to the statistical techniques they’re taught in academia,
and 2) doesn’t mix in the hard-to-measure stuff that may be
more important. That is a mistake I’ve tried all my life to avoid,
and I have no regrets for having done that.
The late, great Thomas Hunt Morgan, who was one of the
greatest biologists who ever lived, when he got to Caltech had a
very interesting, extreme way of avoiding some mistakes from
overcounting what could be measured and undercounting what
couldn’t. At that time, there were no computers, and the
computer substitute then available to science and engineering
was the Friden calculator, and Caltech was full of Friden
calculators. Thomas Hunt Morgan banned the Friden calculator
from the biology department. And when they said, “What the hell
are you doing, Dr. Morgan?,” he said, “Well, I am like a guy who is
prospecting for gold along the banks of the Sacramento River in
1849. With a little intelligence, I can reach down and pick up big
nuggets of gold. And as long as I can do that, I’m not going to let
any people in my department waste scarce resources in placer
mining.76 And that’s the way Thomas Hunt Morgan got through
life.
I’ve adopted the same technique, and here I am in my 80th
year. I haven’t had to do any placer mining yet. And it begins to
look like I’m going to get all the way through, as I’d always hoped,
without doing any of that damned placer mining. Of course, if I

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were a physician, particularly an academic physician, I’d have to
do the statistics, do the placer mining. But it’s amazing what you
can do in life without the placer mining if you’ve got a few good
mental tricks and just keep ragging the problems the way
Thomas Hunt Morgan did.
TWO
Failure to follow the fundamental full-attribution ethos
of hard science
What’s wrong with the way Mankiw does economics is that he
grabs from other disciplines without attribution. He doesn’t label
the grabbed items as physics or biology or psychology or game
theory or whatever they really are, fully attributing the concept to
the basic knowledge from which it came. If you don’t do that, it’s
like running a business with a sloppy ﬁling system. It reduces
your power to be as good as you can be.
Now, Mankiw is so smart he does pretty well even when his
technique is imperfect. He got the largest advance any textbook
writer ever got. But nonetheless, he’d be better if he had
absorbed a hard-science ethos, which has been helpful to me.
I have names for Mankiw’s approach, grabbing whatever you
need without attribution. Sometimes I call it “take what you
wish,” and sometimes I call it “Kiplingism.” And when I call it
Kiplingism, I’m reminding you of [Joseph Rudyard] Kipling’s77
stanza of poetry, which went something like this: “When Homer
smote his blooming lyre, he’d heard men sing by land and sea,
and what he thought he might require, he went and took, the
same as me.”
Well, that’s the way Mankiw does it. He just grabs. This is
much better than not grabbing. But it is much worse than

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grabbing with full attribution and full discipline, using all
knowledge plus extreme reductionism where feasible.
THREE
Physics envy
The third weakness that I ﬁnd in economics is what I call physics
envy. And, of course, that term has been borrowed from “penis
envy,” as described by one of the world’s great idiots, Sigmund
Freud. But he was very popular in his time, and the concept got a
wide vogue.
One of the worst examples of what physics envy did to
economics was cause adoption of hard-form efﬁcient-market
theory. Then, when you logically derived consequences from this
wrong theory, you would get conclusions such as it can never be
correct for any corporation to buy its own stock. Because the
stock price, by deﬁnition, is totally efﬁcient, there could never be
any advantage, QED. And they taught this theory to some partner
at McKinsey when he was at some school of business that had
adopted this crazy line of reasoning from economics, and the
partner became a paid consultant for The Washington Post. And
Washington Post stock was selling at a ﬁfth of what an orangutan
could ﬁgure was the plain value per share by just counting up the
values and dividing. But he so believed what he’d been taught in
graduate school that he told The Washington Post it shouldn’t buy
its own stock.
Well, fortunately, they put Warren Buffett on the board, and
he convinced them to buy back more than half of the outstanding
stock, which enriched the remaining shareholders by much
more than a billion dollars. So there was at least one instance of a
place that quickly killed a wrong academic theory.

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It’s my view that economics could avoid a lot of this trouble
that comes from physics envy. I want economics to pick up the
basic ethos of hard science, the full attribution habit, but not the
craving for an unattainable precision that comes from physics
envy. The sort of precise, reliable formula that includes
Boltzmann’s constant is not going to happen, by and large, in
economics. Economics involves too complex a system. And the
craving for that physics-style precision does little but get you in
terrible trouble, like the poor fool from McKinsey.
I think that economists would be way better off if they paid
more attention to Einstein and Sharon Stone. Well, Einstein is
easy because Einstein is famous for saying “Everything should
be made as simple as possible, but no more simple.” Now, the
saying is a tautology, but it’s very useful, and some economist—it
may have been Herb Stein—had a similar tautological saying that
I dearly love: “If a thing can’t go on forever, it will eventually
stop.”
Sharon Stone contributed to the subject because someone
once asked her if she was bothered by penis envy. And she said,
“Absolutely not. I have more trouble than I can handle with what
I’ve got.”
When I talk about this false precision, this great hope for
reliable, precise formulas, I am reminded of Arthur Laffer, who’s
in my political party, and who takes a mistaken approach,
sometimes, when it comes to doing economics. His trouble is his
craving for false precision, which is not an adult way of dealing
with his subject matter.
The situation of people like Laffer reminds me of a rustic
legislator—and this really happened in America. I don’t invent
these stories. Reality is always more ridiculous than what I’m
going to tell you. At any rate, this rustic legislator proposed a new
law in his state. He wanted to pass a law rounding pi to an even

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3.2 so it would be easier for the schoolchildren to make the
computations.
Well, you can say that this is too ridiculous, and it can’t be fair
to liken economics professors like Laffer to a rustic legislator like
this. I say I’m under-criticizing the professors. At least when this
rustic legislator rounded pi to an even number, the error was
relatively small. But once you try to put a lot of false precision
into a complex system like economics, the errors can compound
to the point where they’re worse than those of the McKinsey
partner when he was incompetently advising The Washington Post.
So economics should emulate physics’ basic ethos, but its search
for precision in physics-like formulas is almost always wrong in
economics.
FOUR
Too much emphasis on macroeconomics
My fourth criticism is that there’s too much emphasis on macro -
economics and not enough on microeconomics. I think this is
wrong. It’s like trying to master medicine without knowing
anatomy and chemistry. Also, the discipline of microeconomics
is a lot of fun. It helps you correctly understand
macroeconomics, and it’s a perfect circus to do. In contrast, I
don’t think macroeconomics people have all that much fun. For
one thing, they are often wrong because of extreme complexity
in the system they wish to understand.
Let me demonstrate the power of microeconomics by solving
two microeconomic problems, one simple and one a little harder.
The ﬁrst problem is this: Berkshire Hathaway just opened a
furniture and appliance store in Kansas City, Kansas. At the time
Berkshire opened it, the largest-selling furniture and appliance
store in the world was another Berkshire Hathaway store selling

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$350 million worth of goods per year. The new store in a strange
city opened up selling at the rate of more than $500 million a
year. From the day it opened, the 3,200 spaces in the parking lot
were full. The women had to wait outside the ladies’ restroom
because the architects didn’t understand biology. It’s hugely
successful.
Well, I’ve given you the problem. Now, tell me what explains
the runaway success of this new furniture and appliance store
that is outselling everything else in the world.
Let me do it for you. Is this a low-priced store or a high-priced
store? It’s not going to have runaway success in a strange city as
a high-priced store. That would take time. Number two, if it’s
moving $500 million worth of furniture through it, it’s one hell of
a big store, furniture being as bulky as it is. And what does a big
store do? It provides a big selection. So what could this possibly
be except a low-priced store with a big selection?
But you may wonder, why wasn’t it done before, preventing its
being done ﬁrst now? Again, the answer just pops into your head:
It costs a fortune to open a store this big, so nobody’s done it
before. So you quickly know the answer. With a few basic
concepts, these microeconomic problems that seem hard can be
solved much as you put a hot knife through butter. I like such
easy ways of thought that are very remunerative. And I suggest
that you people should also learn to do microeconomics better.
Now I’ll give you a harder problem. There’s a tire store chain
in the Northwest that has slowly succeeded over 50 years, the
Les Schwab78 tire store chain. It just ground ahead. It started
competing with the stores that were owned by the big tire
companies that made all the tires, the Goodyears and so forth.
And, of course, the manufacturers favored their own stores.
Their “tied stores” had a big cost advantage. Later, Les Schwab
rose in competition with the huge price discounters like Costco
and Sam’s Club and before that Sears, Roebuck and so forth. And

## Page 258

yet, here is Schwab now, with hundreds of millions of dollars in
sales. And here’s Les Schwab in his 80s, with no education,
having done the whole thing.
How did he do it? I don’t see a whole lot of people looking like
a light bulb has come on. Well, let’s think about it with some
micro economic ﬂuency.
Is there some wave that Schwab could have caught? The
minute you ask the question, the answer pops in. The Japanese
had a zero position in tires, and they got big. So this guy must
have ridden that wave some in the early times. Then, the slow
following success has to have some other causes. And what
probably happened here, obviously, is this guy did one hell of a
lot of things right. And among the things that he must have done
right is he must have harnessed what Mankiw calls the
superpower of incentives. He must have a very clever incentive
structure driving his people. And a clever personnel selection
system, etc. And he must be pretty good at advertising. Which he
is. He’s an artist.
So he had to get a wave in the Japanese tire invasion, the
Japanese being as successful as they were. And then a talented
fanatic had to get a hell of a lot of things right and keep them
right with clever systems. Again, not that hard of an answer. But
what else would be a likely cause of the peculiar success?
We hire business school graduates, and they’re no better at
these problems than you were. Maybe that’s the reason we hire
so few of them.
Well, how did I solve those problems? Obviously, I was using a
simple search engine in my mind to go through checklist-style,
and I was using some rough algorithms that work pretty well in a
great many complex systems, and those algorithms run
something like this:
Extreme success is likely to be caused by some combination
of the following factors:

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1. Extreme maximization or minimization of one or two
variables. Example, Costco or our furniture and appliance
store.
2. Adding success factors so that a bigger combination drives
success, often in nonlinear fashion, as one is reminded by
the concept of breakpoint and the concept of critical mass
in physics. Often, results are not linear. You get a little bit
more mass and you get a lollapalooza result. And, of
course, I’ve been searching for lollapalooza results all my
life, so I’m very interested in models that explain their
occurrence.
3. An extreme of good performance over many factors.
Example, Toyota or Les Schwab.
4. Catching and riding some sort of big wave. Example,
Oracle. By the way, I cited Oracle before I knew that the
Oracle CFO [Jeff Henley] was a big part of the proceedings
here today.
Generally, I recommend and use in problem-solving cut-to-
the-quick algorithms, and I ﬁnd you have to use them both
forward and backward. Let me give you an example. I irritate my
family by giving them little puzzles, and one of the puzzles that I
gave my family not very long ago was when I said, “There’s an
activity in America with one-on-one contests and a national
championship. The same person won the championship on two
occasions about 65 years apart. Now,” I said, “name the activity.”
Again, I don’t see a lot of light bulbs going on. And in my
family, not a lot of light bulbs were ﬂashing. But I have a physicist
son who has been trained more in the type of thinking I like. And
he immediately got the right answer, and here’s the way he
reasoned: It can’t be anything requiring a lot of hand-eye

## Page 260

coordination. Nobody 85 years of age is going to win a national
billiards tournament, much less a national tennis tournament. It
just can’t be. Then he ﬁgured it couldn’t be chess, which this
physicist plays very well, because it’s too hard. The complexity of
the system and the stamina required are too great. But that led
into checkers. And he thought, “Aha! There’s a game where vast
experience might guide you to be the best even though you’re 85
years of age.”
Anyway, I recommend that sort of mental puzzle-solving to all
of you, ﬂipping one’s thinking both backward and forward. And I
recommend that academic economics get better at very small-
scale microeconomics as demonstrated here.
FIVE
Too little synthesis in economics
My ﬁfth criticism is there is too little synthesis in economics, not
only with matter outside traditional economics but also within
economics.
I have posed before two different business school classes the
following problem. I say, “You have studied supply and demand
curves. You have learned that when you raise the price,
ordinarily the volume you can sell goes down, and when you
reduce the price, the volume you can sell goes up. Is that right?
That’s what you’ve learned?” They all nod yes. And I say, “Now
tell me several instances when, if you want the physical volume
to go up, the correct answer is to increase the price.” And there’s
this long and ghastly pause. And ﬁnally, in each of the two
business schools in which I’ve tried this, maybe one person in 50
could name one instance. They come up with the idea that under
certain circumstances, a higher price acts as a rough indicator of
quality and thereby increases sales volumes.

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This happened in the case of my friend Bill Ballhaus. When he
was head of Beckman Instruments, it produced some
complicated product where if it failed, it caused enormous
damage to the purchaser. It wasn’t a pump at the bottom of an oil
well, but that’s a good mental example. And he realized that the
reason this thing was selling so poorly, even though it was better
than anybody else’s product, was because it was priced lower. It
made people think it was a low-quality gizmo. So he raised the
price by 20 percent or so, and the volume went way up.
But only one in 50 can come up with this sole instance in a
modern business school—one of the business schools being
Stanford, which is hard to get into. And nobody has yet come up
with the main answer that I like. Suppose you raise that price
and use the extra money to bribe the other guy’s purchasing
agent? Is that going to work? And are there functional
equivalents in economics, micro economics, of raising the price
and using the extra sales proceeds to drive sales higher? And, of
course, there are a zillion, once you’ve made that mental jump.
It’s so simple.
One of the most extreme examples is in the investment
management ﬁeld. Suppose you’re the manager of a mutual
fund, and you want to sell more. People commonly come to the
following answer: You raise the commissions, which, of course,
reduces the number of units of real investments delivered to the
ultimate buyer, so you’re increasing the price per unit of real
investment that you’re selling the ultimate customer. And you’re
using that extra commission to bribe the customer’s purchasing
agent. You’re bribing the broker to betray his client and put the
client’s money into the high-commission product. This has
worked to produce at least a trillion dollars of mutual fund sales.
This tactic is not an attractive part of human nature, and I
want to tell you that I pretty completely avoided it in my life. I
don’t think it’s necessary to spend your life selling what you

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would never buy. Even though it’s legal, I don’t think it’s a good
idea. But you shouldn’t accept all my notions, because you’ll risk
becoming unemployable. You shouldn’t take my notions unless
you’re willing to risk being unemployable by all but a few.
I think my experience with my simple question is an example
of how little synthesis people get, even in advanced academic
settings, considering economic questions. Obvious questions,
with such obvious answers. Yet people take four courses in
economics, go to business school, have all these IQ points, and
write all these essays, but they can’t synthesize worth a damn.
This failure is not because the professors know all this stuff
and they’re deliberately withholding it from the students. This
failure happens because the professors aren’t all that good at this
kind of synthesis. They were trained in a different way. I can’t
remember if it was Keynes or Galbraith who said that economics
professors are most economical with ideas. They make a few
they learned in graduate school last a lifetime.
The second interesting problem with synthesis involves two
of the most famous examples in economics. Number one is
[David] Ricardo’s79 principle of comparative advantage in trade,
and the other is Adam Smith’s pin factory.80 And both of these, of
course, work to vastly increase economic output per person, and
they’re similar in that each somehow directs functions into the
hands of people who are very good at doing the functions. Yet
they’re radically different examples in that one of them is the
ultimate example of central planning—the pin factory—where the
whole system was planned by somebody, while the other
example, Ricardo’s, happens automatically as a natural
consequence of trade.
And, of course, once you get into the joys of synthesis, you
immediately think, “Do these things interact?” Of course they
interact. Beautifully. And that’s one of the causes of the power of
a modern economic system.

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I saw an example of that kind of interaction years ago.
Berkshire had this former savings and loan company, and it had
made this loan on a hotel right opposite the Hollywood Park
Racetrack. In due time, the neighborhood changed, and it was
full of gangs, pimps, and dope dealers. They tore copper pipe out
of the wall for dope ﬁxes, and there were people hanging around
the hotel with guns, and nobody would come. We foreclosed on it
two or three times, and the loan value went down to nothing. We
seemed to have an insolvable economic problem—a
microeconomic problem.
Now, we could have gone to McKinsey, or maybe to a bunch of
professors from Harvard, and we would have gotten a report
about 10 inches thick about the ways we could approach this
failing hotel in this terrible neighborhood. But instead, we put a
sign on the property that said, “For sale or rent.” And in came, in
response to that sign, a man who said, “I’ll spend $200,000 ﬁxing
up your hotel and buy it at a high price on credit if you can get
zoning so I can turn the parking lot into a putting green.”
“You’ve got to have a parking lot in a hotel,” we said. “What do
you have in mind?”
He said, “No, my business is ﬂying seniors in from Florida,
putting them near the airport, and then letting them go out to
Disneyland and various places by bus and coming back. I don’t
care how bad the neighborhood is going to be because my people
are self-contained behind walls. All they have to do is get on the
bus in the morning and come home in the evening. They don’t
need a parking lot; they need a putting green.”
So we made the deal with the guy. The whole thing worked
beautifully, and the loan got paid off, and it all worked out.
Obviously, that’s an interaction of Ricardo and the pin factory
examples. The odd system that this guy had designed to amuse
seniors was pure pin factory, and ﬁnding the guy with this
system was pure Ricardo. So these things are interacting.

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Well, I’ve taken you partway through the synthesis. It gets
harder when you want to ﬁgure out how much activity should be
within private ﬁrms, and how much should be within the
government, and what are the factors that determine which
functions are where, and why do the failures occur, and so on
and so on.
It’s my opinion that anybody with a high IQ who graduated in
economics ought to be able to sit down and write a 10-page
synthesis of all these ideas that’s quite persuasive. And I would
bet a lot of money that I could give this test in practically every
economics department in the country and get a perfectly lousy
bunch of synthesis. They’d give me Ronald Coase.81 They’d talk
about transaction costs. They’d click off a little something that
their professors gave them and spit it back. But in terms of really
understanding how it all ﬁts together, I would conﬁdently predict
that most people couldn’t do it very well.
By the way, if any of you want to try and do this, go ahead. I
think you’ll ﬁnd it hard. In this connection, one of the interesting
things that I want to mention is that Max Planck, the great Nobel
laureate who found Planck’s constant, tried once to do
economics. He gave it up.
Now, why did Max Planck, one of the smartest people who
ever lived, give up economics? The answer is, he said, “It’s too
hard. The best solution you can get is messy and uncertain.” It
didn’t satisfy Planck’s craving for order, and so he gave it up. And
if Max Planck early on realized he was never going to get perfect
order, I will conﬁdently predict that all of the rest of you are going
to have exactly the same result.
By the way, there’s a famous story about Max Planck that is
apocryphal: After he won his prize, he was invited to lecture
everywhere, and he had this chauffeur who drove him around to
give public lectures all through Germany. And the chauffeur
memorized the lecture, so one day he said, “Gee, Professor

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Planck, why don’t you let me try it by switching places?” So he
got up and gave the lecture. At the end of it, some physicist stood
up and posed a question of extreme difﬁculty. But the chauffeur
was up to it. “Well,” he said, “I’m surprised that a citizen of an
advanced city like Munich is asking so elementary a question, so
I’m going to ask my chauffeur to respond.”
SIX
Extreme and counterproductive psychological
ignorance
All right, I’m down to the sixth main defect, and this is a
subdivision of the lack of adequate multidisciplinarity: extreme
and counter productive psychological ignorance in economics.
Here, I want to give you a very simple problem. I specialize in
simple problems.
You own a small casino in Las Vegas. It has 50 standard slot
machines. Identical in appearance, they’re identical in the
function. They have exactly the same payout ratios. The things
that cause the payouts are exactly the same. They occur in the
same percentages. But there’s one machine in this group of slot
machines that, no matter where you put it among the 50, in fairly
short order, when you go to the machines at the end of the day,
there will be 25 percent more winnings from this one machine
than from any other machine.
Now, surely, I’m not going to have a failure here. What is
different about that heavy-winning machine? Can anybody do it?
Audience member: More people play it.
No, no, I want to know why more people play it. What’s
different about that machine is people have used modern
electronics to give a higher ratio of near misses. That machine is

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going bar, bar, lemon, bar, bar, grapefruit, way more often than
normal machines, and that will cause heavier play.
How do you get an answer like that? Easy. Obviously, there’s a
psychological cause: That machine is doing something to trigger
some basic psychological response. If you know the
psychological factors, if you’ve got them on a checklist in your
head, you just run down the factors, and boom! You get to one
that must explain this occurrence. There isn’t any other way to
do it effectively.
These answers are not going to come to people who don’t
learn these problem-solving methods. If you want to go through
life like a one-legged man in an ass-kicking contest, why, be my
guest. But if you want to succeed like a strong man with two legs,
you have to pick up these methods, including doing micro- and
macro economics while knowing psychology.
In this vein, I next want to mention a strange Latin American
case of a dysfunctional economy that got ﬁxed. In this little sub -
division of Latin America, a culture had arisen wherein
everybody stole everything. They embezzled from the company;
they stole everything that was loose in the community. And, of
course, the economy came practically to a halt. And this thing got
ﬁxed.
Now, where did I read about this case? I’ll give you a hint. It
wasn’t in the annals of economics. I found this case in the annals
of psychology. Clever people went down and used a bunch of
psychological tricks. And they ﬁxed it.
Well, I think there’s no excuse if you’re an economist, when
there are wonderful cases like that of the dysfunctional economy
becoming ﬁxed, and these simple tricks that solve so many
problems, and you don’t know how to do the ﬁxes and
understand the problems. Why be so ignorant about psychology
that you don’t even know psychology’s tricks that will ﬁx your
own dysfunctional economic systems?

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Here, I want to give you an extreme injunction. This is even
tougher than the fundamental organizing ethos of hard science.
This has been attributed to Samuel Johnson. He said, in
substance, that if an academic maintains in place an ignorance
that can be easily removed with a little work, the conduct of the
academic amounts to treachery. That was his word, “treachery.”
You can see why I love this stuff. He says you have a duty if you’re
an academic to be as little of a klutz as you can possibly be, and
therefore you have got to keep grinding out of your system as
much removable ignorance as you can remove.
SEVEN
Too little attention to second- and higher-order effects
On to the next one, the seventh defect: too little attention in
economics to second-order and even higher-order effects. This
defect is quite understandable because the consequences have
consequences, and the consequences of the consequences have
consequences, and so on. It gets very complicated. When I was a
meteorologist, I found this stuff very irritating, and economics
makes meteorology look like a tea party.
Extreme economic ignorance was displayed when various
experts, including PhD economists, forecast the cost of the
original Medicare law. They did simple extrapolations of past
costs. Well, the cost forecast was off by a factor of more than
1,000 percent. The cost they projected was less than 10 percent
of the cost that happened. Once they put in place various new
incentives, the behavior changed in response to the incentives,
and the numbers became quite different from their projection.
And medicine invented new and expensive remedies, as it was
sure to do.

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How could a great group of experts make such a silly forecast?
Answer: They oversimpliﬁed to get easy ﬁgures, like the rube
rounding pi to 3.2. They chose not to consider effects of effects of
effects, and so on.
One good thing about this common form of misthinking from
the viewpoint of academia is that businesspeople are even more
foolish about microeconomics. The business version of the
Medicare-type insanity is when you own a textile plant and a guy
comes in and says, “Oh, isn’t this wonderful? They invented a
new loom. It’ll pay for itself in three years at current prices
because it adds so much efﬁciency to the production of textiles.”
And you keep buying these looms, and their equivalent, for 20
years, and you keep making 4 percent on capital; you never go
anywhere. And the answer is, it wasn’t that the technology didn’t
work, it’s that the laws of economics caused the beneﬁt from the
new looms to go to the people that bought the textiles, not to the
guy who owned the textile plant.
How could anybody not know that if he’d taken freshman
economics or been through business school? I think the schools
are doing a lousy job. Otherwise, such insanities wouldn’t
happen so often.
Usually, I don’t use formal projections. I don’t let people do
them for me because I don’t like throwing up on the desk, but I
see them made in a very foolish way all the time, and many
people believe in them, no matter how foolish they are. It’s an
effective sales technique in America to put a foolish projection
on a desk. And if you’re an investment banker, it’s an art form. I
don’t read their projections either. Once, Warren and I bought a
company, and the seller had a big study done by an investment
banker. It was about this thick. We just turned it over as if it were
a diseased carcass. He said, “We paid $2 million for that.” I said,
“We don’t use them. Never look at them.”

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Anyway, as the Medicare example showed, all human systems
are gamed, for reasons rooted deeply in psychology, and great
skill is displayed in the gaming because game theory has so
much potential. That’s what’s wrong with the workers’ comp
system in California. Gaming has been raised to an art form. In
the course of gaming the system, people learn to be crooked. Is
this good for civilization? Is it good for economic performance?
Hell no. The people who design easily gameable systems belong
in the lowest circle of hell.
I’ve got a friend whose family controls about 8 percent of the
truck trailer market. He just closed his last factory in California,
and he had one in Texas that was even worse. The workers’ comp
cost in his Texas plant got to be double-digit percentages of
payroll. Well, there’s no such proﬁt in making truck trailers. He
closed his plant and moved it to Ogden, Utah, where a bunch of
believing Mormons are raising big families and don’t game the
workers’ comp system. The workers’ comp expense is 2 percent
of payroll.
Are the Latinos who were peopling his plant in Texas intrinsi -
cally dishonest or bad compared to the Mormons? No. It’s just
the incentive structure that so rewards all this fraud is put in
place by these ignorant legislatures, many members of which
have been to law school, and they just don’t think about what
terrible things they’re doing to the civilization because they don’t
take into account the second-order effects and the third-order
effects in lying and cheating. So this happens everywhere, and
when economics is full of it, it is just like the rest of life.
There was a wonderful example of gaming a human system in
the career of Victor Niederhoffer82 in the economics department
of Harvard. Victor Niederhoffer was the son of a police
lieutenant, and he needed to get As at Harvard. But he didn’t
want to do any serious work at Harvard because what he really
liked doing was 1) playing world-class checkers; 2) gambling in

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high-stakes card games, at which he was very good, all hours of
the day and night; 3) being the squash champion of the United
States, which he was for years; and 4) being about as good a
tennis player as a part-time tennis player could be.
This did not leave much time for getting As at Harvard, so he
went into the economics department. You’d think he would have
chosen French poetry. But remember, this was a guy who could
play championship checkers. He thought he was up to
outsmarting the Harvard economics department. And he was.
He noticed that the graduate students did most of the boring
work that would otherwise go to the professors, and he noticed
that because it was so hard to get to be a graduate student at
Harvard, they were all very brilliant and organized and
hardworking, as well as much needed by grateful professors.
And therefore, by custom, and as would be predicted from the
psychological force called reciprocity tendency, in a really
advanced graduate course, the professors always gave an A. So
Victor Niederhoffer signed up for nothing but the most advanced
graduate courses in the Harvard economics department, and of
course he got A after A after A after A, and was hardly ever near a
class. And for a while, some people at Harvard may have thought
it had a new prodigy on its hands.
That’s a ridiculous story, but the scheme will work still. And
Niederhoffer is famous: They call his style “Niederhoffering the
curriculum.”
This shows how all human systems are gamed. Another
example of not thinking through the consequences of the
consequences is the standard reaction in economics to Ricardo’s
law of comparative advantage83 giving beneﬁt on both sides of
trade.
Ricardo came up with a wonderful, non obvious explanation
that was so powerful that people were charmed with it, and they
still are because it’s a very useful idea. Everybody in economics

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understands that comparative advantage is a big deal when one
considers ﬁrst-order advantages in trade from the Ricardo effect.
But suppose you’ve got a very talented ethnic group, like the
Chinese, and they’re very poor, and you’re an advanced nation,
and you create free trade with China, and it goes on for a long
time. Now let’s follow second- and third-order consequences.
You are more prosperous than you would have been if you hadn’t
traded with China in terms of average well being in the United
States, right? Ricardo proved it. But which nation is going to be
growing faster in economic terms? It’s obviously China. They’re
absorbing all the modern technology of the world through this
great facilitator in free trade, and, like the Asian Tigers have
proved, they will get ahead fast. Look at Hong Kong. Look at
Taiwan. Look at early Japan.
So you start in a place where you’ve got a weak nation of a
billion and a quarter people, and in the end, they’re going to be a
much bigger, stronger nation than you are, maybe even having
more and better atomic bombs. Well, Ricardo did not prove that
that’s a wonderful outcome for the former leading nation. He
didn’t try to determine second-order and higher-order effects.
If you try to talk like this to economics professors—and I’ve
done this three times—they shrink in horror and offense because
they don’t like this kind of talk. It really gums up this nice
discipline of theirs, which is so much simpler when you ignore
second- and third-order consequences.
The best answer I ever got on that subject—in three tries—was
from George Shultz. He said, “Charlie, the way I ﬁgure it is if we
stop trading with China, the other advanced nations will do it
anyway. We wouldn’t stop the ascent of China compared to us,
and we’d lose the Ricardo-diagnosed advantages of trade.” Which
is obviously correct.
I said, “Well, George, you’ve just invented a new form of the
tragedy of the commons. You’re locked in this system, and you

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can’t ﬁx it. You’re going to go to a tragic hell in a handbasket, if
going to hell involves being once the great leader of the world
and ﬁnally going to the shallows in terms of leadership.”
And he said, “Charlie, I do not want to think about this.”
I think he’s wise. He’s even older than I am, and maybe I
should learn from him.
EIGHT
Not enough attention to the concept of febezzlement
Okay, I’m now down to my eighth objection: too little attention
within economics to the simplest and most fundamental
principle of algebra.
Now, this sounds outrageous, that economics doesn’t do
algebra, right? Well, I want to try an example—I may be wrong on
this. I’m old and I’m iconoclastic. But I throw it out anyway. I say
that economics doesn’t pay enough attention to the concept of
febezzlement. And that I derive from Galbraith’s idea.
Galbraith’s idea was that if you have an undisclosed
embezzlement, it has a wonderful Keynesian stimulating effect
on the economy because the guy who’s been embezzled thinks
he is as rich as he always was and spends accordingly, and the
guy who has stolen the money gets all this new purchasing
power. I think that’s correct analysis on Galbraith’s part. The
trouble with his notion is that he’s described a minor
phenomenon. Because when the embezzlement is discovered, as
it almost surely will be, the effect will quickly reverse. So the
effect quickly cancels out.
But suppose you paid a lot of attention to algebra, which I
guess Galbraith didn’t, and you think, “Well, the fundamental
principle of algebra is ‘If A is equal to B and B is equal to C, then
A is equal to C.’” You’ve then got a fundamental principle that

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demands that you look for functional equivalents, all you can
ﬁnd.
So suppose you ask the question “Is there such a thing in
economics as a febezzlement?” By the way, Galbraith invented
the word “bezzle” to describe the amount of undisclosed
embezzlement, so I invented the word “febezzlement,” the
functional equivalent of embezzlement. This happened after I
asked the question “Is there a functional equivalent of
embezzlement?” I came up with a lot of wonderful, afﬁrmative
answers. Some were in investment management. After all, I’m
near investment management. I considered the billions of
dollars totally wasted in the course of investing common stock
portfolios for American owners. As long as the market keeps
going up, the guy who’s wasting all this money doesn’t feel it
because he’s looking at these steadily rising values. And to the
guy who is getting the money for investment advice, the money
looks like well-earned income when he’s really selling detriment
for money—surely the functional equivalent of undisclosed
embezzlement. You can see why I don’t get invited to many
lectures.
So I say, if you look in the economy for febezzlement, the
functional equivalent of embezzlement, you’ll ﬁnd some
enormously powerful factors. They create some wealth effect
that is on steroids compared to the old wealth effect. But
practically nobody thinks as I do, and I quitclaim my idea to any
hungry graduate student who has independent means, which he
will need before his thesis topic is approved.

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NINE
Not enough attention to virtue and vice effects
Okay, my ninth objection: not enough attention to virtue and vice
effects in economics.
It has been plain to me since early life that there are
enormous virtue effects in economics and also enormous vice
effects. But economists get very uncomfortable when you talk
about virtue and vice. It doesn’t lend itself to a lot of columns of
numbers. But I would argue that there are big virtue effects in
economics. I would say that the spreading of double-entry
bookkeeping by the monk Fra Luca de Pacioli84 was a big virtue
effect in economics. It made business more controllable, and it
made it more honest.
Then the cash register. The cash register did more for human
morality than the congregational church. It was a really powerful
phenomenon to make an economic system work better, just as in
reverse, a system that can be easily defrauded ruins a
civilization. A system that’s very hard to defraud, like a cash
register– based system, helps the economic performance of a
civilization by reducing vice, but very few people within
economics talk about it in those terms.
I’ll go further: I say economic systems work better when
there’s an extreme reliability ethos. The traditional way to get a
reliability ethos, at least in past generations in America, was
through religion. The religions instilled guilt. We have a
charming Irish Catholic priest in our neighborhood, and he loves
to say, “Those old Jews may have invented guilt, but we perfected
it.” This guilt, derived from religion, has been a huge driver of a
reliability ethos, which has been very helpful to economic
outcomes for man.

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Many bad effects from vice are clear. You’ve got the crazy
booms and crooked promotions—all you have to do is read the
paper over the last six months. There’s enough vice to make us
all choke. And by the way, everybody’s angry about unfair
compensation at the top of American corporations, and people
should be. We now face various crazy governance nostrums
invented by lawyers and professors that won’t give us a ﬁx for
unfair compensation, yet a good partial solution is obvious: If
directors were signiﬁcant shareholders who got a pay of zero,
you’d be amazed what would happen to unfair compensation of
corporate executives as we dampened effects from reciprocity
tendency.
A roughly similar equivalent of this no-pay system has been
tried in a strange place. In England, lay magistrates staff the
lower criminal courts, which can send you to prison for a year or
ﬁne you substantially. You’ve got three judges sitting up there,
and they all get a pay of zero. Their expenses are reimbursed, but
not too liberally. And they work about 40 half-days a year as
volunteers. It’s worked beautifully for about 700 years. Able and
honest people compete to become magistrates, to perform the
duty and get the signiﬁcance but no pay.
This is the system Benjamin Franklin, near the end of his life,
wanted for the US government. He didn’t want the high
executives of government to be paid but to be like himself or the
entirely unpaid, well-off ministers and rulers of the Mormon
Church. And when I see what’s happened in California, I’m not
sure he wasn’t right. At any rate, no one now drifts in Franklin’s
direction. For one thing, professors—and most of them need
money—get appointed directors.
It is not always recognized that to function best, morality
should sometimes appear unfair, like most worldly outcomes.
The craving for perfect fairness causes a lot of terrible problems
in system function. Some systems should be made deliberately

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unfair to individuals because they’ll be fairer on average for all of
us. Thus, there can be virtue in apparent non-fairness.
I frequently cite the example of having your career over in the
Navy if your ship goes aground, even if it wasn’t your fault. I say
the lack of justice for the one guy who wasn’t at fault is way more
than made up by a greater justice for everybody when every
captain of a ship always sweats blood to make sure the ship
doesn’t go aground. Tolerating a little unfairness to some to get a
greater fairness for all is a model I recommend to all of you. But
again, I wouldn’t put it in your assigned college work if you want
to be graded well, particularly in a modern law school wherein
there is usually an over love of fairness-seeking process.
There are, of course, enormous vice effects in economics. You
have these bubbles with so much fraud and folly. The aftermath
is frequently very unpleasant, and we’ve had some of that lately.
One of the ﬁrst big bubbles, of course, was the huge and horrible
South Sea Bubble85 in England. The aftermath was interesting.
Many of you probably don’t remember what happened after
the South Sea Bubble, which caused an enormous ﬁnancial
contraction and a lot of pain. Except in certain rare cases, they
banned publicly traded stock in England for decades. Parliament
passed a law that said you can have a partnership with a few
partners but you can’t have publicly traded stock. And by the
way, England continued to grow without publicly traded stock.
The people who are in the business of prospering because
there’s a lot of stock being traded in casino-like frenzy wouldn’t
like this example if they studied it enough.
It didn’t ruin England to have a long period when they didn’t
have publicly traded shares. Just as in real estate—we had all the
shopping centers and auto dealerships and so on we needed for
years when we didn’t have publicly traded real estate shares. It’s
a myth that once you’ve got some capital market, economic

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considerations demand that it has to be as fast and efﬁcient as a
casino. It doesn’t.
Another interesting problem is raised by vice effects involving
envy. Envy wisely got a very strong condemnation in the laws of
Moses. You remember how they laid it on with a trowel: You
couldn’t covet thy neighbor’s ass, you couldn’t covet thy
neighbor’s servant girl, you couldn’t covet … Those old Jews
knew how envious people are and how much trouble it caused.
They really laid it on hard, and they were right.
But [Bernard de] Mandeville—remember his fable of bees?86
He demonstrated convincingly, to me, anyway, that envy was a
great driver of proclivity to spend. And so, here’s this terrible
vice, which is forbidden in the Ten Commandments, and here it’s
driving all these favorable results in economics. There’s some
paradox in economics that nobody’s going to get out.
When I was young, everybody was excited by [Kurt] Gödel,87
who came up with proof that you couldn’t have a mathematical
system without a lot of irritating incompleteness in it. Well, since
then, my betters tell me that they’ve come up with more
irremovable defects in mathematics and have decided that
you’re never going to get mathematics without some paradox in
it. No matter how hard you work, you’re going to have to live with
some paradox if you’re a mathematician.
Well, if the mathematicians can’t get the paradox out of their
system when they’re creating it themselves, the poor economists
are never going to get rid of paradoxes, nor are any of the rest of
us. It doesn’t matter. Life is interesting with some paradox. When
I run into a paradox, I think either I’m a total horse’s ass to have
gotten to this point or I’m fruitfully near the edge of my
discipline. It adds excitement to life to wonder which it is.
As I conclude, I want to tell one more story demonstrating
how awful it is to get a wrong idea from a limited repertoire and
just stick to it. This is the story of Hyman Liebowitz, who came to

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America from the old country. In the new country, as in the old,
he tried to make his way in the family trade, which was
manufacturing nails. And he struggled, and he struggled, and
ﬁnally his little nail business got to vast prosperity, and his wife
said to him, “You are old, Hyman. It’s time to go to Florida and
turn the business over to our son.”
So down he went to Florida, turning his business over to the
son, but he got weekly ﬁnancial reports. And he hadn’t been in
Florida very long before they turned sharply negative. In fact,
they were terrible. So he got on an airplane, and he went back to
New Jersey where the factory was. As he left the airport on the
way to the factory, he saw this enormous outdoor advertising
sign lighted up. There was Jesus, spread out on the cross. And
under it was a big legend: “They Used Liebowitz’s Nails.”
So he stormed into the factory and said, “You dumb son! What
do you think you’re doing? It took me 50 years to create this
business!” “Papa,” the son said, “trust me. I will ﬁx it.”
So back he went to Florida, and while he was in Florida, he got
more reports, and the results kept getting worse. So he got on the
airplane again. Left the airport, drove by the sign, looked up at
this big lighted sign, and now there’s a vacant cross. And lo and
behold, Jesus is crumpled on the ground under the cross, and
the sign said, “They Didn’t Use Liebowitz’s Nails.”
Well, you can laugh at that. It is ridiculous, but it’s no more
ridiculous than the way a lot of people cling to failed ideas.
Keynes said, “It’s not bringing in the new ideas that’s so hard.
It’s getting rid of the old ones.” And Einstein said it better,
attributing his mental success to “curiosity, concentration,
perseverance, and self-criticism.” By self-criticism, he meant
becoming good at destroying your own best-loved and hardest-
won ideas. If you can get really good at destroying your own
wrong ideas, that is a great gift.

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Well, it’s time to repeat the big lesson in this little talk. What
I’ve urged is the use of a bigger multidisciplinary bag of tricks,
mastered to ﬂuency, to help economics and everything else. And
I also urged that people not be discouraged by irremovable
complexity and paradox. It just adds more fun to the problems.
My inspiration again is Keynes: Better roughly right than
precisely wrong.
And so, I end by repeating what I said once before on a similar
occasion. If you skillfully follow the multidisciplinary path, you
will never wish to come back. It would be like cutting off your
hands.
Well, that’s the end. I’ll take questions as long as people can
endure me.
Audience question: [The question was garbled, but the person
asked about derivatives, which Buffett has called “ﬁnancial
weapons of mass destruction.”] Buffett said that the genie’s
out of the bottle and the hangover may be proportionate to the
binge. Would you speculate for us how that scenario can play
out?
Well, of course, catastrophe predictions have always been quite
difﬁcult to make with success. But I conﬁdently predict that there
are big troubles to come. The system is almost insanely
irresponsible. And what people think are ﬁxes aren’t really ﬁxes.
It’s so complicated I can’t do it justice here, but you can’t believe
the trillions of dollars involved. You can’t believe the complexity.
You can’t believe how difﬁcult it is to do the accounting. You can’t
believe how big the incentives are to have wishful thinking about
values and wishful thinking about ability to clear.
Running off a derivative book is agony and takes time. You
saw what happened when they tried to run off the derivative
books at Enron. Its certiﬁed net worth vanished. In the derivative

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books of America, there are a lot of reported proﬁts that were
never earned and assets that never existed.
There are large febezzlement effects and some ordinary
embezzlement effects that come from derivative activity. And the
reversal of these is going to cause pain. How big the pain will be
and how well it will be handled, I can’t tell you. But you would be
disgusted if you had a fair mind and spent a month really delving
into a big derivative operation. You would think it was Lewis
Carroll. You would think it was the Mad Hatter’s tea party. And
the false precision of these people is just unbelievable. They
make the worst economics professors look like gods. Moreover,
there is depravity augmenting the folly.
Read the book Fiasco, by law professor and former derivatives
trader Frank Partnoy, an insider account of depravity in
derivative trading at one of the biggest and best-regarded Wall
Street ﬁrms. The book will turn your stomach.
Could you describe Warren’s reaction to the negative reaction
he got from musing about the defects of California’s Prop 13?88
Was he shocked, surprised?
It’s hard to shock Warren. He’s past 70; he’s seen a lot. And his
brain works quickly. He generally avoids certain subjects before
elections, and that is what I am going to do here.
TALK NINE REVISITED
This waggish talk on economics, given in 2003, gave me pleasure
as I put it together. But I hope it provided more than harmless
fun. I even hope that some shred of my ideas eventually gets into
academic economics, not because I want recognition but
because I think academic economics needs some improvement.

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Since the talk was given, I came across a book published by
Alfred A. Knopf in 2005. It was written by a distinguished
Harvard economics professor, Benjamin M. Friedman, and dealt
with the interplay of economics and morals, much as I wished to
in my talk. The title of this book is The Moral Consequences of
Economic Growth.
As readers will note from the title, Professor Friedman is
particularly interested in the impact of economic growth on
morals, whereas my interest is mostly in the reverse direction,
the impact of morals on economic growth. This difference is not
a big deal, because every educated person can see reciprocal
effects, for good or ill, between the two factors, creating what is
often called either a virtuous circle or vicious circle. Professor
Friedman supplies a marvelous quotation on this subject from
Rabbi Eleazar ben Azariah: “Where there is no bread, there is no
law; where there is no law, there is no bread.”

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CHAPTER 4; TALK TEN
stripe.press/pca-14
USC Gould School of LawCommencement Address
MAY 13, 2007UNIVERSITY OF SOUTHERN CALIFORNIA
On a warm late-spring day in 2007, Charlie addressed 194 Juris
Doctor, 89 Master of Laws, and three Master of Comparative Laws
degree recipients in the University of Southern California’s Alumni
Park. He offered insights into the practices that have contributed
to his success and to his standing as one of the wealthiest people
in the world. He observed that the acquisition of wisdom is a moral
duty, and he stressed that while attending law school he realized
the best road to success in life and learning would be a
multidisciplinary one.
Following the audience’s enthusiastic reaction to this speech,
USC Law Dean Edward J. McCaffery awarded Charlie honorary admission
into the Order of the Coif, a scholastic society founded to
encourage excellence in legal education.
No doubt many of you are wondering why this speaker is so old.
Well, the answer is obvious: He hasn’t died yet. And why was this
speaker chosen? Well, I don’t know that. I’d like to think that the
development department had nothing to do with it.

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Whatever the reason, I think it’s ﬁtting that I’m speaking here
because I see a crowd of older people in the rear, not wearing
robes. And I know, from having educated an army of
descendants, who it is that really deserves a lot of the honors that
are being given today to the robe-wearing students in front. The
sacriﬁces and the wisdom and the value transfer that come from
one generation to the next should always be appreciated.
I also take pleasure from the sea of Asian faces to my left. All
my life I have admired Confucius. I like the idea of ﬁlial piety,89 of
ideas or values that are taught and duties that come naturally
that should be passed onto the next generation. You people who
don’t think there’s anything in this idea, please note how fast
Asian people are rising in American life. I think they have
something.
All right, I’ve scratched out a few notes, and I’m going to try
and give an account of certain ideas and attitudes that have
worked well for me. I don’t claim that they’re perfect for
everybody. But I think many of them contain universal values
and that many of them are can’t-fail ideas.
What are the core ideas that helped me? Well, luckily I had the
idea at a very early age that the safest way to try to get what you
want is to try to deserve what you want. It’s such a simple idea.
It’s the golden rule. You want to deliver to the world what you
would buy if you were on the other end. There is no ethos in my
opinion that is better for any lawyer or any other person to have.
By and large, the people who have had this ethos win in life, and
they don’t win just money and honors. They win the respect, the
deserved trust of the people they deal with. And there is huge
pleasure in life to be obtained from getting deserved trust.
Now, occasionally you will ﬁnd a perfect rogue of a person
who dies rich and widely known. But mostly these people are
fully understood as despicable by the surrounding civilization. If

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the cathedral is full of people at the funeral ceremony, most of
them are there to celebrate the fact that the person is dead.
That reminds me of the story of the time when one of these
people died, and the minister said, “It’s now time to say
something nice about the deceased.” And nobody came forward,
and nobody came forward, and nobody came forward. And
ﬁnally, one man came up and said, “Well, his brother was worse.”
That is not where you want to go. A life ending in such a funeral
is not the life you want to have.
The second idea that I developed very early is that there’s no
love that’s so right as admiration-based love, and such love
should include the instructive dead. Somehow I picked up that
idea, and I’ve lived with it all my life. It’s been very useful to me.
A love like that described by [William] Somerset Maugham in his
book Of Human Bondage90 is a sick kind of love. It’s a disease, and
if you ﬁnd yourself with a disease like that, you should eliminate
it.
Another idea—and this may remind you of Confucius, too—is
that the acquisition of wisdom is a moral duty. It’s not something
you do just to advance in life. And there’s a corollary to that idea
that is very important. It requires that you’re hooked on lifetime
learning. Without lifetime learning, you people are not going to
do very well. You are not going to get very far in life based on
what you already know. You’re going to advance in life by what
you learn after you leave here.
Consider Berkshire Hathaway, one of the best-regarded
corporations in the world. It may have the best long-term, big-
assets-involving investment record in the history of civilization.
The skill that got Berkshire through one decade would not have
sufﬁced to get it through the next decade with comparable levels
of achievement. Warren Buffett had to be a continuous learning
machine.

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The same requirement exists in lower walks of life. I
constantly see people rise in life who are not the smartest,
sometimes not even the most diligent. But they are learning
machines. They go to bed every night a little wiser than they
were that morning. And boy, does that habit help, particularly
when you have a long run ahead of you.
Alfred North Whitehead correctly said at one time that the
rapid advance of civilization came only when man “invented the
method of invention.” He was referring to the huge growth in
GDP per capita and many other good things we now take for
granted. Big-time progress started a few hundred years ago.
Before that, progress per century was almost nil. Just as
civilization can progress only when it invents the method of
invention, you can progress only when you learn the method of
learning.
I was very lucky. I came to law school having learned the
method of learning, and nothing has served me better in my long
life than continuous learning. Consider Warren Buffett again. If
you watched him with a time clock, you’d ﬁnd that about half of
his waking time is spent reading. Then a big chunk of the rest of
his time is spent talking one-on-one, either on the telephone or
personally, with highly gifted people whom he trusts and who
trust him. Viewed up close, Warren looks quite academic as he
achieves worldly success.
Academia has many wonderful values in it. I came across an
example not too long ago. In my capacity as a hospital board
chairman, I was dealing with a medical school academic named
Joseph M. Mirra, MD.91 This man, over years of disciplined work,
made himself know more about bone tumor pathology than
almost anyone else in the world. He wanted to pass this
knowledge on to help treat bone cancer. How was he going to do
it? Well, he decided to write a textbook, and even though I don’t
think a textbook like this sells more than a few thousand copies,

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they do end up in cancer treatment centers all over the world. He
took a sabbatical year and sat down at his computer with all his
slides, carefully saved and organized. He worked 17 hours a day,
seven days a week, for a year. Some sabbatical. At the end of the
year, he had created one of the two great bone tumor pathology
textbooks of the world. When you’re around values like Mirra’s,
you want to pick up as much as you can.
Another idea that was hugely useful to me was one I obtained
when I listened in law school when some waggish professor said,
“A legal mind is a mind that considers it feasible and useful,
when two things are all twisted up together and interacting, to
try to think about one thing without considering the other.”
Well, I could see from that indirectly pejorative sentence that
any such legal approach was ridiculous. And this pushed me
further along in my natural drift, which was toward learning all
the big ideas in all the big disciplines, so I wouldn’t be the perfect
damn fool the professor described. And because the really big
ideas carry about 95 percent of the freight, it wasn’t at all hard
for me to pick up about 95 percent of what I needed from all the
disciplines and to include use of this knowledge as a standard
part of my mental routines.
Once you have the ideas, of course, you must continuously
practice their use. Like a concert pianist, if you don’t practice you
can’t perform well. So I went through life constantly practicing a
multi disciplinary approach.
Well, this habit has done a lot for me. It’s made life more fun.
It’s made me more constructive. It’s made me more helpful to
others. It’s made me richer than can be explained by any genetic
gifts. My mental routine, properly practiced, really helps.
Now, there are dangers in it because it works so well. If you
use it, you will frequently ﬁnd when you’re with some expert
from another discipline—maybe even an expert who is your
employer, with a vast ability to harm you—that you know more

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than he does about ﬁtting his specialty to the problem at hand.
You’ll sometimes see the correct answer when he’s missed it.
That is a very dangerous position to be in. You can cause
enormous offense by being right in a way that causes somebody
else to lose face in his own discipline or hierarchy. I never found
the perfect way to avoid harm from this serious problem. Even
though I was a good poker player when I was young, I wasn’t
good enough at pretending when I thought I knew more than my
supervisors did. And I didn’t try as hard at pretending as would
have been prudent. So I gave a lot of offense. Now, I’m generally
tolerated as a harmless eccentric who will soon be gone. But
coming up, I had a difﬁcult period to go through.
My advice to you is to be better than I was at keeping insights
hidden. One of my colleagues, who graduated as number one in
his class in law school and clerked at the US Supreme Court,
tended as a young lawyer to show that he knew a lot. One day, the
senior partner he was working under called him in and said,
“Listen, Chuck, I want to explain something to you. Your duty is
to behave in such a way that the client thinks he’s the smartest
person in the room. If you have any energy or insight available
after that, use it to make your senior partner look like the
second-smartest person in the room. And only after you’ve
satisﬁed those two obligations do you want your light to shine at
all.”
Well, that was a good system for rising in many a large law
ﬁrm. But it wasn’t what I did. I usually moved with the drift of my
nature, and if some other people didn’t like it, well, I didn’t need
to be adored by everybody.
Let me further develop the idea that a multidisciplinary
attitude is required if maturity is to be effective. Here I’m
following a key idea of the greatest lawyer of antiquity, Marcus
Tullius Cicero. Cicero is famous for saying that a man who
doesn’t know what happened before he’s born goes through life

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like a child. That is a very correct idea. Cicero is right to ridicule
somebody so foolish as not to know history. But if you generalize
Cicero, as I think one should, there are a lot of other things that
one should know in addition to history. And those other things
are the big ideas in all the disciplines.
And it doesn’t help you much just to know something well
enough so that on one occasion you can prattle your way to an A
in an exam. You have to learn many things in such a way that
they’re in a mental latticework in your head and you
automatically use them the rest of your life. If many of you try
that, I solemnly promise that one day most will correctly come to
think, “Somehow I’ve become one of the most effective people in
my whole age cohort.” In contrast, if no effort is made toward
such multidisciplinarity, many of the brightest of you who
choose this course will live in the middle ranks, or in the
shallows.
Another idea that I discovered was encapsulated by that story
Dean McCaffery recounted earlier about the rustic who wanted
to know where he was going to die so he wouldn’t go there. The
rustic who had that ridiculous-sounding idea had a profound
truth in his possession. The way complex adaptive systems work,
and the way mental constructs work, problems frequently
become easier to solve through inversion. If you turn problems
around into reverse, you often think better. For instance, if you
want to help India, the question you should consider asking is
not “How can I help India?” Instead, you should ask, “How can I
hurt India?” You ﬁnd what will do the worst damage and then try
to avoid it.
Perhaps the two approaches seem logically the same thing.
But those who have mastered algebra92 know that inversion will
often and easily solve problems that otherwise resist solution.
And in life, just as in algebra, inversion will help you solve
problems that you can’t otherwise handle.

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Let me use a little inversion now. What will really fail in life?
What do we want to avoid? Some answers are easy. For example,
sloth and unreliability will fail. If you’re unreliable, it doesn’t
matter what your virtues are, you’re going to crater immediately.
So faithfully doing what you’ve engaged to do should be an
automatic part of your conduct. Of course you want to avoid sloth
and unreliability.
Another thing to avoid is extremely intense ideology, because
it cabbages up one’s mind. You see a lot of it in the worst of the
TV preachers. They have different, intense, inconsistent ideas
about technical theology, and a lot of them have minds reduced
to cabbage. That can happen with political ideology. And if you’re
young, it’s particularly easy to drift into intense and foolish
political ideology and never get out.
When you announce that you’re a loyal member of some cult-
like group and you start shouting out the orthodox ideology, what
you’re doing is pounding it in, pounding it in, pounding it in.
You’re ruining your mind, sometimes with startling speed. So
you want to be very careful with intense ideology. It presents a
big danger for the only mind you’re ever going to have.
Darwin formulated his theories on the transmutation of
species in the late 1830s, but it was not until 1859 that he
published his seminal work, On the Origin of Species by Means of
Natural Selection. Darwin accepted that any scientiﬁc theory
proffering an alternative explanation to human origins would be
met with widespread prejudice, and that therefore prudence
dictated he become fully versed in every possible
counterargument before publishing his ideas. Accordingly, he
spent 20 years painstakingly cultivating his theory and
preparing for its defense.
There is a warning example I use whenever I feel threatened
by a drift toward intense political ideology. Some Scandinavian
canoeists succeeded in getting through all the rapids of

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Scandinavia, and they thought they would continue their success
by tackling the big whirlpools in northwest America. The death
rate was 100 percent. A big whirlpool is something you want to
avoid. And I think the same is true about intense ideology,
particularly when your companions are all true believers.
I have what I call an iron prescription that helps me keep sane
when I drift toward preferring one intense ideology over another.
I feel that I’m not entitled to have an opinion unless I can state
the arguments against my position better than the people who
are in opposition. I think that I am qualiﬁed to speak only when
I’ve reached that state.
This sounds almost as extreme as the iron prescription Dean
Acheson was fond of attributing to William the Silent of Orange,
who roughly said, “It’s not necessary to hope in order to
persevere.” That probably is too tough for most people, although
I hope it won’t ever become too tough for me. My way of avoiding
over intensity in ideology is easier than Acheson’s injunction and
worth learning. This business of not drifting into extreme
ideology is very, very important in life. If you want to end up
wise, heavy ideology is very likely to prevent that outcome.
Another thing that often causes folly and ruin is the self-
serving bias, often subconscious, to which we’re all subject. You
think that “the true little me” is entitled to do what it wants to do.
For instance, why shouldn’t the true little me get what it wants by
overspending its income?
Well, there once was a man who became the most famous
composer in the world, but he was utterly miserable most of the
time. One of the reasons was that he always overspent his
income. That was Mozart.93 If Mozart couldn’t get by with this
kind of asinine conduct, I don’t think you should try it.
Generally speaking, envy, resentment, revenge, and self-pity
are disastrous modes of thought. Self-pity can get pretty close to
paranoia. Paranoia is one of the very hardest things to reverse.

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You do not want to drift into self-pity. I had a friend who carried a
thick stack of linen-based cards. When somebody would make a
comment that reﬂected self-pity, he would slowly and
portentously pull out his huge stack of cards, take the top one,
and hand it to the person. The card said, “Your story has touched
my heart. Never have I heard of anyone with as many
misfortunes as you.”
Well, you can say that’s waggery, but I suggest it can be mental
hygiene. Every time you ﬁnd you’re drifting into self-pity,
whatever the cause, even if your child is dying of cancer, self-pity
is not going to help. Just give yourself one of my friend’s cards.
Self-pity is always counterproductive. It’s the wrong way to think.
And when you avoid it you get a great advantage over everybody
else, or almost everybody else, because self-pity is a standard
response. And you can train yourself out of it.
Of course, you also want to get self-serving bias out of your
mental routines. Thinking that what’s good for you is good for
the wider civilization and rationalizing foolish or evil conduct
based on your subconscious tendency to serve yourself is a
terrible way to think. You want to drive that out of yourself
because you want to be wise, not foolish, and good, not evil.
You also have to allow, in your own cognition and conduct, for
the self-serving bias of everybody else, because most people are
not going to be very successful at removing such bias, the human
condition being what it is. If you don’t allow for self-serving bias
in the conduct of others, you are, again, a fool.
I watched the brilliant and worthy Harvard Law Review–
trained general counsel of Salomon Brothers lose his career
there. When the able CEO was told that an underling had done
something wrong, the general counsel said, “Gee, we don’t have
any legal duty to report this, but I think it’s what we should do.
It’s our moral duty.”

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The general counsel was technically and morally correct, but
his approach didn’t persuade. He recommended a very
unpleasant thing for the busy CEO to do and the CEO, quite
understandably, put the issue off, and put it off, not with any
intent to do wrong. In due course, when powerful regulators
resented not having been promptly informed, down went the
CEO and the general counsel with him.
The correct persuasive technique in situations like that was
given by Ben Franklin. He said, “If you would persuade, appeal to
interest, not to reason.” The self-serving bias of man is extreme,
and should have been used in attaining the correct outcome. So
the general counsel should have said, “Look, this is likely to
erupt into something that will destroy you, take away your
money, take away your status, grossly impair your reputation. My
recommendation will prevent a likely disaster from which you
can’t recover.” That approach would have worked. You should
often appeal to interest, not to reason, even when your motives
are lofty.
Another thing to avoid is being subjected to perverse
incentives. You don’t want to be in a perverse incentive system
that’s rewarding you if you behave more and more foolishly, or
worse and worse. Perverse incentives are so powerful as
controllers of human cognition and human behavior that one
should avoid their inﬂuence. One of the things you’re going to
ﬁnd in at least a few modern law ﬁrms is high billable-hour
quotas. I could not have lived under billable-hour quotas of 2,400
hours a year. That would have caused too many problems for me.
I wouldn’t have done it. I don’t have a solution for the situation
some of you will face. You’ll have to ﬁgure out for yourselves how
to handle such signiﬁcant problems.
Perverse associations are also to be avoided. You particularly
want to avoid working directly under somebody you don’t admire
and don’t want to be like. It’s dangerous. We’re all subject to

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control to some extent by authority ﬁgures, particularly authority
ﬁgures who are rewarding us. Dealing properly with this danger
requires both some talent and will.
I coped in my time by identifying people I admired and by
maneuvering, mostly without criticizing anybody, so that I was
usually working under the right sort of people. A lot of law ﬁrms
will permit that if you’re shrewd enough to work it out with some
tact. Generally, your outcome in life will be more satisfactory if
you work under people you correctly admire.
Engaging in routines that allow you to maintain objectivity
are, of course, very helpful to cognition. We all remember that
Darwin paid special attention to disconﬁrming evidence,
particularly when it disconﬁrmed something he believed and
loved. Routines like that are required if a life is to maximize
correct thinking.
One also needs checklist routines. They prevent a lot of
errors, and not just for pilots. You should not only possess wide-
ranging elementary wisdom but also go through mental checklist
routines in using it. There is no other procedure that will work as
well.
Another idea that I found important is that maximizing non-
egality will often work wonders. What do I mean? Well, John
Wooden of UCLA presented an instructive example when he was
the number one basketball coach in the world. He said to the
bottom ﬁve players, “You don’t get to play; you are practice
partners.” The top seven did almost all the playing. Well, the top
seven learned more—remember the importance of the learning
machine—because they were doing all the playing. And when he
adopted that non-egalitarian system, Wooden won more games
than he had won before.
I think the game of competitive life often requires maximizing
the experience of the people who have the most aptitude and the
most determination as learning machines. If you want the very

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highest reaches of human achievement, that’s where you have to
go. You do not want to choose a brain surgeon for your child by
drawing straws to select one of 50 applicants, all of whom take
turns doing procedures. You don’t want your airplanes designed
in too egalitarian a fashion. You don’t want your Berkshire
Hathaways run that way either. You want to provide a lot of
playing time for your best players.
I frequently tell the apocryphal story about how Max Planck,
after he won the Nobel Prize, went around Germany giving the
same standard lecture on the new quantum mechanics. Over
time, his chauffeur memorized the lecture and said, “Would you
mind, Professor Planck, because it’s so boring to stay in our
routine, if I gave the lecture in Munich and you just sat in front
wearing my chauffeur’s hat?” Planck said, “Why not?” And the
chauffeur got up and gave this long lecture on quantum
mechanics, after which a physics professor stood up and asked a
perfectly ghastly question. The speaker said, “Well, I’m surprised
that in an advanced city like Munich I get such an elementary
question. I’m going to ask my chauffeur to reply.”
Well, the reason I tell that story is not to celebrate the quick-
wittedness of the protagonist. In this world, I think we have two
kinds of knowledge. One is Planck knowledge, that of the people
who really know. They’ve paid the dues, they have the aptitude.
Then we’ve got chauffeur knowledge. They have learned to
prattle the talk. They may have a big head of hair. They often
have a ﬁne timbre in their voices. They make a big impression.
But in the end, what they’ve got is chauffeur knowledge
masquerading as real knowledge. I think I’ve just described
practically every politician in the United States. You’re going to
have the problem in your life of getting as much responsi bility as
you can to the people with the Planck knowledge and away from
the people who have the chauffeur knowledge. And there are
huge forces working against you.

## Page 295

My generation has failed you to some extent. More and more,
we’re delivering to you in California a legislature in which mostly
the certiﬁed nuts from the left and the certiﬁed nuts from the
right are the ones allowed to serve. And none of them are
removable. That’s what my generation has done for you. But you
wouldn’t like it to be too easy, would you?
Another thing that I have found is that intense interest in any
subject is indispensable if you’re really going to excel in it. I
could force myself to be fairly good in a lot of things, but I
couldn’t excel in anything in which I didn’t have an intense
interest. So, to some extent, you’re going to have to do as I did. If
at all feasible, you want to maneuver yourself into doing
something in which you have an intense interest.
Another thing you have to do is have a lot of assiduity. I like
that word because to me it means “Sit down on your ass until you
do it.” I’ve had marvelous partners, full of assiduity, all my life. I
think I got them partly because I tried to deserve them and partly
because I was shrewd enough to select them, and partly there
was some luck.
Two partners that I chose for one phase in my life made the
following simple agreement when they created a little design-
and-build construction team in the middle of the Great
Depression: “Two-man partnership,” they said, “and divide
everything equally. And whenever we’re behind in our
commitments to other people, we will both work 14 hours a day,
seven days a week, until we’re caught up.” Well, needless to say
that ﬁrm didn’t fail, and my partners were widely admired.
Simple, old-fashioned ideas like theirs are almost sure to provide
a good outcome.
Another thing to cope with is that life is very likely to provide
terrible blows, unfair blows. Some people recover and others
don’t. There I think the attitude of Epictetus helps guide one to
the right reaction. He thought that every mischance in life,

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however bad, created an opportunity to behave well. He believed
every mischance provided an opportunity to learn something
useful, and one’s duty was not to become immersed in self-pity
but to utilize each terrible blow in a constructive fashion. His
ideas were very sound, inﬂuencing the best of the Roman
emperors, Marcus Aurelius and many others over many
centuries. And you may remember the epitaph that Epictetus
made for himself: “Here lies Epictetus, a slave, maimed in body,
the ultimate in poverty, and favored by the gods.”
Well, that’s the way Epictetus is now remembered: favored by
the gods. He was favored because he became wise, became
manly, and instructed others, both in his own time and over
following centuries.
I’ve another idea to emphasize in a brief account. My
grandfather Munger94 was the only federal judge in his city for
nearly 40 years. I admired him. I’m his namesake. And I’m
Confucian enough that even now, as I speak, I’m thinking, “Well,
Judge Munger would be pleased to have me here.” All these years
after my grandfather is dead, I conceive myself as duty-bound to
carry the torch for my grandfather’s values. One such value was
prudence as the servant of duty. Grandfather Munger was a
federal judge at a time when there were no pensions for widows
of federal judges. So if he didn’t save from his income, my
grandmother would become a destitute widow. And besides, net
worth would enable him to serve others better. Being the kind of
man he was, he underspent his income all his life and left his
widow in comfortable circumstances.
But that was not all that his prudence enabled. Along the way,
in the ’30s, my uncle’s tiny bank failed and couldn’t reopen
without help. My grandfather saved the bank by exchanging over
a third of his good assets for horrible bank assets. I’ve always
remembered the event. It reminds me of [A. E.] Housman’s little
poem that went something like this:

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The thoughts of others
Were light and ﬂeeting,
Of lovers’ meeting
Or luck or fame.
Mine were of trouble,
And mine were steady,
And I was ready
When trouble came.
You may well say, “Who wants to go through life anticipating
trouble?” Well, I did, trained as I was. I’ve gone through a long
life anticipating trouble. And here I am now, well along in my
84th year. Like Epictetus, I’ve had a favored life. It didn’t make
me unhappy to anticipate trouble all the time and be ready to
perform adequately if trouble came. It didn’t hurt me at all. In
fact, it helped me. So I quitclaim to you Housman and Judge
Munger.
The last idea that I want to give to you, as you go out into a
profession that frequently puts a lot of procedure and some
mumbo-jumbo into what it does, is that complex bureaucratic
procedure does not represent the highest form civilization can
reach. One higher form is a seamless, non-bureaucratic web of
deserved trust. Not much fancy procedure, just totally reliable
people correctly trusting one another. That’s the way an
operating room works at the Mayo Clinic. If lawyers would
introduce a lot of lawyer-like process, more patients would die.
So never forget, when you’re a lawyer, that while you may have to
sell procedure, you don’t always have to buy. In your own life,
what you want to maximize is a seamless web of deserved trust.
And if your proposed marriage contract has 47 pages, my
suggestion is that you not enter.
Well, that’s enough for one graduation. I hope these
ruminations of an old man are useful to you. In the end, I’m

## Page 298

speaking toward the only outcome feasible for old Valiant-for-
Truth in Pilgrim’s Progress:95 “My sword I leave to him who can
wield it.”

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CHAPTER 4; TALK ELEVEN
stripe.press/pca-15
The Psychology of HumanMisjudgment
2005SELECTIONS FROM THREE OF CHARLIE’S TALKS, COMBINED INTO ONE TALKNEVER MADE, AFTER REVISIONS BY CHARLIE IN 2005 THAT INCLUDEDCONSIDERABLE NEW MATERIAL
In the run-up to publishing this book, Charlie remarked that one of
the most important talks in our list, “The Psychology of Human
Misjudgment,” could use “a little revising” to bring it in line
with his most current views on the subject. Little did we know,
Charlie’s little revision would amount to a full-scale rewrite,
with loads of new material and a stop-the-press completion
schedule. The talk features Charlie’s original concept of
behavioral finance, which has now burgeoned into its own academic
field of study. As attendee Donald Hall recalls, “Charlie was
espousing his well-reasoned views on behavioral finance before the
term was even coined.”
Charlie also addresses the importance of recognizing patterns to
determine how humans behave, both rationally and irrationally. He
shares with us his checklist of 25 standard causes of human
misjudgment, which contains observations that are ingenious,
counter intuitive, and important—values Charlie treasures in the
work of other great thinkers throughout history. He also emphasizes
the “lolla palooza” power of psychological misjudgments in
combination.
Here, then, written exclusively for Poor Charlie’s Almanack, is
Charlie’s magnum opus on why we behave the way we do. We wish you

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success in the application of these ideas in your own personal and
business endeavors.
Selections from three of Charlie’s talks, combined into one talk
never made, after revisions by Charlie in 2005 that included
considerable new material.
The three talks were:
1. The Bray lecture at the Caltech Faculty Club, February 2,
1992
2. Talk under the sponsorship of the Cambridge Center for
Behavioral Studies at the Harvard Faculty Club, October 6,
1994
3. Talk under the sponsorship of the Cambridge Center for
Behavioral Studies at the Boston Harbor Hotel, April 24, 1995
The extensive revision by Charlie in 2005, made from memory and
unassisted by any research, occurred because Charlie thought he
could do better at age 81 than he did more than 10 years earlier
when he 1) knew less and was more harried by a crowded life and 2)
was speaking from rough notes instead of revising transcripts.
PREFACE
When I read transcripts of my psychology talks given about 15
years ago, I realized that I could now create a more logical but
much longer talk, including most of what I had earlier said. But I
immediately saw four big disadvantages.
First, the longer talk, because it was written out with more
logical completeness, would be more boring and confusing to

## Page 301

many people than any earlier talk. This would happen because I
would use idiosyncratic deﬁnitions of psychological tendencies
in a manner reminiscent of both psychology textbooks and
Euclid. And who reads textbooks for fun or revisits Euclid?
Second, because my formal psychological knowledge came
only from skimming three psychology textbooks about 15 years
ago, I know virtually nothing about any academic psychology
later developed. Yet in a longer talk containing guesses, I would
be criticizing much academic psychology. This sort of intrusion
into a professional territory by an amateur would be sure to be
resented by professors, who would rejoice in ﬁnding my errors
and might be prompted to respond to my published criticism by
providing theirs. Why should I care about new criticism? Well,
who likes new hostility from articulate critics with an
information advantage?
Third, a longer version of my ideas would surely draw some
disapproval from people formerly disposed to liking me. Not
only would there be stylistic and substantive objections but also
there would be perceptions of arrogance in an old man who
displayed much disregard for conventional wisdom while
“popping off” on a subject in which he had never taken a course.
My old Harvard Law classmate, Ed Rothschild, always called
such a popping off the shoe-button complex, named for the
condition of a family friend who spoke in oracular style on all
subjects after becoming dominant in the shoe-button business.
Fourth, I might make a fool of myself.
Despite these four very considerable objections, I decided to
publish the much-expanded version. Thus, after many decades
in which I have succeeded mostly by restricting my action to jobs
and methods in which I was unlikely to fail, I have now chosen a
course of action in which 1) I have no signiﬁcant personal beneﬁt
to gain, 2) I will surely give some pain to family members and
friends, and 3) I may make myself ridiculous.

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Why am I doing this?
One reason may be that my nature makes me incline toward
diagnosing and talking about errors in conventional wisdom.
And despite years of being smoothed out by the hard knocks that
were inevitable for one with my attitude, I don’t believe life ever
knocked all the boy’s brashness out of the man.
A second reason for my decision is my approval of the attitude
of Diogenes when he asked, “Of what use is a philosopher who
never offends anybody?”
My third and ﬁnal reason is the strongest. I have fallen in love
with my way of laying out psychology because it has been so
useful for me. And so, before I die, I want to imitate to some
extent the bequest practices of three characters: the protagonist
in John Bunyan’s Pilgrim’s Progress, Benjamin Franklin, and my
ﬁrst employer, Ernest Buffett.
Bunyan’s character, the knight wonderfully named Old
Valiant-for-Truth, makes the only practical bequest available to
him when he says at the end of his life, “My sword I leave to him
who can wear it.” And like this man, I don’t mind if I have
misappraised my sword, provided I have tried to see it correctly,
or if many will not wish to try it, or if some who try to wield it
may ﬁnd it serves them not. Ben Franklin, to my great beneﬁt,
left behind his autobiography, his Almanacks, and much else. And
Ernest Buffett did the best he could in the same mode when he
left behind How to Run a Grocery Store and a Few Things I Have
Learned about Fishing. Whether or not this last contribution to the
genre was the best, I will not say. But I will report that I have now
known four generations of Ernest Buffett’s descendants and that
the results have encouraged my imitation of the founder.

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THE PSYCHOLOGY OF HUMAN MISJUDGMENT
I have long been very interested in standard thinking errors.
However, I was educated in an era wherein the contributions of
non-patient-treating psychology to an understanding of
misjudgment met little approval from members of the
mainstream elite. Instead, interest in psychology was pretty well
conﬁned to a group of professors who talked and published
mostly for themselves, with much natural detriment from
isolation and groupthink.
And so, right after my time at Caltech and Harvard Law
School, I possessed a vast ignorance of psychology. Those
institutions failed to require knowledge of the subject. And, of
course, they couldn’t integrate psychology with their other
subject matter when they didn’t know psychology. Also, like the
Nietzsche character who was proud of his lame leg, the
institutions were proud of their willful avoidance of “fuzzy”
psychology and “fuzzy” psychology professors.
I shared this ignorant mindset for a considerable time, and so
did a lot of other people. What are we to think, for instance, of the
Caltech course catalog that for years listed just one psychology
professor, self-described as a “professor of psychoanalytical
studies,” who taught both abnormal psychology and
psychoanalysis in literature?
Soon after leaving Harvard, I began a long struggle to get rid
of the most dysfunctional part of my psychological ignorance.
Today, I will describe my long struggle for elementary wisdom
and a brief summary of my ending notions. After that, I will give
examples, many quite vivid and interesting to me, of both
psychology at work and antidotes to psychology-based
dysfunction. Then I will end by asking and answering some

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general questions raised by what I have said. This will be a long
talk.
When I started law practice, I had respect for the power of
genetic evolution and an appreciation of man’s many evolution-
based resemblances to less cognitively gifted animals and
insects. I was aware that man was a social animal, greatly and
automatically inﬂuenced by behavior he observed in men
around him. I also knew that man lived, like barnyard animals
and monkeys, in limited-size dominance hierarchies, wherein he
tended to respect authority and to like and cooperate with his
own hierarchy members while displaying considerable distrust
and dislike for competing men not in his own hierarchy.
But this generalized, evolution-based theory structure was
inadequate to enable me to cope properly with the cognition I
encountered. I was soon surrounded by much extreme
irrationality, displayed in patterns and subpatterns. So
surrounded, I could see that I was not going to cope as well as I
wished with life unless I could acquire a better theory-structure
on which to hang my observations and experiences.
By then, my craving for more theory had a long history. Partly,
I had always loved theory as an aid in puzzle-solving and as a
means of satisfying my monkey-like curiosity. And partly, I had
found that theory-structure was a superpower in helping one get
what one wanted, as I had early discovered in school, wherein I
had excelled without labor, guided by theory, while many others,
without mastery of theory, failed despite monstrous effort. Better
theory, I thought, had always worked for me, and, if now
available, could make me acquire capital and independence
faster and better assist everything I loved. So I slowly developed
my own system of psychology, more or less in the self-help style
of Ben Franklin and with the determination displayed in the
refrain of the nursery story: “‘Then I’ll do it myself,’ said the
Little Red Hen.”

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I was greatly helped in my quest by two turns of mind. First, I
had long looked for insight by inversion in the intense manner
counseled by the great algebraist Jacobi: “Invert, always invert.” I
sought good judgment mostly by collecting instances of bad
judgment, then pondering ways to avoid such outcomes.
Second, I became so avid a collector of instances of bad
judgment that I paid no attention to boundaries between
professional territories. After all, why should I search for some
tiny, unimportant, hard-to-ﬁnd new stupidity in my own ﬁeld
when some large, important, easy-to-ﬁnd stupidity was just over
the fence in the other fellow’s professional territory? Besides, I
could already see that real-world problems didn’t neatly lie
within territorial boundaries. They jumped right across. And I
was dubious of any approach that, when two things were
inextricably intertwined and interconnected, would try and
think about one thing but not the other. I was afraid, if I tried any
such restricted approach, that I would end up, in the immortal
words of John L. Lewis, “with no brain at all, just a neck that had
haired over.”
Pure curiosity, somewhat later, made me wonder how and
why destructive cults were often able, over a single long
weekend, to turn many tolerably normal people into
brainwashed zombies and thereafter keep them in that state
indeﬁnitely. I resolved that I would eventually ﬁnd a good answer
to this cult question if I could do so by general reading and much
musing.
I also got curious about social insects. It fascinated me that
both the fertile female honeybee and the fertile female harvester
ant could multiply their quite different normal life expectancies
by exactly 20 by engaging in one orgy in the sky. The extreme
success of the ants also fascinated me—how a few behavioral
algorithms caused such extreme evolutionary success grounded
in extremes of cooperation within the breeding colony and,

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almost always, extremes of lethal hostility toward ants outside
the breeding colony, even ants of the same species.
Motivated as I was, by midlife I should probably have turned
to psychology textbooks. But I didn’t, displaying my share of the
outcome predicted by the German folk saying “We are too soon
old and too late smart.” However, as I later found out, I may have
been lucky to avoid for so long the academic psychology that was
then laid out in most textbooks. These would not have guided me
well with respect to cults and were often written as if the authors
were collecting psychology experiments as a boy collects
butterﬂies—with a passion for more butterﬂies and more contact
with fellow collectors and little craving for synthesis in what is
already possessed.
When I ﬁnally got to the psychology texts, I was reminded of
the observation of Jacob Viner, the great economist, that many
an academic is like the trufﬂe hound, an animal so trained and
bred for one narrow purpose that it is no good at anything else. I
was also appalled by the hundreds of pages of extremely
nonscientiﬁc musing about comparative weights of nature and
nurture in human outcomes. And I found that introductory
psychology texts, by and large, didn’t deal appropriately with a
fundamental issue: Psychological tendencies tend to be both
numerous and inseparably intertwined, now and forever, as they
interplay in life. Yet the complex parsing out of effects from
intertwined tendencies was usually avoided by the writers of the
elementary texts.
Possibly the authors did not wish, through complexity, to
repel entry of new devotees to their discipline. And possibly, the
cause of their inadequacy was the one given by Samuel Johnson
in response to a woman who inquired as to what accounted for
his dictionary’s mis-deﬁnition of the word “pastern.” “Pure
ignorance,” Johnson replied. Finally, the text writers showed
little interest in describing standard antidotes to standard

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psychology-driven folly, and they thus avoided most discussion
of exactly what most interested me.
But academic psychology has some very important merits
alongside its defects. I learned this eventually in the course of
general reading from a book, Inﬂuence, aimed at a popular
audience by a distinguished psychology professor, Robert
Cialdini at Arizona State, a very big university. Cialdini had made
himself into a super-tenured regents professor at a very young
age by devising, describing, and explaining a vast group of clever
experiments in which man manipulated man to his detriment,
with all of this made possible by man’s intrinsic thinking ﬂaws.
I immediately sent copies of Cialdini’s book to all my children.
I also gave Cialdini a share of Berkshire stock (Class A) to thank
him for what he had done for me and the public. Incidentally, the
sale by Cialdini of hundreds of thousands of copies of a book
about social psychology was a huge feat, considering that
Cialdini didn’t claim that he was going to improve your sex life or
make you any money.
Part of Cialdini’s large book-buying audience came because,
like me, it wanted to learn how to become less often tricked by
salesmen and circumstances. However, as an outcome not
sought by Cialdini, who is a profoundly ethical man, a huge
number of his books were bought by salesmen who wanted to
learn how to become more effective in misleading customers.
Please remember this perverse outcome when my discussion
comes to incentive-caused bias as a consequence of the
superpower of incentives.
With the push given by Cialdini’s book, I soon skimmed
through three much-used textbooks covering introductory
psychology. I also pondered considerably while craving synthesis
and taking into account all my previous training and experience.
The result was Munger’s partial summary of the non-patient-
treating, non-nature versus nurture weighing parts of non-

## Page 308

developmental psychology. This material was stolen from its
various discoverers (most of whose names I did not even try to
learn), often with new descriptions and titles selected to ﬁt
Munger’s notion of what makes recall easy for Munger, then
revised to make Munger’s use easy as he seeks to avoid errors.
I will start my summary with a general observation that helps
explain what follows. This observation is grounded in what we
know about social insects. The limitations inherent in evolution’s
development of the nervous system cells that control behavior
are beautifully demonstrated by these insects, which often have
a mere 100,000 or so cells in their entire nervous systems,
compared to man’s multiple billions of cells in his brain alone.
Each ant, like each human, is composed of a living physical
structure, plus behavioral algorithms in its nerve cells. In the
ant’s case, the behavioral algorithms are few in number and
almost entirely genetic in origin. The ant learns a little behavior
from experiences, but mostly it merely responds to 10 or so
stimuli with a few simple responses programmed into its
nervous system by its genes.
Naturally, the simple ant behavior system has extreme
limitations because of its limited nerve-system repertoire. For
instance, one type of ant, when it smells a pheromone given off
by a dead ant’s body in the hive, immediately responds by
cooperating with other ants in carrying the dead body out of the
hive. Harvard’s great E.O. Wilson performed one of the best
psychology experiments ever done when he painted dead ant
pheromone on a live ant. Quite naturally, the other ants dragged
this useful live ant out of the hive even though it kicked and
otherwise protested throughout the entire process. Such is the
brain of the ant. It has a simple program of responses that
generally work out all right but which are imprudently used by
rote in many cases.

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Another type of ant demonstrates that the limited brain of
ants can be misled by circumstances as well as by clever
manipulation from other creatures. The brain of this ant
contains a simple behavioral program that directs the ant, when
walking, to follow the ant ahead. And when these ants stumble
into walking in a big circle, they sometimes walk round and
round until they perish.
It seems obvious, to me at least, that the human brain must
often operate counterproductively, just like the ant’s, from
unavoidable oversimplicity in its mental process, albeit usually
in trying to solve problems more difﬁcult than those faced by
ants that don’t have to design airplanes. The perception system
of man clearly demonstrates just such an unfortunate outcome.
Man is easily fooled, either by the cleverly thought-out
manipulation of man, by circumstances occurring by accident,
or by very effective manipulation practices that man has
stumbled into during “practice evolution” and kept in place
because they work so well.
One such outcome is caused by a quantum effect in human
perception. If stimulus is kept below a certain level, it does not
get through. And for this reason, a magician was able to make
the Statue of Liberty “disappear” after a certain amount of
magician lingo expressed in the dark. The audience was not
aware that it was sitting on a platform that was rotating so slowly,
below man’s sensory threshold, that no one could feel the
acceleration implicit in the considerable rotation. When a
surrounding curtain was then opened in the place on the
platform where the statue had earlier appeared, it seemed to
have disappeared.
Even when perception does get through to man’s brain, it is
often misweighted, because what is registered in perception is in
the shockingness of apparent contrast, not the standard

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scientiﬁc units that make possible science and good
engineering.
A magician demonstrates this sort of contrast-based error in
your nervous system when he removes your wristwatch without
your feeling it. As he does this, he applies pressure of touch on
your wrist that you would sense if it was the only pressure of
touch you were experiencing. But he has concurrently applied
other intense pressure of touch on your body, but not on your
wrist, “swamping” the wrist pressure by creating a high-contrast
touch pressure elsewhere. This high contrast takes the wrist
pressure below perception.
Some psychology professors like to demonstrate the
inadequacy of contrast-based perception by having students put
one hand in a bucket of hot water and one hand in a bucket of
cold water. They are then suddenly asked to remove both hands
and place them in a single bucket of room-temperature water.
Now, with both hands in the same water, one hand feels as if it
has just been put in cold water and the other hand feels as if it
has just been placed in hot water.
When one thus sees perception so easily fooled by mere
contrast, where a simple temperature gauge would make no
error, and realizes that cognition mimics perception in being
misled by mere contrast, he is well on the way toward
understanding not only how magicians fool one but also how life
will fool one. This can occur, through deliberate human
manipulation or otherwise, if one doesn’t take certain
precautions against often wrong effects from generally useful
tendencies in his perception and cognition.
Man’s often wrong but generally useful psychological
tendencies are quite numerous and quite different. The natural
consequence of this profusion of tendencies is the grand general
principle of social psychology: Cognition is ordinarily situation-
dependent, so that different situations often cause different

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conclusions, even when the same person is thinking in the same
general subject area.
With this introductory instruction from ants, magicians, and
the grand general principle of social psychology, I will next
simply number and list psychology-based tendencies that, while
generally useful, often mislead. Discussion of errors from each
tendency will come later, together with a description of some
antidotes to these errors, followed by some general discussion.
Here are the tendencies:
1. Reward- and punishment-superresponse tendency
2. Liking / loving tendency
3. Disliking / hating tendency
4. Doubt-avoidance tendency
5. Inconsistency-avoidance tendency
6. Curiosity tendency
7. Kantian fairness tendency
8. Envy / jealousy tendency
9. Reciprocation tendency
10. Inﬂuence-from-mere-association tendency
11. Simple, pain-avoiding psychological denial
12. Excessive self-regard tendency
13. Overoptimism tendency
14. Deprival-superreaction tendency
15. Social-proof tendency
16. Contrast-misreaction tendency
17. Stress-inﬂuence tendency
18. Availability-misweighing tendency
19. Use-it-or-lose-it tendency
20. Drug-misinﬂuence tendency
21. Senescence-misinﬂuence tendency

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22. Authority-misinﬂuence tendency
23. Twaddle tendency
24. Reason-respecting tendency
25. Lollapalooza tendency—the tendency to get extreme
consequences from conﬂuences of psychological
tendencies acting in favor of a particular outcome
ONE
Reward- and punishment-superresponse tendency
I place this tendency ﬁrst in my discussion because almost
everyone thinks he fully recognizes how important incentives
and disincentives are in changing cognition and behavior. But
this is not often so. For instance, I think I’ve been in the top 5
percent of my age cohort almost all my adult life in
understanding the power of incentives, yet I’ve always
underestimated that power. Never a year passes but I get some
surprise that pushes a little further my appreciation of incentive
superpower.
One of my favorite cases about the power of incentives is the
Federal Express case. The integrity of the Federal Express
system requires that all packages be shifted rapidly among
airplanes in one central airport each night. The system has no
integrity for the customers if the night work shift can’t
accomplish its assignment fast. And Federal Express had one
hell of a time getting the night shift to do the right thing. They
tried moral suasion. They tried everything in the world without
luck. And ﬁnally, somebody got the happy thought that it was
foolish to pay the night shift by the hour when what the employer
wanted was not maximized billable hours of employee service
but fault-free, rapid performance of a particular task. Maybe, this
person thought, if they paid the employees per shift and let all

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night shift employees go home when all the planes were loaded,
the system would work better. And, lo and behold, that solution
worked.
Early in the history of Xerox, Joe Wilson, who was then in the
government, had a similar experience. He had to go back to
Xerox because he couldn’t understand why its new machine was
selling so poorly in relation to its older and inferior machine.
When he got back to Xerox, he found out that the commission
arrangement with the salesmen gave a large and perverse
incentive to push the inferior machine on customers, who
deserved a better result.
Then there is the case of Mark Twain’s cat that, after a bad
experience with a hot stove, never again sat on a hot stove, or a
cold stove either.
We should also heed the general lesson implicit in the
injunction of Ben Franklin in Poor Richard’s Almanack: “If you
would persuade, appeal to interest and not to reason.”
This maxim is a wise guide to a great and simple precaution
in life: Never, ever, think about something else when you should
be thinking about the power of incentives. I once saw a very
smart house counsel for a major investment bank lose his job,
with no moral fault, because he ignored the lesson in this maxim
of Franklin. This counsel failed to persuade his client because he
told him his moral duty, as correctly conceived by the counsel,
without also telling the client in vivid terms that he was very
likely to be clobbered to smithereens if he didn’t behave as his
counsel recommended. As a result, both client and counsel lost
their careers.
We should also remember how a foolish and willful ignorance
of the superpower of rewards caused Soviet communists to get
their ﬁnal result, as described by one employee: “They pretend
to pay us, and we pretend to work.” Perhaps the most important
rule in management is “Get the incentives right.”

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But there is some limit to a desirable emphasis on incentive
superpower. One case of excess emphasis happened at Harvard,
where B. F. Skinner, a psychology professor, ﬁnally made himself
ridiculous. At one time, Skinner may have been the best-known
psychology professor in the world. He partly deserved his peak
reputation because his early experiments using rats and pigeons
were ingenious, and his results were both counterintuitive and
important. With incentives, he could cause more behavior
change, culminating in conditioned reﬂexes in his rats and
pigeons, than he could in any other way. He made obvious the
extreme stupidity, in dealing with children or employees, of
rewarding behavior one didn’t want more of. Using food rewards,
he even caused strong superstitions, predesigned by himself, in
his pigeons. He demonstrated, again and again, a great recurring
generalized behavioral algorithm in nature: “Repeat behavior
that works.”
He also demonstrated that prompt rewards worked much
better than delayed rewards in changing and maintaining
behavior. And once his rats and pigeons had conditioned reﬂexes
caused by food rewards, he found what withdrawal pattern of
rewards kept the reﬂexive behavior longest in place: random
distribution. With this result, Skinner thought he had pretty well
explained man’s misgambling compulsion, whereunder he often
foolishly proceeds to ruin. But as we shall later see when we
discuss other psychological tendencies that contribute to
misgambling compulsion, he was only partly right.
Later, Skinner lost most of his personal reputation by 1)
overclaiming for incentive superpower, to the point of thinking
he could create a human utopia with it, and 2) displaying hardly
any recognition of the power of the rest of psychology. He thus
behaved like one of Jacob Viner’s trufﬂe hounds as he tried to
explain everything with incentive effects.

## Page 315

Nonetheless, Skinner was right in his main idea: Incentives
are superpowers. The outcome of his basic experiments will
always remain in high repute in the annals of experimental
science.
When I was at Harvard Law School, the professors sometimes
talked about an overfocused, Skinner-like professor at Yale Law
School. They used to say, “Poor old Eddie Blanchard, he thinks
declaratory judgments will cure cancer.” Well, that’s the way
Skinner got with his very extreme emphasis on incentive
superpower. I always call the Johnny-one-note turn of mind that
eventually so diminished Skinner’s reputation the man-with-a-
hammer tendency, after the folk saying “To a man with only a
hammer, every problem looks pretty much like a nail.”
Man-with-a-hammer tendency does not exempt smart people
like Blanchard and Skinner. And it won’t exempt you if you don’t
watch out. I will return to man-with-a-hammer tendency at
various times in this talk because, fortunately, there are effective
antidotes that reduce the ravages of what pretty much ruined the
personal reputation of the brilliant Skinner.
One of the most important consequences of incentive
superpower is what I call incentive-caused bias. A man has an
acculturated nature, making him a pretty decent fellow, and yet,
driven both consciously and subconsciously by incentives, he
drifts into immoral behavior in order to get what he wants—a
result he facilitates by rationalizing his bad behavior, like the
salesmen at Xerox who harmed customers in order to maximize
their sales commissions.
Here, my early education involved a surgeon who, over the
years, sent bushel baskets full of normal gallbladders down to
the pathology lab in the leading hospital in Lincoln, Nebraska,
my grandfather’s town. And, with that permissive quality control
for which community hospitals are famous, many years after this
surgeon should’ve been removed from the medical staff, he was.

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One of the doctors who participated in the removal was a
family friend, and I asked him, “Did this surgeon think, ‘Here’s a
way for me to exercise my talents’”—this guy was very skilled
technically—“‘and make a high living by doing a few maimings
and murders every year in the course of routine fraud?’” And my
friend answered, “Hell no, Charlie. He thought that the
gallbladder was the source of all medical evil, and if you really
loved your patients, you couldn’t get that organ out rapidly
enough.”
Now, that’s an extreme case, but in lesser strength, the
cognitive drift of that surgeon is present in every profession and
in every human being. And it causes perfectly terrible behavior.
Consider the presentations of brokers selling commercial real
estate and businesses. I’ve never seen one that I thought was
even within hailing distance of objective truth. In my long life, I
have never seen a management consultant’s report that didn’t
end with the same advice: “This problem needs more
management consulting services.”
Widespread incentive-caused bias requires that one should
often distrust or take with a grain of salt the advice of one’s
professional adviser, even if he is an engineer. The general
antidotes here are: 1) Especially fear professional advice when it
is especially good for the adviser, 2) learn and use the basic
elements of your adviser’s trade as you deal with your adviser,
and 3) double-check, disbelieve, or replace much of what you’re
told, to the degree that seems appropriate after objective
thought.
The power of incentives to cause rationalized terrible
behavior is also demonstrated by Defense Department
procurement history. After the Defense Department had much
truly awful experience with misbehaving contractors motivated
under contracts paying on a cost-plus-percentage of cost basis,
the reaction of our republic was to make it a crime for a

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contracting ofﬁcer in the Defense Department to sign such a
contract—and not only a crime but a felony. And by the way,
although the government was right to create this new felony,
much of the way the rest of the world is run, including the
operation of many law ﬁrms and a lot of other ﬁrms, is still under
what is, in essence, a cost-plus-percentage of cost reward
system.
Human nature, bedeviled by incentive-caused bias, causes a
lot of ghastly abuse under these standard incentive patterns of
the world. And many of the people who are behaving terribly you
would be glad to have married into your family, compared to
what you’re otherwise likely to get.
Now, there are huge implications from the fact that the
human mind is put together this way. One implication is that
people who create things like cash registers, which make
dishonest behavior hard to accomplish, are some of the effective
saints of our civilization because, as Skinner so well knew, bad
behavior is intensely habit-forming when it is rewarded. And so
the cash register was a great moral instrument when it was
created.
And by the way, Patterson, the great evangelist of the cash
register, knew that from his own experience. He had a little store,
and his employees were stealing him blind, so that he never
made any money. Then people sold him a couple of cash
registers, and his store went to proﬁt immediately. He promptly
closed the store and went into the cash register business,
creating what became the mighty National Cash Register
company, one of the glories of its time.
“Repeat behavior that works” is a behavioral guide that really
succeeded for Patterson, after he applied one added twist. So did
high moral cognition. An eccentric, inveterate do-gooder (except
when destroying competitors, all of which he regarded as would-
be patent thieves), Patterson, like [Andrew] Carnegie,96 pretty

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well gave away all his money to charity before he died, always
pointing out that “shrouds have no pockets.” So great was the
contribution of Patterson’s cash register to civilization, and so
effectively did he improve the cash register and spread its use,
that in the end, he probably deserved the epitaph chosen for the
Roman poet Horace: “I did not completely die.”
The strong tendency of employees to rationalize bad conduct
in order to get rewards requires many antidotes in addition to
the good cash control promoted by Patterson. Perhaps the most
important of these antidotes is the use of sound accounting
theory and practice. This was seldom better demonstrated than
at Westinghouse, which had a subsidiary that made loans having
no connection to the rest of Westinghouse’s businesses. The
ofﬁcers of Westinghouse, perhaps inﬂuenced by envy of General
Electric, wanted to expand proﬁts from loans to outsiders. Under
Westinghouse’s accounting practice, provisions for future credit
losses on these loans depended largely on the past credit
experience of its lending subsidiary, which mainly made loans
unlikely to cause massive losses.
Now, there are two special classes of loans that naturally
cause much trouble for lenders. The ﬁrst is 95 percent-of-value
construction loans to any kind of real estate developer, and the
second is any kind of construction loan on a hotel. So, naturally,
if one was willing to loan approximately 95 percent of the real
cost to a developer constructing a hotel, the loan would bear a
much higher than normal interest rate because the credit loss
danger would be much higher than normal. So, sound
accounting for Westinghouse in making a big, new mass of 95
percent-of-value construction loans to hotel developers would
have been to report almost no proﬁt, or even a loss, on each loan
until, years later, the loan became clearly worth par.
But Westinghouse instead plunged into big-time construction
lending on hotels, using accounting that made its lending

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ofﬁcers look good because it showed extremely high starting
income from loans that were very inferior to the loans from
which the company had suffered small credit losses in the past.
This terrible accounting was allowed by both international and
outside accountants for Westinghouse as they displayed the
conduct predicted by the refrain “Whose bread I eat, his song I
sing.” The result was billions of dollars of losses.
Who was at fault? The guy from the refrigerator division, or
some similar division, who as lending ofﬁcer was suddenly in
charge of loans to hotel developers? Or the accountants and
other senior people who tolerated a nearly insane incentive
structure, almost sure to trigger incentive-caused bias in a
lending ofﬁcer? My answer puts the most blame on the
accountants and other senior people who created the accounting
system. These people became the equivalent of an armored car
cash-carrying service that suddenly decided to dispense with
vehicles and have unarmed children hand-carry its customers’
cash through slums in open bushel baskets.
I wish I could tell you that this sort of thing no longer happens,
but this is not so. After Westinghouse blew up, General Electric’s
Kidder, Peabody subsidiary put a silly computer program in
place that allowed a bond trader to show immense ﬁctional
proﬁts. And after that, much accounting became even worse,
perhaps reaching its nadir at Enron.
So incentive-caused bias is a huge, important thing, with
highly important antidotes, like the cash register and a sound
accounting system. But when I came years ago to the psychology
texts, I found that, while they were about 1,000 pages long, there
was little therein that dealt with incentive-caused bias and no
mention of Patterson or sound accounting systems.
Somehow incentive-caused bias and its antidotes pretty well
escaped the standard survey courses in psychology, even though
incentive-caused bias had long been displayed prominently in

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much of the world’s great literature, and antidotes to it had long
existed in standard business routines. In the end, I concluded
that when something was obvious in life but not easily
demonstrable in certain kinds of easy-to-do, repeatable
academic experiments, the trufﬂe hounds of psychology very
often missed it.
In some cases, other disciplines showed more interest in
psychological tendencies than did psychology, at least as
explicated in psychology textbooks. For instance, economists,
speaking from the employer’s point of view, have long had a
name for the natural results of incentive-caused bias: agency
cost.
As the name implies, economists have typically known that,
just as grain is always lost to rats, employers always lose to
employees who improperly think of themselves ﬁrst. Employer-
installed antidotes include tough internal audit systems and
severe public punishment for identiﬁed miscreants, as well as
misbehavior-preventing routines and such machines as cash
registers. From the employee’s point of view, incentive-caused
bias quite naturally causes opposing abuse from the employer:
the sweatshop, the unsafe workplace, etc. And these bad results
for employees have antidotes not only in pressure from unions
but also in government action, such as wage and hour laws,
workplace safety rules, measures fostering unionization, and
workers’ compensation systems. Given the opposing psychology-
induced strains that naturally occur in employment because of
incentive-caused bias on both sides of the relationship, it is no
wonder the Chinese are so much into yin and yang.
The inevitable ubiquity of incentive-caused bias has vast,
generalized consequences. For instance, a sales force living only
on commissions will be much harder to keep moral than one
under less pressure from the compensation arrangement. On the
other hand, a purely commissioned sales force may well be more

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efﬁcient per dollar spent. Therefore, difﬁcult decisions involving
trade-offs are common in creating compensation arrangements
in the sales function.
The extreme success of free-market capitalism as an
economic system owes much to its prevention of many bad
effects from incentive-caused bias. Most capitalist owners in a
vast web of free-market economic activity are selected for ability
by surviving in a brutal competition with other owners and have
a strong incentive to prevent all waste in operations within their
ownership. After all, they live on the difference between their
competitive prices and their overall costs, and their businesses
will perish if costs exceed sales. Replace such owners by salaried
employees of the state and you will normally get a substantial
reduction in overall efﬁciency, as each employee who replaces
an owner is subject to incentive-caused bias as he determines
what service he will give in exchange for his salary and how
much he will yield to peer pressure from many fellow employees
who do not desire his creation of any strong performance model.
Another generalized consequence of incentive-caused bias is
that man tends to game all human systems, often displaying
great ingen uity in wrongly serving himself at the expense of
others. Anti-gaming features, therefore, constitute a huge and
necessary part of almost all system design.
Also needed in system design is an admonition: Dread, and
avoid as much you can, rewarding people for what can be easily
faked. Yet our legislators and judges, usually including many
lawyers educated in eminent universities, often ignore this
injunction. Society consequently pays a huge price in the
deterioration of behavior and efﬁciency, as well as the
incurrence of unfair costs and wealth transfers. If education
were improved, with psychological reality becoming better
taught and assimilated, better system design might well come
out of our legislatures and courts.

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Of course, money is now the main reward that drives habits. A
monkey can be trained to seek and work for an intrinsically
worthless token as if it were a banana if the token is routinely
exchangeable for a banana. So it is with humans working for
money, only more so, because human money is exchangeable for
many desired things in addition to food, and one ordinarily gains
status from either holding or spending it. Moreover, a rich
person will often, through habit, work or connive energetically
for more money long after he has almost no real need for more.
Averaged out, money is a mainspring of modern civilization,
having little precedent in the behavior of nonhuman animals.
Money rewards are also intertwined with other forms of reward.
For instance, some people use money to buy status, and others
use status to get money, while still others sort of do both things at
the same time.
Although money is the main driver among rewards, it is not
the only reward that works. People also change their behavior
and cognition for sex, friendship, companionship, advancement
in status, and other nonmonetary items.
“Granny’s rule” provides another example of reward
superpower, so extreme in its effects that it must be mentioned
here. You can successfully manipulate your own behavior with
this rule, even if you are using as rewards items that you already
possess! Indeed, consultant PhD psychologists often urge
business organizations to improve their reward systems by
teaching executives to use “granny’s rule” to govern their own
daily behavior.
Granny’s rule, to be speciﬁc, is the requirement that children
eat their carrots before they get dessert. The business version
requires that executives force themselves daily to ﬁrst do their
unpleasant and necessary tasks before rewarding themselves by
proceeding to their pleasant tasks. Given reward superpower,
this practice is wise and sound. Moreover, the rule can also be

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used in the non-business part of life. The emphasis on daily use
of this practice is not accidental. The consultants well know, after
the teaching of Skinner, that prompt rewards work best.
Punishments, of course, also strongly inﬂuence behavior and
cognition, although not so ﬂexibly and wonderfully as rewards.
For instance, illegal price ﬁxing was fairly common in America
when it was customarily punished by modest ﬁnes. Then, after a
few prominent business executives were removed from their
eminent positions and sent to federal prisons, price-ﬁxing
behavior was greatly reduced.
Military and naval organizations have very often been
extreme in using punishment to change behavior, probably
because they needed to cause extreme behavior. Around the time
of Caesar, there was a European tribe that, when the assembly
horn blew, always killed the last warrior to reach his assigned
place, and no one enjoyed ﬁghting this tribe. And George
Washington hanged farm-boy deserters 40 feet high as an
example to others who might contemplate desertion.
TWO
Liking/loving tendency
A newly hatched baby goose is programmed, through the
economy of its genetic program, to love and follow the ﬁrst
creature that is nice to it, which is almost always its mother. But
if the mother goose is not present right after the hatching and a
man is there instead, the gosling will love and follow the man,
who becomes a sort of substitute mother.
Somewhat similarly, a newly arrived human is born to like
and love under the normal and abnormal triggering outcomes
for its kind. Perhaps the strongest inborn tendency to love, ready
to be triggered, is that of the human mother for its child. On the

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other hand, the similar child-loving behavior of a mouse can be
eliminated by the deletion of a single gene, which suggests there
is some sort of triggering gene in a mother mouse as well as in a
gosling.
Each child, like a gosling, will almost surely come to like and
love, not only as driven by its sexual nature but also in social
groups not limited to its genetic or adoptive family. Current
extremes of romantic love almost surely did not occur in man’s
remote past. Our early human ancestors were surely more like
apes triggered into mating in a pretty mundane fashion.
And what will a man naturally come to like and love, apart
from his parent, spouse, and child? Well, he will like and love
being liked and loved. So many a courtship competition will be
won by a person displaying exceptional devotion, and man will
generally strive lifelong for the affection and approval of many
people not related to him.
One very practical consequence of liking/loving tendency is
that it acts as a conditioning device that makes the liker or lover
tend to 1) ignore the faults of, and comply with the wishes of, the
object of his affection; 2) favor people, products, and actions
merely associated with the object of his affection, as we shall see
when we get to inﬂuence-from-mere-association tendency; and
3) distort other facts to facilitate love.
The phenomenon of liking and loving causing admiration also
works in reverse. Admiration also causes or intensiﬁes liking or
love. With this feedback mode in place, the consequences are
often extreme, sometimes even causing deliberate self-
destruction to help what is loved.
Liking or loving, intertwined with admiration in a feedback
mode, often has vast practical consequences in areas far
removed from sexual attachments. For instance, a man who is so
constructed that he loves admirable persons and ideas with a
special intensity has a huge advantage in life. This blessing came

## Page 325

to both Buffett and myself in large measure, sometimes from the
same persons and ideas. One common beneﬁcial example for us
both was Warren’s uncle, Fred Buffett, who cheerfully did the
endless grocery store work that Warren and I ended up admiring
from a safe distance. Even now, after I have known so many other
people, I doubt it is possible to be a nicer man than Fred Buffett
was, and he changed me for the better.
There are large social policy implications in the amazingly
good consequences that ordinarily come from people likely to
trigger extremes of love and admiration boosting each other in a
feedback mode. For instance, it is obviously desirable to attract a
lot of lovable, admirable people into the teaching profession.
THREE
Disliking/hating tendency
In a pattern obverse to liking/loving tendency, the newly arrived
human is also born to dislike and hate, as triggered by normal
and abnormal triggering forces in its life. It is the same with most
apes and monkeys. As a result, the long history of man contains
almost continuous war. For instance, most American Indian
tribes warred incessantly, and some tribes would occasionally
bring captives home to women so that all could join in the fun of
torturing captives to death. Even with the spread of religion and
the advent of advanced civilization, much modern war remains
pretty savage. But we also get what we observe in present-day
Switzerland and the United States, wherein the clever political
arrangements of man channel the hatreds and dislikings of
individuals and groups into nonlethal patterns, including
elections.
But the dislikings and hatreds never go away completely. Born
into man, these driving tendencies remain strong. Thus, we get

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maxims like the one from England: “Politics is the art of
marshaling hatreds.” And we also get the extreme popularity of
very negative political advertising in the United States.
At the family level, we often see one sibling hate his other
siblings and litigate with them endlessly if he can afford it.
Indeed, a wag named Buffett has repeatedly explained to me that
“a major difference between rich and poor people is that the rich
people can spend their lives suing their relatives.” My father’s
law practice in Omaha was full of such intrafamily hatreds. When
I got to the Harvard Law School and its professors taught me
property law with no mention of sibling rivalry in the family
business, I appraised the school as a pretty unrealistic place that
wore blinders like the milk-wagon horses of yore. My current
guess is that sibling rivalry has not yet made it into property law
as taught at Harvard.
Disliking / hating tendency also acts as a conditioning device
that makes the disliker / hater tend to 1) ignore virtues in the
object of dislike; 2) dislike people, products, and actions merely
associated with the object of his dislike; and 3) distort other facts
to facilitate hatred.
FOUR
Doubt-avoidance tendency
The brain of man is programmed with a tendency to quickly
remove doubt by reaching some decision.
It is easy to see how evolution would make animals, over the
eons, drift toward such quick elimination of doubt. After all, the
one thing that is surely counterproductive for a prey animal that
is threatened by a predator is to take a long time in deciding
what to do. So man’s doubt-avoidance tendency is quite
consistent with the history of his ancient, nonhuman ancestors.

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So pronounced is the tendency in man to quickly remove
doubt by reaching some decision that behavior to counter the
tendency is required from judges and jurors. Here, delay before
decision-making is forced, and one is required to comport
himself, prior to conclusion time, so that he is wearing a “mask”
of objectivity. And the mask works to help real objectivity along,
as we shall see when we next consider man’s inconsistency-
avoidance tendency.
Of course, once one has recognized that man has a strong
doubt-avoidance tendency, it is logical to believe that at least
some leaps of religious faith are greatly boosted by this
tendency. Even if one is satisﬁed that his own faith comes from
revelation, one must still account for the inconsistent faiths of
others. And man’s doubt-avoidance tendency is almost surely a
big part of the answer.
What triggers doubt-avoidance tendency? Well, an
unthreatened man, thinking of nothing in particular, is not being
prompted to remove doubt through rushing to some decision. As
we shall see later when we get to social-proof tendency and
stress-inﬂuence tendency, what usually triggers doubt-
avoidance tendency is some combination of 1) puzzlement and
2) stress. And both of these factors naturally occur in facing
religious issues. Thus, the natural state of most men is in some
form of religion. And this is what we observe.
FIVE
Inconsistency-avoidance tendency
The brain of man conserves programming space by being
reluctant to change, which is a form of inconsistency avoidance.
We see this in all human habits, constructive and destructive.
Few people can list a lot of bad habits that they have eliminated,

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and some people cannot identify even one of these. Instead,
practically everyone has a great many bad habits he has long
maintained despite their being known as bad.
Given this situation, it is not too much in many cases to
appraise early-formed habits as destiny. When Marley’s
miserable ghost [in A Christmas Carol] says, “I wear the chains I
forged in life,” he is talking about the chains of habit that were
too light to be felt before they became too strong to be broken.
The rare life that is wisely lived has in it many good habits
maintained and many bad habits avoided or cured. The great
rule that helps here is again from Franklin’s Poor Richard’s
Almanack: “An ounce of prevention is worth a pound of cure.”
What Franklin is here indicating, in part, is that inconsistency-
avoidance tendency makes it much easier to prevent a habit than
to change it.
Also tending to be maintained in place by the anti-change
tendency of the brain are one’s previous conclusions, human
loyalties, reputational identity, commitments, accepted role in a
civilization, etc. It is not entirely clear why evolution would
program into man’s brain an anti-change mode alongside his
tendency to quickly remove doubt. My guess is the anti-change
mode was signiﬁcantly caused by a combination of the following
factors:
1. It facilitated faster decisions when speed of decision was
an important contribution to the survival of nonhuman
ancestors that were prey.
2. It facilitated the survival advantage that our ancestors
gained by cooperating in groups, which would have been
more difﬁcult to do if everyone was always changing
responses.

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3. It was the best form of solution that evolution could get to
in the limited number of generations between the start of
literacy and today’s complex modern life.
It is easy to see that a quickly reached conclusion, triggered
by doubt-avoidance tendency, when combined with a tendency
to resist any change in that conclusion, will naturally cause a lot
of errors in cognition for modern man. And so it observably
works out. We all deal much with others whom we correctly
diagnose as imprisoned in poor conclusions that are maintained
by mental habits they formed early and will carry to their graves.
So great is the bad-decision problem caused by
inconsistency-avoidance tendency that our courts have adopted
important strategies against it. For instance, before making
decisions, judges and juries are required to hear long and skillful
presentations of evidence and arguments from the side they will
not naturally favor, given their ideas in place. This helps prevent
considerable bad thinking from ﬁrst-conclusion bias. Similarly,
other modern decision-makers will often force groups to
consider skillful counterarguments before making decisions.
Proper education is one long exercise in the augmentation of
high cognition so that our wisdom becomes strong enough to
destroy wrong thinking maintained by resistance to change. As
Lord Keynes pointed out about his exalted intellectual group at
one of the greatest universities in the world, it was not the
intrinsic difﬁculty of new ideas that prevented their acceptance.
Instead, the new ideas were not accepted because they were
inconsistent with old ideas in place.
What Keynes was reporting is that the human mind works a
lot like the human egg. When one sperm gets into a human egg,
there’s an automatic shut-off device that bars any other sperm
from getting in. The human mind tends strongly toward the

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same sort of result. And so, people tend to accumulate large
mental holdings of ﬁxed conclusions and attitudes that are not
often reexamined or changed, even though there is plenty of
good evidence that they are wrong.
Moreover, this doesn’t just happen in social science
departments, like the one that once thought Freud should serve
as the only choice as a psychology teacher for Caltech. Holding to
old errors even happens, although with less frequency and
severity, in hard science departments. We have no less an
authority for this than Max Planck, Nobel laureate, ﬁnder of
Planck’s constant. Planck is famous not only for his science but
also for saying that even in physics the radically new ideas are
seldom really accepted by the old guard. Instead, said Planck,
progress is made by a new generation that comes along, less
brain-blocked by its previous conclusions.
Indeed, precisely this sort of brain blocking happened to a
degree in Einstein. At his peak, Einstein was a great destroyer of
his own ideas, but an older Einstein never accepted the full
implications of quantum mechanics.
One of the most successful users of an antidote to ﬁrst-
conclusion bias was Charles Darwin. He trained himself, early, to
intensively consider any evidence tending to disconﬁrm any
hypothesis of his, more so if he thought his hypothesis was a
particularly good one. The opposite of what Darwin did is now
called conﬁrmation bias, a term of opprobrium. Darwin’s
practice came from his acute recognition of man’s natural
cognitive faults arising from inconsistency-avoidance tendency.
He provides a great example of psychological insight correctly
used to advance some of the ﬁnest mental work ever done.
Inconsistency-avoidance tendency has many good effects in
civilization. For instance, rather than act inconsistently with
public commitments, new or old public identities, etc., most

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people are more loyal in their roles in life as priests, physicians,
citizens, soldiers, spouses, teachers, employees, etc.
One corollary of inconsistency-avoidance tendency is that a
person making big sacriﬁces in the course of assuming a new
identity will intensify his devotion to the new identity. After all, it
would be quite inconsistent behavior to make a large sacriﬁce for
something that was no good. Thus civilization has invented
many tough and solemn initiation ceremonies, often public in
nature, that intensify new commitments made.
Tough initiation ceremonies can intensify bad conduct as well
as good. The loyalty of the new made-man maﬁa member or of
the military ofﬁcer making the required blood oath of loyalty to
Hitler was boosted through the triggering of inconsistency-
avoidance tendency.
Moreover, the tendency will often make man a patsy of
manipulative compliance practitioners, who gain advantage
from triggering his subconscious inconsistency-avoidance
tendency. Few people demonstrated this process better than Ben
Franklin. As he was rising from obscurity in Philadelphia and
wanted the approval of some important man, Franklin would
often maneuver that man into doing Franklin some unimportant
favor, like lending Franklin a book. Thereafter, the man would
admire and trust Franklin more because a non-admired and
non-trusted Franklin would be inconsistent with the appraisal
implicit in lending Franklin the book.
During the Korean War, this technique of Franklin’s was the
most important feature of the Chinese brainwashing system that
was used on enemy prisoners. Small step by small step, the
technique often worked better than torture in altering prisoner
cognition in favor of Chinese captors.
The practice of Franklin, whereunder he got approval from
someone by maneuvering him into treating Franklin favorably,
works viciously well in reverse. When one is maneuvered into

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deliberately hurting some other person, one will tend to
disapprove of or even hate that person. This effect, from
inconsistency-avoidance tendency, accounts for the insight
implicit in the saying “A man never forgets where he has buried
the hatchet.” The effect accounts for much prisoner abuse by
guards, increasing their dislike and hatred for prisoners that
exists as a consequence of the guards’ reciprocation of hostility
from prisoners who are treated like animals.
Given the psychology-based hostility natural in prisons
between guards and prisoners, an intense, continuous effort
should be made to 1) prevent prisoner abuse from starting and
2) stop it instantly when it starts, because it will grow by feeding
on itself, like a cluster of infectious disease. More psychological
acuity on this subject, aided by more insightful teaching, would
probably improve the overall effectiveness of the US Army.
So strong is inconsistency-avoidance tendency that it will
often prevail after one has merely pretended to have some
identity, habit, or conclusion. Thus, for a while, many an actor
sort of believes he is Hamlet, prince of Denmark. And many a
hypocrite is improved by his pretensions of virtue. And many a
judge and juror, while pretending objectivity, is gaining
objectivity. And many a trial lawyer or other advocate comes to
believe what he formerly only pretended to believe.
While inconsistency-avoidance tendency, with its status quo
bias, immensely harms sound education, it also causes much
beneﬁt. For instance, a near-ultimate inconsistency would be to
teach something to others that one did not believe true. So in
clinical medical education, the learner is forced to “see one, do
one, then teach one,” with the teaching pounding the learning
into the teacher. Of course, the power of teaching to inﬂuence the
cognition of the teacher is not always a beneﬁt to society. When
such power ﬂows into political and cult evangelism, there are
often bad consequences.

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For instance, modern education often does much damage
when young students are taught dubious political notions and
then enthusiastically push these notions on the rest of us. The
pushing seldom convinces others. But as students pound into
their mental habits what they are pushing out, the students are
often permanently damaged. Educational institutions that create
a climate where much of this goes on are, I think, irresponsible.
It is important not to thus put one’s brain in chains before one
has come anywhere near his full potentiality as a rational
person.
SIX
Curiosity tendency
There is a lot of innate curiosity in mammals, but its nonhuman
version is highest among apes and monkeys. Man’s curiosity, in
turn, is much stronger than that of his simian relatives.
In advanced human civilization, culture greatly increases the
effectiveness of curiosity in advancing knowledge. For instance,
Athens (including its colony, Alexandria) developed much math
and science out of pure curiosity, while the Romans made almost
no contribution to either math or science. They instead
concentrated their attention on the “practical” engineering of
mines, roads, aqueducts, etc.
Curiosity, enhanced by the best of modern education—which
is, by deﬁnition, a minority part in many places—much helps
man to prevent or reduce bad consequences arising from other
psychological tendencies. The curious are also provided with
much fun and wisdom long after formal education has ended.

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SEVEN
Kantian fairness tendency
Kant was famous for his categorical imperative, a sort of golden
rule that required humans to follow those behavior patterns that,
if followed by all others, would make the surrounding human
system work best for everybody. It is not too much to say that
modern acculturated man displays, and expects from others, a
lot of fairness as thus deﬁned by Kant.
In a small community having a one-way bridge or tunnel for
autos, it is the norm in the United States to see a lot of reciprocal
courtesy, despite the absence of signs or signals. And many
freeway drivers, including myself, will often let other drivers
come in front of them, in lane changes or the like, because that is
the courtesy they desire when roles are reversed. Moreover,
there is in modern human culture a lot of courteous lining up by
strangers so that all are served on a ﬁrst-come-ﬁrst-served basis.
Also, strangers often voluntarily share equally in unexpected,
unearned good and bad fortune. And, as an obverse
consequence of such fair-sharing conduct, much reactive
hostility occurs when fair sharing is expected yet not provided.
It is interesting how the world’s slavery was pretty well
abolished during the last three centuries after being tolerated for
a great many previous centuries, during which it coexisted with
the world’s major religions. My guess is that Kantian fairness
tendency was a major contributor to this result.
EIGHT
Envy/jealousy tendency
A member of a species designed through evolutionary process to
want often scarce food is going to be driven strongly toward

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getting food when it ﬁrst sees food. This is going to occur often,
and will tend to create some conﬂict when the food is seen in the
possession of another member of the same species. This is
probably the evolutionary origin of the envy/jealousy tendency
that lies so deep in human nature.
Sibling jealousy is clearly very strong and usually greater in
children than adults. It is often stronger than jealousy directed at
strangers. Kantian fairness tendency probably contributes to this
result.
Envy/jealousy is extreme in myth, religion, and literature,
wherein, in account after account, it triggers hatred and injury. It
was regarded as so pernicious by the Jews of the civilization that
preceded Christ that it was forbidden, by phrase after phrase, in
the laws of Moses. You were even warned by the prophet not to
covet your neighbor’s donkey.
Envy/jealousy is also extreme in modern life. For instance,
university communities often go bananas when some university
employee in money management or some professor in surgery
gets annual compensation in multiples of the standard
professorial salary. And in modern investment banks, law ﬁrms,
etc., the envy/jealousy effects are usually more extreme than
they are in university faculties. Many big law ﬁrms, fearing
disorder from envy/jealousy, have long treated all senior
partners alike in compensation, no matter how different their
contributions to ﬁrm welfare. As I have shared the observation of
life with Warren Buffett over decades, I have heard him wisely
say on several occasions, “It is not greed that drives the world
but envy.”
Because this is roughly right, one would expect a vast
coverage of envy/jealousy in psychology textbooks. But no such
vast coverage existed when I read my three textbooks. Indeed,
the very words “envy” and “jealousy” were often absent from
indexes.

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Non-discussion of envy/jealousy is not a phenomenon
conﬁned to psychology texts. When did any of you last engage in
any large group discussion of some issue wherein adult
envy/jealousy was identiﬁed as the cause of someone’s
argument? There seems to be a general taboo against any such
claim. If so, what accounts for the taboo?
My guess is that people widely and generally sense that
labeling some position as driven by envy/jealousy will be
regarded as extremely insulting to the position taker, possibly
more so when the diagnosis is correct than when it is wrong. And
if calling a position envy-driven is perceived as the equivalent of
describing its holder as a childish mental basket case, then it is
quite understandable how a general taboo has arisen. But should
this general taboo extend to psychology texts when it creates
such a large gap in the correct psychological explanation of what
is widespread and important? My answer is no.
NINE
Reciprocation tendency
The automatic tendency of humans to reciprocate both favors
and disfavors has long been noticed as extreme, as it is in apes,
monkeys, dogs, and many less cognitively gifted animals. The
tendency clearly facilitates group cooperation for the beneﬁt of
members. In this respect, it mimics much genetic programming
of the social insects.
We see the extreme power of the tendency to reciprocate
disfavors in some wars, wherein it increases hatred to a level
causing very brutal conduct. For long stretches in many wars, no
prisoners were taken, the only acceptable enemy being a dead
one. And sometimes that was not enough, as in the case of

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Genghis Khan, who was not satisﬁed with corpses. He insisted on
their being hacked into pieces.
One interesting mental exercise is to compare Genghis Khan,
who exercised extreme, lethal hostility toward other men, with
ants that display extreme, lethal hostility toward members of
their own species that are not part of their breeding colony.
Genghis looks sweetly lovable when compared to the ants. The
ants are more disposed to ﬁght, and ﬁght with more extreme
cruelty. Indeed, E. O. Wilson once waggishly suggested that if
ants were suddenly to get atom bombs, all ants would be dead
within 18 hours.
What both human and ant history suggest is that 1) nature
has no general algorithm making intraspecies, turn-the-other-
cheek behavior a booster of species survival; 2) it is not clear that
a country would have good prospects were it to abandon all
reciprocate-disfavor tendency directed at outsiders; and 3) if
turn-the-other-cheek behavior is a good idea for a country as it
deals with outsiders, man’s culture is going to have to do a lot of
heavy lifting because his genes won’t be of much help.
I next turn to man’s reciprocated hostility that falls well short
of war. Peacetime hostility can be pretty extreme, as in many
modern cases of road rage or injury-producing temper tantrums
on athletic ﬁelds. The standard antidote to one’s overactive
hostility is to train oneself to defer reaction. As my smart friend
Tom Murphy so frequently says, “You can always tell the man off
tomorrow, if it is such a good idea.”
Of course, the tendency to reciprocate favor for favor is also
very intense, so much so that it occasionally reverses the course
of reciprocated hostility. Weird pauses in ﬁghting have
sometimes occurred right in the middle of wars, triggered by
some minor courtesy or favor on the part of one side, followed by
favor reciprocation from the other side, and so on, until ﬁghting
stopped for a considerable period. This happened more than

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once in the trench warfare of World War I, over big stretches of
the front and much to the dismay of the generals.
It is obvious that commercial trade, a fundamental cause of
modern prosperity, is enormously facilitated by man’s innate
tendency to reciprocate favors. In trade, enlightened self-interest
joining with reciprocation tendency results in constructive
conduct. Daily interchange in marriage is also assisted by
reciprocation tendency, without which marriage would lose
much of its allure.
Reciprocation tendency, insomuch as it causes good results,
does not join forces only with the superpower of incentives. It
also joins inconsistency-avoidance tendency in helping cause 1)
the fulﬁllment of promises made as part of a bargain, including
loyalty promises in marriage ceremonies; and 2) correct
behavior expected from persons serving as priests, shoemakers,
physicians, and all else.
Like other psychological tendencies, and also man’s ability to
turn somersaults, reciprocate-favor tendency operates to a very
considerable degree at a subconscious level. This helps make the
tendency a strong force that can sometimes be used by some
men to mislead others, which happens all the time. For instance,
when an automobile salesman graciously steers you into a
comfortable place to sit and gives you a cup of coffee, you are
very likely being tricked, by this small courtesy alone, into
parting with an extra $500. This is far from the most extreme
case of sales success that is rooted in a salesman dispensing
minor favors. However, in this scenario of buying a car, you are
going to be disadvantaged by parting with an extra $500 of your
own money. This potential loss will protect you to some extent.
But suppose you are the purchasing agent of someone else—a
rich employer, for instance. Now, the minor favor you receive
from the salesman is less opposed by the threat of extra cost to
you because someone else is paying the extra cost. Under such

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circumstances, the salesman is often able to maximize his
advantage, particularly when the government is the purchaser.
Wise employers, therefore, try to oppose the reciprocate-favor
tendencies of employees engaged in purchasing. The simplest
antidote works best: Don’t let them accept any favors from
vendors.
Sam Walton agreed with this idea of absolute prohibition. He
wouldn’t let purchasing agents accept so much as a hot dog from
a vendor. Given the subconscious level at which much
reciprocation tendency operates, this policy of Walton’s was
profoundly correct. If I controlled the Defense Department, its
policies would mimic Walton’s.
In a famous psychology experiment, Cialdini brilliantly
demonstrated the power of compliance practitioners to mislead
people by triggering their subconscious reciprocation tendency.
Carrying out this experiment, Cialdini caused his compliance
practitioners to wander around his campus and ask strangers to
supervise a bunch of juvenile delinquents on a trip to a zoo.
Because this happened on a campus, one person in six out of a
large sample actually agreed to do this. After accumulating this
1-in-6 statistic, Cialdini changed his procedure. His practitioners
next wandered around the campus asking strangers to devote a
big chunk of time every week for two years to the supervision of
juvenile delinquents. This ridiculous request got him a 100
percent rejection rate. But the practitioner had a follow-up
question: “Will you at least spend one afternoon taking juvenile
delinquents to a zoo?” This raised Cialdini’s former acceptance
rate of 1 in 6 to 1 in 2—a tripling.
What Cialdini’s compliance practitioners had done was make
a small concession, which was reciprocated by a small
concession from the other side. This subconscious reciprocation
of a concession by Cialdini’s experimental subjects actually
caused a much-increased percentage of them to end up

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irrationally agreeing to go to a zoo with juvenile delinquents.
Now, a professor who can invent an experiment like that, which
so powerfully demonstrates something so important, deserves
much recognition in the wider world, which he indeed got, to the
credit of many universities that learned a great deal from
Cialdini.
Why is reciprocation tendency so important? Well, consider
the folly of having law students graduate and go out in the world
representing clients in negotiations, not knowing the nature of
the subconscious processes of the mind as exhibited in Cialdini’s
experiment. Yet such folly was prevalent in the law schools of the
world for decades, in fact generations. The correct name for that
is educational malpractice. The law schools didn’t know, or care
to teach, what Sam Walton so well knew.
The importance and power of reciprocate-favor tendency was
also demonstrated in Cialdini’s explanation of the foolish
decision of the attorney general of the United States to authorize
the Watergate burglary. There, an aggressive subordinate made
some extreme proposal for advancing Republican interests
through the use of some combination of whores and a gigantic
yacht. When this ridiculous request was rejected, the
subordinate backed off, in gracious concession, to merely asking
for consent to a burglary, and the attorney general went along.
Cialdini believes that subconscious reciprocation tendency thus
became one important cause of the resignation of a United States
president in the Watergate debacle, and so do I. Reciprocation
tendency subtly causes many extreme and dangerous
consequences, not just on rare occasions but pretty much all the
time.
Man’s belief in reciprocate-favor tendency, following eons of
his practicing it, has done some queer and bad things in
religions. The ritualized murder of the Phoenicians and the
Aztecs, in which they sacriﬁced human victims to their gods, was

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a particularly egregious example. And we should not forget that
as late as the Punic Wars, the civilized Romans, out of fear of
defeat, returned in a few instances to the practice of human
sacriﬁce. On the other hand, the reciprocity-based, religion-
boosting idea of obtaining help from God in reciprocation for
good human behavior has probably been vastly constructive.
Overall, both inside and outside religions, it seems clear to me
that reciprocation tendency’s constructive contributions to man
far outweigh its destructive effects. In cases of psychological
tendencies being used to counter or prevent bad results from
one or more other psychological tendencies—for instance, in the
case of interventions to end chemical dependency—you will
usually ﬁnd reciprocation tendency performing strongly on the
constructive side. And the very best part of human life probably
lies in relationships of affection wherein parties are more
interested in pleasing than being pleased—a not-uncommon
outcome in display of reciprocate-favor tendency.
Before we leave reciprocate-favor tendency, the ﬁnal
phenomenon we will consider is widespread human misery from
feelings of guilt. To the extent the feeling of guilt has an
evolutionary base, I believe the most plausible cause is the
mental conﬂict triggered in one direction by reciprocation
tendency and in the opposite direction by reward-superresponse
tendency pushing one to 100 percent of some good thing.
Of course, human culture has often greatly boosted the
genetic tendency to suffer from feelings of guilt. Most especially,
religious culture has imposed hard-to-follow ethical and
devotional demands on people. There is a charming Irish
Catholic priest in my neighborhood who, with rough accuracy,
often says, “The old Jews may have invented guilt, but we
Catholics perfected it.” And if you, like me and this priest, believe
that, averaged out, feelings of guilt do more good than harm, you

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may join in my special gratitude for reciprocate-favor tendency,
no matter how unpleasant you ﬁnd feelings of guilt.
TEN
Inﬂuence-from-mere-association tendency
In the standard conditioned reﬂexes studied by Skinner and
most common in the world, responsive behavior, creating a new
habit, is directly triggered by rewards previously bestowed. For
instance, a man buys a can of branded shoe polish, has a good
experience with it when shining his shoes, and because of this
“reward” buys the same shoe polish when he needs another can.
But there is another type of conditioned reﬂex wherein mere
association triggers a response. For instance, consider the case
of many men who have been trained by their previous
experience in life to believe that when several similar items are
presented for purchase, the one with the highest price will have
the highest quality. Knowing this, some seller of an ordinary
industrial product will often change his product’s trade dress
and raise its price signiﬁcantly, hoping that quality-seeking
buyers will be tricked into becoming purchasers by mere
association of his product and its high price.
This industrial practice frequently is effective in driving up
sales, and even more so in driving up proﬁts. For instance, it
worked wonderfully with high-priced power tools for a long time,
and it would work better yet with high-priced pumps at the
bottom of oil wells. With luxury goods, the process works with a
special boost because buyers who pay high prices often gain
extra status from thus demonstrating both their good taste and
their ability to pay.
Even association that appears to be trivial, if carefully
planned, can have extreme and peculiar effects on purchasers of

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products. The target purchaser of shoe polish may like pretty
girls, so he chooses the polish with the pretty girl on the can or
the one with the pretty girl in the last ad for shoe polish that he
saw.
Advertisers know about the power of mere association. You
won’t see Coke advertised alongside some account of the death of
a child. Instead, Coke ads picture life as happier than reality.
Similarly, it is not from mere chance that military bands play
such impressive music. That kind of music, appearing in mere
association with military service, helps to attract soldiers and
keep them in the army. Most armies have learned to use mere
association in this successful way.
However, the most damaging miscalculations from mere
association do not ordinarily come from advertisers and music
providers. Some of the most important miscalculations come
from what is accidentally associated with one’s past success, or
one’s liking and loving, or one’s disliking and hating, which
includes a natural hatred for bad news.
To avoid being misled by the mere association of some fact
with past success, use this memory clue. Think of Napoleon and
Hitler when they invaded Russia after using their armies with
much success elsewhere. And there are plenty of mundane
examples of results like those of Napoleon and Hitler. For
instance, a man foolishly gambles in a casino and yet wins. This
unlikely correlation causes him to try the casino again, or again
and again, to his horrid detriment. Or a man gets lucky in an
odds-against venture headed by an untalented friend. So
inﬂuenced, he tries again what worked before—with terrible
results.
The proper antidotes to being made such a patsy by past
success are 1) to carefully examine each past success, looking for
accidental, non-causative factors associated with such success
that will tend to mislead as one appraises the odds implicit in a

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proposed new undertaking; and 2) to look for dangerous aspects
of the new undertaking that were not present when past success
occurred.
The damage to the mind that can come from liking and loving
was once demonstrated by obviously false testimony given by an
other wise very admirable woman, the wife of a party in a jury
case. The famous opposing counsel wanted to minimize his
attack on such an admirable woman yet destroy the credibility of
her testimony. And so, in his closing argument, he came to her
testimony last. He then shook his head sadly and said, “What are
we to make of such testimony? The answer lies in the old rhyme:
‘As the husband is,
So the wife is.
She is married to a clown,
And the grossness of his nature
Drags her down.’”
The jury disbelieved the woman’s testimony. They easily
recognized the strong misinﬂuence of love on her cognition. And
we now often see even stronger misinﬂuence from love as tearful
mothers, with heartfelt conviction, declare before TV cameras
the innocence of their obviously guilty sons.
People disagree about how much blindness should
accompany the association called love. In Poor Richard’s
Almanack, Franklin counseled, “Keep your eyes wide open before
marriage and half shut thereafter.” Perhaps this eyes-half-shut
solution is about right, but I favor a tougher prescription: “See it
like it is and love anyway.”
Hating and disliking also cause miscalculation triggered by
mere association. In business, I commonly see people under-
appraise both the competency and morals of competitors they

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dislike. This is a dangerous practice, usually disguised because it
occurs on a sub conscious basis.
Another common bad effect from the mere association of a
person and a hated outcome is displayed in Persian messenger
syndrome. Ancient Persians actually killed some messengers
whose sole fault was that they brought home truthful bad news,
say, of a battle lost. It was actually safer for the messenger to run
away and hide instead of doing his job as a wiser boss would
have wanted it done.
Persian messenger syndrome is alive and well in modern life,
albeit in less lethal versions. It is actually dangerous in many
careers to be a carrier of unwelcome news. Union negotiators
and employer representatives often know this, and it leads to
many tragedies in labor relations. Sometimes lawyers, knowing
their clients will hate them if they recommend an unwelcome
but wise settlement, will carry on to disaster.
Even in places well known for high cognition, one will
sometimes ﬁnd Persian messenger syndrome. For instance,
years ago, two major oil companies litigated in a Texas trial court
over some ambiguity in an operating agreement covering one of
the largest oil reservoirs in the Western hemisphere. My guess is
that the cause of the trial was some general counsel’s
unwillingness to carry bad news to a strong-minded CEO.
CBS, in its late heyday, was famous for the occurrence of
Persian messenger syndrome because chairman Paley was
hostile to people who brought him bad news. The result was that
Paley lived in a cocoon of unreality from which he made one bad
deal after another, even exchanging a large share of CBS for a
company that had to be liquid ated shortly thereafter.
The proper antidote to creating Persian messenger syndrome
and its bad effects, like those at CBS, is to develop, through
exercise of will, a habit of welcoming bad news. At Berkshire,
there is a common injunction: “Always tell us the bad news

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promptly. It is only the good news that can wait.” It also helps to
be so wise and informed that people fear not telling you bad
news because you are so likely to get it elsewhere.
Inﬂuence-from-mere-association tendency often has a
shocking effect that helps swamp the normal tendency to return
favor for favor. Sometimes, when one receives a favor, his
condition is unpleasant, due to poverty, sickness, subjugation, or
something else. In addition, the favor may trigger an envy-driven
dislike for the person who was in so favorable a state that he
could easily be a favor giver. Under such circumstances, the
favor receiver, prompted partly by mere association of the favor
giver with past pain, will not only dislike the man who helped
him but also try to injure him. This accounts for a famous
response, sometimes dubiously attributed to Henry Ford: “Why
does that man hate me so? I never did anything for him.”
I have a friend, whom I will now call Glotz, who had an
amusing experience in favor-giving. Glotz owned an apartment
building that he had bought because he wanted, eventually, to
use the land in a different development. Pending this outcome,
Glotz was very lenient in collecting below-market rents from
tenants. When, at last, there was a public hearing on Glotz’s
proposal to tear down the building, one tenant who was far
behind in his rent payments was particularly angry and hostile.
He came to the public hearing and said, “This proposal is
outrageous. Glotz doesn’t need any more money. I know this
because I was supported in college by Glotz fellowships.”
A ﬁnal serious clump of bad thinking caused by mere
association lies in the common use of classiﬁcation stereotypes.
Because Pete knows that Joe is 90 years old and that most 90-
year-old persons don’t think very well, Pete appraises old Joe as
a thinking klutz even if old Joe still thinks very well. Or, because
Jane is a white-haired woman and Pete knows no old women

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good at higher math, Pete appraises Jane as no good at it even if
Jane is a whiz.
This sort of wrong thinking is both natural and common.
Pete’s antidote is not to believe that, on average, 90-year-olds
think as well as 40-year-olds, or that there are as many females
as males among PhDs in math. Instead, just as he must learn that
trend does not always correctly predict destiny, he must learn
that the average dimension in some group will not reliably guide
him to the dimension of some speciﬁc item. Otherwise, Pete will
make many errors, like that of the fellow who drowned in a river
that averaged out to only 18 inches deep.
ELEVEN
Simple, pain-avoiding psychological denial
This phenomenon ﬁrst hit me hard in World War II when the
super-athlete, super-student son of a family friend ﬂew off over
the Atlantic Ocean and never came back. His mother, who was a
very sane woman, then refused to believe he was dead. That’s
simple, pain-avoiding psychological denial. The reality is too
painful to bear, so one distorts the facts until they become
bearable. We all do that to some extent, often causing terrible
problems. The tendency’s most extreme outcomes are usually
mixed up with love, death, and chemical dependency.
Where denial is used to make dying easier, the conduct meets
almost no criticism. Who would begrudge a fellow man such help
at such a time? But some people hope to leave life hewing to the
iron prescription “It is not necessary to hope in order to
persevere.” And there is something admirable in anyone able to
do this.
In chemical dependency, wherein morals usually break down
horribly, addicted persons tend to believe that they remain in

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respectable condition, with respectable prospects. They thus
display an extremely unrealistic denial of reality as they go
deeper and deeper into deterioration. In my youth, Freudian
remedies failed utterly in reversing chemical dependency, but
nowadays Alcoholics Anonymous routinely achieves a 50
percent cure rate by causing several psychological tendencies to
act together to counter addiction. However, the cure process is
typically difﬁcult and draining, and a 50 percent success rate
implies a 50 percent failure rate. One should stay far away from
any conduct at all likely to drift into chemical dependency. Even
a small chance of suffering so great a damage should be avoided.
TWELVE
Excessive self-regard tendency
We all commonly observe the excessive self-regard of man. He
mostly misappraises himself on the high side, like the 90 percent
of Swedish drivers who judge themselves to be above average.
Such misappraisals also apply to a person’s major “possessions.”
One spouse usually over-appraises the other spouse. And a
man’s children are likewise appraised higher by him than they
are likely to be in a more objective view.
Even man’s minor possessions tend to be over-appraised.
Once owned, they suddenly become worth more to him than he
would pay if they were offered for sale to him and he didn’t
already own them. There is a name in psychology for this over-
appraise-your-own-possessions phenomenon: the endowment
effect. All man’s decisions are suddenly regarded by him as
better than would have been the case just before he made them.
Man’s excess of self-regard typically makes him strongly
prefer people like himself. Psychology professors have had much
fun demonstrating this effect in lost wallet experiments. Their

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experiments all show that the ﬁnder of a lost wallet containing
identity clues will be most likely to return the wallet when the
owner most closely resembles the ﬁnder. Given this quality in
psychological nature, cliquish groups of similar persons will
always be a very inﬂuential part of human culture, even after we
wisely try to dampen the worst effects.
Some of the worst consequences in modern life come when
dysfunctional groups of cliquish persons, dominated by
excessive self-regard tendency, select as new members of their
organizations persons who are very much like themselves. Thus,
if the English department at an elite university becomes
mentally dysfunctional, or the sales department of a brokerage
ﬁrm slips into routine fraud, the problem will have a natural
tendency to get worse and be quite resistant to change for the
better. So also with a police department or prison guard unit or
political group gone sour, and countless other places mired in
evil and folly, such as the worst of our big-city teachers’ unions
that harm our children by preventing the discharge of ineffective
teachers. Therefore, some of the most useful members of our
civilization are those who are willing to clean house when they
ﬁnd a mess under their ambit of control.
Well, naturally, all forms of excess of self-regard cause much
error. How could it be otherwise?
Let us consider some foolish gambling decisions. In lotteries,
the play is much lower when numbers are distributed randomly
than when the player picks his own number. This is quite
irrational. The odds are almost exactly the same and much
against the player. Because state lotteries take advantage of
man’s irrational love of self-picked numbers, modern man buys
more lottery tickets than he other wise would have, with each
purchase foolish.
Intensify man’s love of his own conclusions by adding the
possessory wallop from the endowment effect and you will ﬁnd

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that a man who has already bought a pork-belly future on a
commodity exchange now foolishly believes even more strongly
than before in the merits of his speculative bet. And foolish
sports betting by people who love sports and think they know a
lot about the relative merits of teams is a lot more addictive than
racetrack betting, partly because of man’s automatic over-
appraisal of his own complicated conclusions.
Also extremely counterproductive is man’s tendency to bet,
time after time, in games of skill, like golf or poker, against
people who are obviously much better players. Excessive self-
regard tendency diminishes the foolish bettor’s accuracy in
appraising his relative degree of talent.
More counterproductive yet are man’s appraisals, typically
excessive, of the quality of the future service he is to provide to
his business. His over-appraisal of these prospective
contributions will frequently cause disaster.
Excesses of self-regard often cause bad hiring decisions
because employers grossly over-appraise the worth of their own
conclusions that rely on impressions in face-to-face contact. The
correct antidote to this sort of folly is to underweigh face-to-face
impressions and overweigh the applicant’s past record.
I once chose exactly this course of action while I served as
chairman of an academic search committee. I convinced fellow
committee members to stop all further interviews and simply
appoint a person whose achievement record was much better
than that of any other applicant. And when it was suggested to
me that I wasn’t giving “academic due process,” I replied that I
was the one being true to academic values because I was using
academic research showing the poor predictive value of
impressions from face-to-face interviews.
Because man is likely to be overinﬂuenced by face-to-face
impressions that, by deﬁnition, involve his active participation, a
job candidate who is a marvelous presenter often causes great

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danger under modern executive search practice. In my opinion,
Hewlett-Packard faced just such a danger when it interviewed
the articulate, dynamic Carly Fiorina in its search for a new CEO.
I believe that 1) Hewlett-Packard made a bad decision when it
chose Ms. Fiorina, and 2) this bad decision would not have been
made if Hewlett-Packard had taken the methodological
precautions it would have taken if it knew more psychology.
There is a famous passage somewhere in Tolstoy that
illuminates the power of excessive self-regard tendency.
According to Tolstoy, the worst criminals don’t appraise
themselves as all that bad. They come to believe either that 1)
they didn’t commit their crimes or 2) considering the pressures
and disadvantages of their lives, it is understandable and
forgivable that they behaved as they did and became what they
became.
The second half of the Tolstoy effect, wherein the man makes
excuses for his ﬁxable poor performance instead of providing
the ﬁx, is enormously important. Because a majority of mankind
will try to get along by making way too many unreasonable
excuses for ﬁxable poor performance, it is very important to
have personal and institutional antidotes limiting the ravages of
such folly.
On the personal level, a man should try to face the two simple
facts: 1) Fixable but unﬁxed bad performance is bad character
and tends to create more of itself, causing more damage to the
excuse-giver with each tolerated instance; and 2) in demanding
places, like athletic teams and General Electric, you are almost
sure to be discarded in due course if you keep giving excuses
instead of behaving as you should.
The main institutional antidotes to this part of the Tolstoy
effect are 1) a fair, meritocratic, demanding culture, plus
personnel handling methods that build up morale; and 2)
severance of the worst offenders.

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Of course, when you can’t sever, as in the case of your own
child, you must try to ﬁx the child as best you can. I once heard of
a child teaching method so effective that the child remembered
the learning experience over 50 years later. The child later
became dean of the USC School of Music, and then related to me
what his father said when he saw his child taking candy from the
stock of his employer with the excuse that he intended to replace
it later. The father said, “Son, it would be better for you to simply
take all you want and call yourself a thief every time you do it.”
The best antidote to folly from an excess of self-regard is to
force yourself to be more objective when you are thinking about
yourself, your family and friends, your property, and the value of
your past and future activity. This isn’t easy to do well and won’t
work perfectly, but it will work much better than simply letting
psychological nature take its normal course.
While an excess of self-regard is often counterproductive in
its effects on cognition, it can cause some weird successes from
overconﬁdence that happens to cause success. This factor
accounts for the adage “Never underestimate the man who
overestimates himself.”
Of course, some high self-appraisals are correct and serve
better than false modesty. Moreover, self-regard in the form of a
justiﬁed pride in a job well done, or a life well lived, is a large
constructive force. Without such justiﬁed pride, many more
airplanes would crash. “Pride” is another word generally left out
of psychology textbooks, and this omission is not a good idea. It
is also not a good idea to construe the Bible’s parable about the
Pharisee and the publican97 as condemning all pride.
Of all forms of useful pride, perhaps the most desirable is a
justiﬁed pride in being trustworthy. Moreover, the trustworthy
man, even after allowing for the inconveniences of his chosen
course, ordinarily has a life that averages out better than he
would have if he provided less reliability.

## Page 353

THIRTEEN
Overoptimism tendency
About three centuries before the birth of Christ, Demosthenes,
the most famous Greek orator, said, “What a man wishes, that
also will he believe.”
Demosthenes, parsed out, was thus saying that man displays
not only simple, pain-avoiding psychological denial but also an
excess of optimism, even when he is already doing well.
The Greek orator was clearly right about an excess of
optimism being the normal human condition, even when pain or
the threat of pain is absent. Witness happy people buying lottery
tickets or believing that credit-furnishing, delivery-making
grocery stores were going to displace a great many superefﬁcient
cash-and-carry supermarkets.
One standard antidote to foolish optimism is trained, habitual
use of the simple probability math of Fermat and Pascal, taught
in my youth to high school sophomores. The mental rules of
thumb that evolution gives you to deal with risk are not
adequate. They resemble the dysfunctional golf grip you would
have if you relied on a grip driven by evolution instead of golf
lessons.
FOURTEEN
Deprival-superreaction tendency
The quantity of man’s pleasure from a $10 gain does not exactly
match the quantity of his displeasure from a $10 loss. That is, the
loss seems to hurt much more than the gain seems to help.
Moreover, if a man almost gets something he greatly wants and
has it jerked away from him at the last moment, he will react
much as if he had long owned the reward and had it jerked away.

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I include the natural human reactions to both kinds of loss
experience—the loss of the possessed reward and the loss of the
almost-possessed reward—under one description, deprival-
superreaction tendency.
In displaying deprival-superreaction tendency, man
frequently incurs disadvantage by misframing his problems. He
will often compare what is near instead of what really matters.
For instance, a man with $10 million in his brokerage account
will often be extremely irritated by the accidental loss of $100
out of the $300 in his wallet.
The Mungers once owned a tame and good-natured dog that
displayed the canine version of deprival-superreaction tendency.
There was only one way to get bitten by this dog, and that was to
try and take some food away from him after he already had it in
his mouth. If you did that, this friendly dog would automatically
bite. He couldn’t help it. Nothing could be more stupid than for
the dog to bite his master. But the dog couldn’t help being foolish.
He had an automatic deprival-superreaction tendency in his
nature.
Humans are much the same as this Munger dog. A man
ordinarily reacts with irrational intensity to even a small loss, or
threatened loss, of property, love, friendship, dominated
territory, opportunity, status, or any other valued thing. As a
natural result, bureaucratic inﬁghting over the threatened loss of
dominated territory often causes immense damage to an
institution as a whole. This factor, among others, accounts for
much of the wisdom of Jack Welch’s long ﬁght against
bureaucratic ills at General Electric. Few business leaders have
ever conducted wiser campaigns.
Deprival-superreaction tendency often protects ideological or
religious views by triggering dislike and hatred directed toward
vocal nonbelievers. This happens in part because the ideas of the
non believers, if they spread, will diminish the inﬂuence of views

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that are now supported by a comfortable environment, including
a strong belief-maintenance system. University liberal arts
departments, law schools, and business organizations all display
plenty of such ideology-based groupthink that rejects almost all
conﬂicting inputs. When the vocal critic is a former believer,
hostility is often boosted both by 1) a concept of betrayal that
triggers additional deprival-superreaction tendency because a
colleague is lost, and 2) fears that conﬂicting views will have
extra persuasive power when they come from a former
colleague.
The foregoing considerations help account for the old idea of
heresy, which for centuries justiﬁed much killing of heretics,
frequently after torture and frequently accomplished by burning
the victim alive. It is almost everywhere the case that extremes of
ideology are maintained with great intensity and with great
antipathy to nonbelievers, causing extremes of cognitive
dysfunction. This happens, I believe, because two psychological
tendencies are usually acting concurrently toward this same sad
result: 1) inconsistency-avoidance tendency, plus 2) deprival-
superreaction tendency.
One antidote to intense, deliberate maintenance of
groupthink is an extreme culture of courtesy, kept in place
despite ideological differences, like the behavior of the justices
now serving on the US Supreme Court. Another antidote is to
deliberately bring in able and articulate disbelievers of
incumbent groupthink. Successful corrective measures to evil
examples of groupthink maintenance have included actions like
that of Derek Bok when, as president of Harvard, he started
disapproving tenure appointments proposed by ideologues at
Harvard Law School.
Even a 1-degree loss from a 180-degree view will sometimes
create enough deprival-superreaction tendency to turn a
neighbor into an enemy, as I once observed when I bought a

## Page 356

house from one of two neighbors locked into hatred by a tiny tree
newly installed by one of them. As the case of these two
neighbors illustrated, the clamor of almost any group of
neighbors displaying irrational, extreme deprival-superreaction
over some triﬂe in a zoning hearing is not a pretty thing to watch.
Such bad behavior drives some people from the zoning ﬁeld. I
once bought some golf clubs from an artisan who was formerly a
lawyer. When I asked him what kind of law he had practiced, I
expected to hear him say divorce law. But his answer was zoning
law.
Deprival-superreaction tendency has ghastly effects in labor
relations. Most of the deaths in the labor strife that occurred
before World War I came when employers tried to reduce wages.
Nowadays we see fewer deaths and more occasions when whole
companies disappear, as competition requires either takeaways
from labor—which it will not consent to—or the death of the
business. Deprival-superreaction tendency causes much of this
labor resistance, often in cases where it would be in labor’s
interest to make a different decision.
In contexts other than labor relations, takeaways are also
difﬁcult to get. Many tragedies therefore occur that would have
been avoided had there been more rationality and less
subconscious heed of the imperative from deprival-
superreaction tendency.
Deprival-superreaction tendency is also a huge contributor to
ruin from the compulsion to gamble. First, it causes the gambler
to have a passion to get even once he has suffered a loss, and the
passion grows with the loss. Second, the most addictive forms of
gambling provide a lot of near misses, and each one triggers
deprival-superreaction tendency. Some slot machine creators
are vicious in exploiting this weakness of man. Electronic
machines enable these creators to produce a lot of meaningless

## Page 357

bar-bar-lemon results that greatly increase play by fools who
think they have very nearly won large rewards.
Deprival-superreaction tendency often does much damage to
man in open-outcry auctions. The social proof that we will next
consider tends to convince man that the last price from another
bidder was reasonable, and then deprival-superreaction
tendency prompts him strongly to top the last bid. The best
antidote to being thus triggered into paying foolish prices at
open-outcry auctions is the simple Buffett practice: Don’t go to
such auctions.
Deprival-superreaction tendency and inconsistency-
avoidance tendency often join to cause one form of business
failure. In this form of ruin, a man gradually uses up all his good
assets in a fruitless attempt to rescue a big venture going bad.
One of the best antidotes to this folly is good poker skill learned
young. The teaching value of poker demonstrates that not all
effective teaching occurs on a standard academic path.
I, myself, the would-be instructor here, many decades ago
made a big mistake caused in part by the subconscious
operation of my deprival-superreaction tendency. A friendly
broker called and offered me 300 shares of ridiculously
underpriced, very thinly traded Belridge Oil at $115 per share,
which I purchased using cash I had on hand. The next day, he
offered me 1,500 more shares at the same price, which I
declined to buy, partly because I could only have made the
purchase had I sold something or borrowed the required
$173,000.
This was a very irrational decision. I was a well-to-do man
with no debt; there was no risk of loss, and similar no-risk
opportunities were not likely to come along. Within two years,
Belridge Oil sold out to Shell at a price of about $3,700 per share,
which made me about $5.4 million poorer than I would have

## Page 358

been had I then been psychologically acute. As this tale
demonstrates, psychological ignorance can be very expensive.
Some people may question my deﬁning deprival-
superreaction tendency to include reaction to proﬁt barely
missed, as in the well-documented responses of slot machine
players. However, I believe that I haven’t deﬁned the tendency as
broadly as I should.
My reason for suggesting an even broader deﬁnition is that
many Berkshire Hathaway shareholders I know never sell or give
away a single share after immense gains in market value have
occurred. Some of this reaction is caused by rational calculation,
and some is no doubt attributable to some combination of 1)
reward super response, 2) status quo bias from inconsistency-
avoidance tendency, and 3) the endowment effect from excessive
self-regard tendency. But I believe the single strongest irrational
explanation is a form of deprival-superreaction tendency. Many
of these shareholders simply can’t stand the idea of having their
Berkshire Hathaway holdings smaller. Partly they dislike facing
what they consider an impairment of identity, but mostly they
fear missing out on future gains from stock sold or given away.
FIFTEEN
Social-proof tendency
The otherwise complex behavior of man is much simpliﬁed
when he automatically thinks and does what he observes to be
thought and done around him. Such followership often works
ﬁne. For instance, what simpler way could there be to ﬁnd out
how to walk to a big football game in a strange city than by
following the ﬂow of the crowd? For some such reason, man’s
evolution left him with social-proof tendency, an automatic

## Page 359

tendency to think and act as he sees others around him thinking
and acting.
Psychology professors love social-proof tendency because in
their experiments it causes ridiculous results. For instance, if a
professor arranges for some stranger to enter an elevator
wherein 10 compliance practitioners are all silently standing so
that they face the rear of the elevator, the stranger will often turn
around and do the same. The psychology professors can also use
social-proof tendency to cause people to make large and
ridiculous measurement errors.
And, of course, teenagers’ parents usually learn more than
they would like about teenagers’ cognitive errors from social-
proof tendency. This phenomenon was recently involved in a
breakthrough by Judith Rich Harris,98 who demonstrated that
super-respect by young people for their peers, rather than for
parents or other adults, is ordained to some considerable extent
by the genes of the young people. This makes it wise for parents
to rely more on manipulating the quality of the peers than on
exhortations to their own offspring. A person like Ms. Harris who
can provide an insight of this quality and utility backed by new
reasons has not lived in vain.
In the highest reaches of business, it is not uncommon to ﬁnd
leaders who display followership akin to that of teenagers. If one
oil company foolishly buys a mine, other oil companies often
quickly join in buying mines. So too if the purchased company
makes fertilizer. Both of these oil-company buying fads actually
bloomed, with bad results.
Of course, it is difﬁcult to identify and correctly weigh all the
possible ways to deploy the cash ﬂow of an oil company. So oil
company executives, like everyone else, have made many bad
decisions that were quickly triggered by discomfort from doubt.
Going along with social proof provided by the action of other oil
companies ends this discomfort in a natural way.

## Page 360

When will social-proof tendency be most easily triggered?
Here, the answer is clear from many experiments: Triggering
most readily occurs in the presence of puzzlement or stress, and
particularly when both exist.
Because stress intensiﬁes social-proof tendency, disreputable
sales organizations—engaged, for instance, in such action as
selling swampland to schoolteachers—manipulate targets into
situations combining isolation and stress. The isolation
strengthens the social proof provided by both the knaves and the
people who buy ﬁrst, and the stress, often increased by fatigue,
augments the targets’ susceptibility to the social proof. And, of
course, the techniques of our worst “religious” cults imitate
those of the knavish salesmen. One cult even used rattlesnakes
to heighten the stress felt by conversion targets.
Because both bad and good behavior are made contagious by
social-proof tendency, it is highly important that human
societies 1) stop any bad behavior before it spreads and 2) foster
and display all good behavior.
My father once told me that just after commencing law
practice in Omaha, he went with a large group from Nebraska to
South Dakota to hunt pheasants. A South Dakota hunting license
was, say, $2 for South Dakota residents and $5 for nonresidents.
All the Nebraska residents, one by one, signed up for South
Dakota licenses with phony South Dakota addresses until it was
my father’s turn. Then, according to him, he barely prevented
himself from doing what the others were doing, which was some
sort of criminal offense.
Not everyone so resists the social contagion of bad behavior.
And therefore we often get Serpico syndrome, named to
commemorate the state of a near-totally corrupt New York police
division joined by Frank Serpico. He was then nearly murdered
by gunﬁre because of his resistance to going along with the
corruption in the division. Such corruption was being driven by

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social proof plus incentives, the combination that creates
Serpico syndrome. The Serpico story should be taught more than
it is because the didactic power of its horror is aimed at a very
important evil, driven substantially by a very important force:
social proof.
In social proof, it is not only action by others that misleads but
also their inaction. In the presence of doubt, inaction by others
becomes social proof that inaction is the right course. Thus, the
inaction of a great many bystanders led to the death of Kitty
Genovese in a famous incident much discussed in introductory
psychology courses.
In the ambit of social proof, the outside directors on a
corporate board usually display the near ultimate form of
inaction. They fail to object to anything much short of an axe
murder until some public embarrassment of the board ﬁnally
causes their intervention. A typical board of directors culture
was once well described by my friend Joe Rosenﬁeld as he said,
“They asked me if I wanted to become a director of Northwest
Bell, and it was the last thing they ever asked me.”
In advertising and sales promotion, social-proof tendency is
about as strong a factor as one could imagine. “Monkey see,
monkey do” is the old phrase that reminds one of how strongly
John will often wish to do something or have something just
because Joe does or has it. One interesting consequence is that
an advertiser will pay a lot to have its soup can instead of
someone else’s in a movie scene involving soup consumption
only in a peripheral way.
Social-proof tendency often interacts in a perverse way with
envy/jealousy and deprival-superreaction tendency. One such
interaction amused my family for years as people recalled the
time when my cousin Russ and I, at ages 3 and 4, fought and
howled over a single surplus shingle while surrounded by a
virtual sea of surplus shingles.

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But the adult versions of this occasion, boosted by
psychological tendencies preserving ideologies, are not funny
and can bring down whole civilizations. The Middle East now
presents just such a threat. By now the resources spent by Jews,
Arabs, and all others over a small amount of disputed land, if
divided arbitrarily among land claimants, would have made
every one better off, even before taking into account any beneﬁt
from reduced threat of war, possibly nuclear.
Outside domestic relations, it is rare now to try to resolve
disputes by techniques including the discussion of impacts from
psychological tendencies. Considering the implications of
childishness that would be raised by such inclusion, and the
defects of psychology as now taught, this result may be sound.
But given the nuclear stakes now involved and the many failures
in important negotiations lasting decades, I often wonder if some
day, in some way, more use of psychological insight will
eventually improve outcomes. If so, correct teaching of
psychology matters a lot. And, if old psychology professors are
even less likely than old physics professors to learn new ways,
which seems nearly certain, then we may, as Max Planck
predicted, need a new generation of psychology professors who
have grown up to think in a different way.
If only one lesson is to be chosen from a package of lessons
involving social-proof tendency and used in self-improvement,
my favorite would be: Learn how to ignore the examples from
others when they are wrong, because few skills are more worth
having.

## Page 363

SIXTEEN
Contrast-misreaction tendency
Because the nervous system of man does not naturally measure
in absolute scientiﬁc units, it must instead rely on something
simpler. The eyes have a solution that limits their programming
needs: The contrast in what is seen is registered. And, as in sight,
so does it go, largely, in the other senses. Moreover, as perception
goes, so goes cognition. The result is man’s contrast-misreaction
tendency.
Few psychological tendencies do more damage to correct
thinking. Small-scale damages involve instances such as man’s
buying an overpriced $1,000 leather dashboard merely because
the price is so low compared to his concurrent purchase of a
$65,000 car. Large-scale damages often ruin lives, as when a
wonderful woman with terrible parents marries a man who
would be judged satisfactory only in comparison to her parents.
Or as when a man takes wife number two, who would be
appraised as all right only in comparison to wife number one.
A particularly reprehensible form of sales practice occurs in
the ofﬁces of some real estate brokers. A buyer from out of the
city, perhaps needing to shift his family there, visits the ofﬁce
with little time available. The salesman deliberately shows the
customer three awful houses at ridiculously high prices. Then he
shows him a merely bad house at a price only moderately too
high. And boom, the broker often makes an easy sale.
Contrast-misreaction tendency is routinely used to cause
disadvantage for customers buying merchandise and services.
To make an ordinary price seem low, the vendor will very
frequently create a highly artiﬁcial price that is much higher
than the price always sought, then advertise his standard price
as a big reduction from his phony price. Even when people know

## Page 364

that this sort of customer manipulation is being attempted, it will
often work to trigger buying. This phenomenon accounts in part
for much advertising in newspapers. It also demonstrates that
being aware of psychological ploys is not a perfect defense.
When a man’s steps are consecutively taken toward disaster,
with each step being very small, the brain’s contrast-misreaction
tendency will often let the man go too far toward disaster to be
able to avoid it. This happens because each step presents so
small a contrast from his present position.
A bridge-playing pal of mine once told me that a frog tossed
into very hot water would jump out, but the same frog would end
up dying if placed in room-temperature water that was later
heated at a very slow rate. My few shreds of physiological
knowledge make me doubt this account. But no matter, because
many businesses die in just the manner claimed by my friend for
the frog. Cognition, misled by tiny changes involving low
contrast, will often miss a trend that is destiny.
One of Ben Franklin’s best-remembered and most useful
aphorisms is “A small leak will sink a great ship.” The utility of
the aphorism is large precisely because the brain so often misses
the functional equivalent of a small leak in a great ship.
SEVENTEEN
Stress-inﬂuence tendency
Everyone recognizes that sudden stress, for instance from a
threat, will cause a rush of adrenaline in the human body,
prompting a faster and more extreme reaction. And everyone
who has taken Psych 101 knows that stress makes social-proof
tendency more powerful. In a phenomenon less well recognized
but still widely known, light stress can slightly improve

## Page 365

performance—say, in examinations—whereas heavy stress
causes dysfunction.
But few people know more about really heavy stress than that
it can cause depression. For instance, most people know that an
“acute stress depression” makes thinking dysfunctional because
it causes an extreme of pessimism, often extended in length and
usually accompanied by activity-stopping fatigue. Fortunately, as
most people also know, such a depression is one of mankind’s
more reversible ailments. Even before modern drugs were
available, many people afﬂicted by depression, such as Winston
Churchill and Samuel Johnson, gained great achievement in life.
Most people know very little about non-depressive mental
breakdowns inﬂuenced by heavy stress. But there is at least one
exception, involving the work of Pavlov when he was in his 70s
and 80s. Pavlov had won a Nobel Prize early in life by using dogs
to work out the physiology of digestion. Then he became world-
famous by working out mere-association responses in dogs,
initially salivating dogs—so much so that changes in behavior
triggered by mere association, like those caused by much
modern advertisement, are today often said to come from
“Pavlovian” conditioning.
What happened to cause Pavlov’s last work was especially
interesting. During the great Leningrad ﬂood of the 1920s,
Pavlov had many dogs in cages. Their habits had been
transformed, by a combination of his Pavlovian conditioning
plus standard reward responses, into distinct and different
patterns. As the waters of the ﬂood came up and receded, many
dogs reached a point where they had almost no airspace between
their noses and the tops of their cages. This subjected them to
maximum stress. Immediately thereafter, Pavlov noticed that
many of the dogs were no longer behaving as they had. The dog
that formerly had liked his trainer now disliked him, for
example.

## Page 366

This result reminds one of modern cognition reversals in
which a person’s love of his parents suddenly becomes hate, as
new love has been shifted suddenly to a cult. The unanticipated,
extreme changes in Pavlov’s dogs would have driven any good
experimental scientist into a near-frenzy of curiosity. That was
indeed Pavlov’s reaction. But not many scientists would have
done what Pavlov next did—which was to spend the rest of his
long life giving stress-induced nervous breakdowns to dogs, after
which he would try to reverse the breakdowns, all the while
keeping careful experimental records.
He found that 1) he could classify dogs so as to predict how
easily a particular dog would break down, 2) the dogs hardest to
break down were also the hardest to return to their pre-
breakdown state, 3) any dog could be broken down, and 4) he
couldn’t reverse a breakdown except by reimposing stress.
Now, practically everyone is revolted by such experimental
treatment of man’s friend, the dog. Moreover, Pavlov was Russian
and did his last work under the Communists. Maybe those facts
account for the present extreme widespread ignorance of
Pavlov’s last work. The two Freudian psychiatrists with whom I
tried many years ago to discuss this work had never heard of it.
And the dean of a major medical school actually asked me,
several years ago, if any of Pavlov’s experiments were
“repeatable” in the experiments of other researchers. Obviously,
Pavlov is now a sort of forgotten hero in medical science.
I ﬁrst found a description of Pavlov’s last work in a popular
paperback, written by some Rockefeller-ﬁnanced psychiatrist,
when I was trying to ﬁgure out 1) how cults worked their horrible
mischief and 2) what the law should say about what parents
could do to “deprogram” children who had become brainwashed
zombies. Naturally, mainstream law objected to the zombies
being physically captured by their parents and next subjected to

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stress that would help to deprogram the effects of the stress they
had endured in cult conversions.
I never wanted to get into the legal controversy that existed
about this subject. But I did conclude that the controversy
couldn’t be handled with maximized rationality without
considering whether, as Pavlov’s last work suggests, the heavy-
handed imposition of stress might be the only reversal method
that would work to remedy one of the worst evils imaginable: a
stolen mind. I have included this discussion of Pavlov 1) partly
out of general antagonism toward taboos, 2) partly to make my
talk reasonably complete as it considers stress, and 3) partly
because I hope some listener may continue my inquiry with
more success.
EIGHTEEN
Availability-misweighing tendency
This mental tendency echoes the words of the song “When I’m
not near the girl I love, I love the girl I’m near.” Man’s imperfect,
limited-capacity brain easily drifts into working with what’s
easily available to it. And the brain can’t use what it can’t
remember or what it is blocked from recognizing because it is
heavily inﬂuenced by one or more psychological tendencies
bearing strongly on it, as the fellow is inﬂuenced by the nearby
girl in the song. So the mind overweighs what is easily available
and thus displays availability-misweighing tendency.
The main antidote to miscues from availability-misweighing
tendency often involve procedures, including the use of
checklists, which are almost always helpful. Another antidote is
to behave somewhat like Darwin did when he emphasized
disconﬁrming evidence: What should be done is to especially
emphasize factors that don’t produce reams of easily available

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numbers instead of drifting mostly or entirely into considering
factors that do produce such numbers. Still another antidote is to
ﬁnd and hire some skeptical, articulate people with far-reaching
minds to act as advocates for notions that are opposite to the
incumbent notions.
One consequence of this tendency is that extra-vivid
evidence, being so memorable and thus more available in
cognition, should often consciously be underweighed, while less
vivid evidence should be overweighed. Still, the special strength
of extra-vivid images in inﬂuencing the mind can be
constructively used 1) in persuading someone else to reach a
correct conclusion or 2) as a device for improving one’s own
memory by attaching vivid images, one after the other, to many
items one doesn’t want to forget. Indeed, such use of vivid
images as memory boosters is what enabled the great orators of
classical Greece and Rome to give such long, organized speeches
without using notes.
The great algorithm to remember in dealing with this
tendency is simple: An idea or a fact is not worth more merely
because it is easily available to you.
NINETEEN
Use-it-or-lose-it tendency
All skills attenuate with disuse. I was a whiz at calculus until age
20, after which the skill was soon obliterated by total nonuse.
The right antidote to such a loss is to make use of the functional
equivalent of the aircraft simulator employed in pilot training.
This allows a pilot to continuously practice all of the rarely used
skills that he can’t afford to lose.
Throughout his life, a wise man engages in practice of all his
useful, rarely used skills, many of them outside his discipline, as

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a sort of duty to his better self. If he reduces the number of skills
he practices, and therefore the number of skills he retains, he
will naturally drift into error from man-with-a-hammer
tendency. His learning capacity will also shrink as he creates
gaps in the latticework of theory he needs as a framework for
understanding new experience. It is also essential for a thinking
man to assemble his skills into a checklist that he routinely uses.
Any other mode of operation will cause him to miss much that is
important.
Skills of a very high order can be maintained only with daily
practice. The pianist [Ignacy Jan] Paderewski once said that if he
failed to practice for a single day, he could notice his
performance deterioration, and that after a week’s gap in
practice, the audience could notice it as well.
The hard rule of use-it-or-lose-it tendency tempers its
harshness for the diligent. If a skill is raised to ﬂuency, instead of
merely being crammed in brieﬂy to enable one to pass some test,
then the skill 1) will be lost more slowly and 2) will come back
faster when refreshed with new learning. These are not minor
advantages, and a wise man engaged in learning some important
skill will not stop until he is really ﬂuent in it.
TWENTY
Drug-misinﬂuence tendency
This tendency’s destructive power is so widely known to be
intense, with frequent tragic consequences for cognition and the
outcome of life, that it needs no discussion here to supplement
that previously given under “Simple, pain-avoiding
psychological denial.”

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TWENTY-ONE
Senescence-misinﬂuence tendency
With advanced age there comes a natural cognitive decay,
differing among individuals in the earliness of its arrival and the
speed of its progression. Practically no one is good at learning
complex new skills when very old. But some people remain
pretty good at maintaining intensely practiced old skills until
late in life, as one can notice in many a bridge tournament.
Old people like me get pretty skilled, without working at it, at
disguising age-related deterioration because social convention,
like clothing, hides much decline. Continuous thinking and
learning, done with joy, can somewhat help delay what is
inevitable.
TWENTY-TWO
Authority-misinﬂuence tendency
Living in dominance hierarchies as he does, like all his ancestors
before him, man was born mostly to follow leaders, with only a
few people doing the leading. And so, human society is formally
organized into dominance hierarchies, with their culture
augmenting the natural follow-the-leader tendency of man.
But automatic as most human reactions are, with the
tendency to follow leaders being no exception, man is often
destined to suffer greatly when the leader is wrong or when his
leader’s ideas don’t get through properly in the bustle of life and
are misunderstood. And so we ﬁnd much miscognition from
man’s authority-misinﬂuence tendency.
Some of the misinﬂuences are amusing, as in a case
described by Cialdini. A physician left a written order for a nurse
treating an earache, as follows: “Two drops, twice a day, r. ear.”

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The nurse then directed the patient to turn over and put the
eardrops in his anus.
Other versions of confused instructions from authority
ﬁgures are tragic. In World War II, a new pilot for a general who
sat beside him in the copilot’s seat was so anxious to please his
boss that he misinterpreted some minor shift in the general’s
position as a direction to do some foolish thing. The pilot
crashed the plane and became a paraplegic. Well, naturally,
cases like this one get the attention of careful thinkers like Boss
Buffett, who always acts like an over-quiet mouse around his
pilots.
Such cases are also given attention in the simulator training
of copilots who have to learn to ignore certain really foolish
orders from boss pilots, because boss pilots will sometimes err
disastrously. Even after going through such a training regime,
however, copilots in simulator exercises will too often allow the
simulated plane to crash because of some extreme and perfectly
obvious simulated error of the chief pilot.
After Corporal Hitler had risen to dominate Germany, leading
a bunch of believing Lutherans and Catholics into orgies of
genocide and other mass destruction, one clever psychology
professor, Stanley Milgram, decided to do an experiment to
determine exactly how far authority ﬁgures could lead ordinary
people into gross misbehavior. In this experiment, a man posing
as an authority ﬁgure, namely a professor governing a
respectable experiment, was able to trick a great many ordinary
people into giving what they had every reason to believe were
massive electric shocks that inﬂicted heavy torture on innocent
fellow citizens. This experiment did demonstrate a terrible result
contributed to by authority-misinﬂuence tendency, but it also
demonstrated extreme ignorance in the psychology
professoriate right after World War II.

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Almost any intelligent person with my checklist of
psychological tendencies in his hand would, by simply going
down the checklist, have seen that Milgram’s experiment
involved about six powerful psychological tendencies acting in
conﬂuence to bring about his extreme experimental result. For
instance, the person pushing Milgram’s shock lever was given
much social proof from the presence of inactive bystanders,
whose silence communicated that his behavior was okay. Yet it
took over a thousand psychological papers, published before I
got to Milgram, for the professoriate to get his experiment only
about 90 percent as well understood as it would have
immediately been by any intelligent person who used 1) any
sensible organization of psychology along the lines of this talk,
plus 2) a checklist procedure. This outcome displaying the
dysfunctional thinking of long-dead professors deserves a better
explanation. I will later deal with the subject in a very hesitant
fashion.
We can be pleased that the psychology professoriate of a
former era wasn’t quite as dysfunctional as the angler in my
next-to-last illustration of authority-misinﬂuence tendency.
When I once ﬁshed in the Rio Colorado in Costa Rica, my guide,
in a state of shock, told me a story about an angler who’d earlier
come to the river without ever having ﬁshed for tarpon. A ﬁshing
guide like the one I had runs the boat and gives ﬁshing advice,
establishing himself in this context as the ultimate authority
ﬁgure. In the case of this guide, his native language was Spanish,
while the angler’s native language was English. The angler got a
big tarpon on and began submitting to many directions from this
authority ﬁgure called a guide: tip up, tip down, reel in, etc.
Finally, when it was necessary to put more pressure on the ﬁsh
by causing more bending of the angler’s rod, the guide said in
English, “Give him the rod, give him the rod.” Well, the angler
threw his expensive rod at the ﬁsh, and when last seen, it was

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going down the Rio Colorado toward the ocean. This example
shows how powerful is the tendency to go along with an
authority ﬁgure and how it can turn one’s brain into mush.
My ﬁnal example comes from business. A psychology PhD
once became a CEO of a major company and went wild, creating
an expensive new headquarters, with a great wine cellar, at an
isolated site. At some point, his underlings remonstrated that
money was running short. “Take the money out of the
depreciation reserves,” said the CEO. Not too easy, because a
depreciation reserve is a liability account. So strong is undue
respect for authority that this CEO, and many even worse
examples, have actually been allowed to remain in control of
important business institutions for long periods after it was clear
they should be removed.
The obvious implication: Be careful whom you appoint to
power, because a dominant authority ﬁgure will often be hard to
remove, aided as he will be by authority-misinﬂuence tendency.
TWENTY-THREE
Twaddle tendency
Man, as a social animal who has the gift of language, is born to
prattle and pour out twaddle that does much damage when
serious work is being attempted. Some people produce copious
amounts of twaddle, and others very little.
Trouble from the honeybee version of twaddle was once
demonstrated in an interesting experiment. A honeybee
normally goes out and ﬁnds nectar and then comes back and
does a dance that communicates to the other bees where the
nectar is. The other bees then go out and get it. Well, some
scientist—clever, like B. F. Skinner—decided to see how well a
honeybee would do with a handicap. He put the nectar straight

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up. Way up. Well, in a natural setting, there is no nectar a long
way straight up, and the poor honeybee doesn’t have a genetic
program that is adequate to handle what she now has to
communicate. You might guess that this honeybee would come
back to the hive and slink into a corner, but she doesn’t. She
comes into the hive and does an incoherent dance.
Well, all my life I’ve been dealing with the human equivalent
of that honeybee. It’s a very important part of wise
administration to keep prattling people pouring out twaddle far
away from the serious work.
A rightly famous Caltech engineering professor, exhibiting
more insight than tact, once expressed his version of this idea as
follows: “The principal job of an academic administration is to
keep the people who don’t matter from interfering with the work
of the people who do.”
I include this quotation partly because I long suffered from
backlash caused by my version of this professor’s conversational
manner. After much effort, I was able to improve only slightly, so
one of my reasons for supplying the quotation is my hope that, at
least in comparison, I will appear tactful.
TWENTY-FOUR
Reason-respecting tendency
There is in man, particularly one in an advanced culture, a
natural love of accurate cognition and a joy in its exercise. This
accounts for the widespread popularity of crossword puzzles,
other puzzles, and bridge and chess columns, as well as all
games requiring mental skill.
This tendency has an obvious implication. It makes man
especially prone to learn well when a would-be teacher gives
correct reasons for what is taught instead of simply laying out

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the desired belief ex cathedra with no reasons given. Few
practices, therefore, are wiser than not only thinking through
reasons before giving orders but also communicating these
reasons to the recipient of the order.
No one knew this better than Carl Braun, who designed oil
reﬁneries with spectacular skill and integrity. He had a very
simple rule, one of many in his large, Teutonic company: You had
to tell who was to do what, where, when, and why. And if you wrote
a communication leaving out your explanation of why the
addressee was to do what was ordered, Braun was likely to ﬁre
you, because Braun well knew that ideas got through best when
the reasons for the ideas were meticulously laid out.
In general, learning is most easily assimilated and used when,
lifelong, people consistently hang their experience, actual and
vicarious, on a latticework of theory answering the question
“Why?” Indeed, the question “Why?” is a sort of Rosetta stone
opening up the major potentiality of mental life.
Unfortunately, reason-respecting tendency is so strong that
even a person’s giving of meaningless or incorrect reasons will
increase compliance with his orders and requests. This has been
demonstrated in psychology experiments wherein compliance
practitioners successfully jump to the head of the lines in front of
copying machines by explaining their reason: “I have to make
some copies.”
This sort of unfortunate byproduct of reason-respecting
tendency is a conditioned reﬂex based on a widespread
appreciation of the importance of reasons. Naturally, the
practice of laying out various claptrap reasons is much used by
commercial and cult compliance practitioners to help them get
what they don’t deserve.

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TWENTY-FIVE
Lollapalooza tendency—the tendency to get extreme
consequences from conﬂuences of psychological
tendencies acting in favor of a particular outcome
This tendency was not in any of the psychology texts I once
examined, at least in any coherent fashion, yet it dominates life.
It accounts for the extreme result in the Milgram experiment and
the extreme success of some cults that have stumbled through
practice evolution into bringing pressure from many
psychological tendencies to bear at the same time on conversion
targets. The targets vary in susceptibility, like the dogs Pavlov
worked with in his old age, but some of the minds that are
targeted simply snap into zombiedom under cult pressure.
Indeed, that is one cult’s name for the conversion phenomenon:
snapping.
What are we to make of the extreme ignorance of the
psychology textbook writers of yesteryear? How could anyone
who had taken a freshman course in physics or chemistry not be
driven to consider, above all, how psychological tendencies
combine and with what effects? Why would anyone think his
study of psychology was adequate without his having endured
the complexity involved in dealing with intertwined
psychological tendencies? What could be more ironic than
professors using oversimpliﬁed notions while studying bad
cognitive effects grounded in the mind’s tendency to use
oversimpliﬁed algorithms?
I will make a few tentative suggestions. Maybe many of the
long-dead professors wanted to create a whole science from one
narrow type of repeatable psychology experiment that was
conductible in a university setting and that aimed at one
psychological tendency at a time. If so, these early psychology

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professors made a massive error in so restricting their approach
to their subject. It would be like physics ignoring 1) astrophysics,
because it couldn’t happen in a physics lab, plus 2) all compound
effects.
What psychological tendencies could account for early
psychology professors adopting an over-restricted approach to
their own subject matter? One candidate would be availability-
misweighing tendency grounded in a preference for easy-to-
control data. And then the restrictions would eventually create
an extreme case of man-with-a-hammer tendency. Another
candidate might be envy/jealousy tendency, through which early
psychology professors displayed some weird form of envy of a
physics that was misunderstood. This possibility tends to
demonstrate that leaving envy/jealousy out of academic
psychology was never a good idea.
I now quitclaim all these historical mysteries to my betters.
Well, that ends my brief description of psychological
tendencies.
QUESTIONS AND ANSWERS
Now, as promised, I will ask and answer a few general questions.
My ﬁrst is a compound question: Isn’t this list of psychological
tendencies tautological to some extent compared to the system
of Euclid? That is, aren’t there overlaps in the tendencies? And
couldn’t the system be laid out just as plausibly in a somewhat
different way? The answers are yes, yes, and yes, but this matters
only moderately. Further reﬁnement of these tendencies, while
desirable, has a limited practical potential because a signiﬁcant
amount of messiness is unﬁxable in a soft science like
psychology.

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My second question is: Can you supply a real-world model,
instead of a Milgram-type controlled psychology experiment,
that uses your system to illustrate multiple psychological
tendencies interacting in a plausibly diagnosable way? The
answer is yes. One of my favorite cases involves the McDonnell
Douglas airliner evacuation test.
Before a new airliner can be sold, the government requires
that it pass an evacuation test, during which a full load of
passengers must get out in some short period of time. The
government directs that the test be realistic, so you can’t pass by
evacuating only 20-year-old athletes. So McDonnell Douglas
scheduled such a test in a darkened hangar using a lot of old
people as evacuees. The passenger cabin was, say, 20 feet above
the concrete ﬂoor of the hangar and was to be evacuated through
moderately ﬂimsy rubber chutes. The ﬁrst test was made in the
morning. There were about 20 very serious injuries, and the
evacuation took so long it ﬂunked the time test. So what did
McDonnell Douglas next do? It repeated the test in the afternoon,
and this time there was another failure, with about 20 more
serious injuries, including one case of permanent paralysis.
What psychological tendencies contributed to this terrible
result? Well, using my tendency list as a checklist, I come up with
the following explanation:
Reward-superresponse tendency drove McDonnell Douglas to
act fast. It couldn’t sell its airliner until it passed the test. Also
pushing the company was doubt-avoidance tendency, with its
natural drive to arrive at a decision and run with it. Then the
government’s direction that the test be realistic drove authority-
misinﬂuence tendency into the mischief of causing McDonnell
Douglas to overreact by using what was obviously too dangerous
a test method. By now the course of action had been decided, so
inconsistency-avoidance tendency helped preserve the near-
idiotic plan. When all the old people got to the dark hangar, with

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its high airline cabin and concrete ﬂoor, the situation must have
made McDonnell Douglas employees very queasy, but they saw
other employees and supervisors not objecting. Social-proof
tendency, therefore, swamped the queasiness. This allowed
continued action as planned, a continuation that was aided by
more authority-misinﬂuence tendency.
Then came the disaster of the morning test with its failure,
plus serious injuries. McDonnell Douglas ignored the strong
disconﬁrming evidence from the failure of the ﬁrst test because
conﬁrmation bias, aided by the triggering of a strong deprival-
superreaction tendency, favored maintaining the original plan.
McDonnell Douglas’s deprival-suppereaction tendency was now
like that which causes a gambler, bent on getting even after a
huge loss, to make his ﬁnal big bet. After all, McDonnell Douglas
was going to lose a lot if it didn’t pass its test as scheduled.
More psychology-based explanation can probably be made,
but the foregoing discussion is complete enough to demonstrate
the utility of my system when used in a checklist mode.
My third question is also compound: In the practical world,
what good is the thought system laid out in this list of
tendencies? Isn’t practical beneﬁt prevented because these
psychological tendencies are so thoroughly programmed into
the human mind by broad evolution—the combination of genetic
and cultural evolution—that we can’t get rid of them?
Well, the answer is that the tendencies are probably much
more good than bad. Otherwise, they wouldn’t be there, working
pretty well for man, given his condition and his limited brain
capacity. So the tendencies can’t be simply washed out
automatically, and shouldn’t be. Nevertheless, the psychological
thought system described, when properly understood and used,
enables the spread of wisdom and good conduct and facilitates
the avoidance of disaster. Tendency is not always destiny, and

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knowing the tendencies and their antidotes can often help
prevent trouble that would otherwise occur.
Here is a short list of examples reminding us of the great
utility of elementary psychological knowledge:
1. Carl Braun’s communication practices.
2. The use of simulators in pilot training.
3. The system of Alcoholics Anonymous.
4. Clinical training methods in medical schools.
5. The rules of the US Constitutional Convention: totally
secret meetings, no recorded vote by name until the ﬁnal
vote, votes reversible at any time before the end of the
convention, then just one vote on the whole Constitution.
These are very clever, psychology-respecting rules. If the
founders had used a different procedure, many people
would have been pushed by various psychological
tendencies into inconsistent, hardened positions. The elite
founders got our Constitution through by a whisker only
because they were psychologically acute.
6. The use of granny’s incentive-driven rule to manipulate
one self toward better performance of one’s duties.
7. The Harvard Business School’s emphasis on decision
trees. When I was young and foolish, I used to laugh at the
Harvard Business School. I said, “They’re teaching 28-
year-old people that high school algebra works in real
life?” But later, I wised up and realized that it was very
important that they do that to counter some bad effects
from psychological tendencies. Better late than never.
8. The use of autopsy equivalents at Johnson & Johnson. At
most corporations, if you make an acquisition and it turns
out to be a disaster, all the people, paperwork, and

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presentations that caused the foolish acquisition are
quickly forgotten. Nobody wants to be associated with the
poor outcome by mentioning it. But at Johnson & Johnson,
the rules make everybody revisit old acquisitions,
comparing predictions with outcomes. That is a very smart
thing to do.
9. The great example of Charles Darwin as he avoided
conﬁrmation bias, which has morphed into the extreme
anti-conﬁrmation bias method of the double-blind studies
wisely required in drug research by the FDA.
10. The Warren Buffett rule for open-outcry auctions: Don’t go.
My fourth question is: What special knowledge problems lie
buried in the thought system demonstrated by your list?
Well, one answer is paradox. In social psychology, the more
people learn about the system, the less it is true, and this is what
gives the system its great value as a preventer of bad outcomes
and a driver of good outcomes. This result is paradoxical and
doesn’t remind one of elementary physics, but so what. One can’t
get all the paradox out of pure math, so why should psychology
be shocked by some paradox?
There is also some paradox in cognition change that works
even when the manipulated person knows he is being
manipulated. This creates a sort of paradox in a paradox, but
again, so what.
I once much enjoyed an occasion of this sort. I drew this
beautiful woman as my dinner partner many years ago. I’d never
seen her before. She was married to a prominent Los Angeles
man. She sat down next to me, turned her beautiful face up, and
said, “Charlie, what one word accounts for your remarkable
success in life?” I knew I was being manipulated by a practiced
routine, and I just loved it. I never see this woman without a little

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lift in my spirits. And, by the way, I told her I was rational. You’ll
have to judge yourself whether that’s true. I may be
demonstrating some psychological tendency I hadn’t planned on
demonstrating.
My ﬁfth question is: Don’t we need more reconciliation of
psychology and economics? My answer is yes, and I suspect that
some slight progress is being made. I have heard of one such
example: Colin Camerer of Caltech, who works in experimental
economics, devised an interesting experiment in which he
caused high-IQ students, playing for real money, to pay price A +
B for a “security” they knew would turn into A dollars at the end
of the day. This foolish action occurred because the students
were allowed to trade with each other in a liquid market for the
security. Some students then paid price A + B because they
hoped to unload on other students at a higher price before the
day was over.
What I will now conﬁdently predict is that, despite Camerer’s
experimental outcome, most economics and corporate ﬁnance
professors who still believe in the hard-form efﬁcient-market
hypothesis will retain their original belief. If so, this will be one
more indication of how irrational smart people can be when
inﬂuenced by psychological tendencies.
My sixth question is: Don’t moral and prudential problems
come with knowledge of these psychological tendencies? The
answer is yes. For instance, psychological knowledge improves
persuasive power, and, like other powers, it can be used for good
or ill. Captain Cook once played a psychology-based trick on his
seamen to cause them to eat sauerkraut and avoid scurvy. In my
opinion, this action was both ethical and wise under the
circumstances, despite the deliberate manipulation involved.
But ordinarily, when you try to use your knowledge of
psychological tendencies in the artful manipulation of someone
whose trust you need, you will be making both a moral and a

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prudential error. The moral error is obvious. The prudential
error comes because many intelligent people, targeted for
conscious manipulation, are likely to ﬁgure out what you are
trying to do and resent your action.
My ﬁnal question is: Aren’t there factual and reasoning errors
in this talk? The answer is yes, almost surely yes. The ﬁnal
revision was made from memory over about 50 hours by a man
81 years old, who never took a course in psychology and has read
none of it, except one book on developmental psychology, for
nearly 15 years.
Even so, I think the totality of my talk will stand up very well,
and I hope all my descendants and friends will carefully consider
what I have said. I even hope that more psychology professors
will join me in 1) making heavy use of inversion, 2) driving for a
complete description of the psychological system so that it works
better as a checklist, and 3) especially emphasizing effects from
combinations of psychological tendencies.
Well, that ends my talk. If in considering what I have said you
had 10 percent the fun I had in saying it, you were lucky
recipients.
TALK ELEVEN REVISITED
In this talk, made in 2000, I gave favorable mention to Judith
Rich Harris’s strong-selling book The Nurture Assumption. You will
recall that this work demonstrated that peer pressure on the
young is far more important, and parental nurture much less
important, than had been commonly recognized.
The success of the book, with its vast practical implications,
has an interesting story behind it. Long before the book was
published, Harris was kicked out of Harvard’s PhD program in
psychology because Harvard believed that she lacked qualities

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ideal in psychological research. Then later, out of illness and
obscurity, as she was pretty much housebound throughout adult
life by unﬁxable auto immune disease, she published an
academic paper on which her subsequent book was based. And
for that paper she won a prestigious medal, named after the man
who signed her dismissal notice from Harvard, awarded
annually by the American Psychological Association for
distinction in published writing.
When I learned from her impressive book that this ironic
result had occurred, I wrote to Harvard, my alma mater, urging it
to award Harris, whom I did not know, an honorary PhD—or,
better yet, a real PhD. I cited the example of Oxford. That great
university once allowed its best student, Samuel Johnson, to
leave without a degree because he was too poor to continue
paying tuition. But Oxford later made gracious amends. It gave
Johnson a doctorate after he conquered sickness and became
famous in a tough climb once described in his own words: “Slow
rises worth, by poverty oppressed.”
I failed utterly in my effort to convince Harvard to imitate
Oxford in this way. But Harvard did later recruit from MIT one of
the most famous living psychology professors, Steven Pinker,
and Pinker is a big admirer of Harris. From this step, we can see
one reason why its liberal arts division is more highly regarded
than most others. The division’s extreme depth often allows
partial correction of bonehead errors that would ﬂourish
unopposed elsewhere.
In 2006, Harris, struggling further through her unﬁxable
illness, published another book, No Two Alike. The title is apt
because one central question the author assaults is why identical
twins turn out to be so different in important aspects of
personality. Her dogged curiosity and rigor in dealing with this
question remind me of both Darwin and Sherlock Holmes. And
her solution is very plausible, as she collects and explains data

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from professional literature, including an interesting case
wherein one of two identical twins became a success in business
and family life while the other twin went to Skid Row.
I won’t here disclose Harris’s desirably generalized answer to
her central question, because it would be better for Almanack
readers to ﬁrst guess the answer, then read her book. If Harris is
roughly right, which seems very likely to me, she has twice, from
a very handicapped position, produced academic insights of
great practical importance in child-rearing, education, and
much else.
How could this rare and desirable result happen? Well, by
Harris’s own account, she was “impertinent and skeptical, even
as a child,” and these qualities, plus patient, determined skill,
have obviously served her truth-seeking well, all the way through
to age 67. No doubt she was also assisted by her enthusiasm in
destroying her own ideas, as she now demonstrates by
apologizing for her former work as a textbook writer who
repeated wrong notions, now outgrown.
In this talk I displayed some impertinency of my own by
delivering an extreme-sounding message. It claims nothing less
than that 1) academic psychology is hugely important; 2) even
so, it is usually ill-thought-out and ill-presented by its PhD
denizens; and 3) my way of presenting psychology often has a
large superiority in practical utility compared to most textbooks.
Naturally, I believe these extreme claims are correct. After all, I
assembled the material contained in this talk to help me succeed
in practical thinking and not to gain advantage by making public
any would-be clever notions.
If I am even partly right, the world will eventually see more
psychology in roughly the form of this talk. If so, I conﬁdently
predict that the change in practice will improve general
competency.

## Page 386

And with that, I have nothing more to add.

## Page 387

Appendix
ENDNOTES
Talk One: Harvard School Commencement Speech
1 A poet, philosopher, rhetorician, and humorist, Marcus
Tullius Cicero (106–43 BC) was also one of Rome’s great orators.
Cicero viewed public service to be a Roman citizen’s highest
duty. He defended those unjustly accused by dictatorial leaders
and brought down corrupt governments. Late in life, he led the
Senate’s unsuccessful battle against Mark Antony, for which he
paid with his life in 43 BC.
2 Samuel Johnson (1709–1784), English author and the
leading literary scholar and critic of his time, was celebrated for
his brilliant and witty conversation. Johnson’s ﬁrst work of
lasting importance, and the one that permanently established
his reputation, was his Dictionary of the English Language (1755).
3 One of the greatest poets of the English language, John Milton
(1608–1674) was best known for his epic poem Paradise Lost
(1667). His powerful prose and the eloquence of his poetry had
an immense inﬂuence, especially on 18th-century verse. Milton
also published pamphlets defending civil and religious rights. To
Samuel Johnson’s point about Milton’s long-windedness, Paradise
Lost runs to 12 books and thousands of lines.

## Page 388

4 Born in Corning, Iowa, Johnny (John William) Carson (1925–
2005) became famous as America’s late-night king of comedy. He
had a popular radio show in Omaha for years and claimed the
city as his hometown. For 30 years, from 1962 to 1992, he
entertained millions as the host of NBC’s The Tonight Show. His
show featured thousands of authors, ﬁlmmakers, actors, singers
—and stand-up comedians, of course, many of whose careers he
launched.
5 Croesus (c. 620–546 BC), legendary for his huge wealth, was
king of Lydia from 585 BC until his defeat by the Persians in
about 546 BC. Upon capture, Croesus supposedly threw himself
upon a funeral pyre.
6 At birth in Lincolnshire, England, Isaac Newton (1642–1727)
was so tiny and frail that he was not expected to live. Yet he lived
into his 80s. During his young adulthood, Newton made
tremendous discoveries in general mathematics, algebra,
geometry, calculus, optics, and celestial mechanics. Most famous
among these discoveries was his description of gravity. The
publication of his book The Mathematical Principles of Natural
Philosophy in 1687 marked the peak of Newton’s creative career.
7 Even though he was born a slave in Hierapolis and endured a
permanent physical disability, Epictetus (55–135) maintained
that all human beings are perfectly free to control their own lives
and to live in harmony with nature. After intense study of the
traditional Stoic curriculum of logic, physics, and ethics,
Epictetus spent his entire career teaching philosophy and
promoting a daily regime of rigorous self-examination. He
eventually gained his freedom but was exiled from Rome by
Domitian in 89.

## Page 389

8 James Clerk Maxwell (1831–1879), born in Edinburgh,
Scotland, demonstrated a very early interest in optics; a favorite
childhood pastime of his was using a mirror to reﬂect the sun’s
rays. His unusual mode of dress earned him the nickname
“Dafty” at Edinburgh Academy. Nonetheless, he was a brilliant
student, excelling in mathematics. He attended Cambridge
University and joined its staff of lecturers following graduation.
His interest in optics led him to study colors and astronomy. He
also made signiﬁcant contributions in the ﬁeld of
electromagnetism, including the ﬁrst proposal that light is a
form of electromagnetic radiation.
9 Albert Einstein (1879–1955) earned a teaching diploma from
a Swiss university and, while working in the Swiss patent ofﬁce
in 1904, wrote his doctoral dissertation on a method to
determine molecular dimensions. That same year and the next,
he wrote several articles that form the foundation of modern
physics. Topics included Brownian motion, the photoelectric
effect, and special relativity. He went on to make major
contributions to the development of quantum mechanics,
statistical mechanics, and cosmology. He won the Nobel Prize for
Physics in 1921.
10 Charles Darwin (1809–1882) was a British naturalist whose
teachings on evolution by natural selection revolutionized the
science of biology. His book On the Origin of Species sold out
immediately and was heavily attacked because it did not support
the depiction of creation given in the Bible.
11 Elihu Root (1845–1937), born in New York and the son of a
mathematics professor, became one of the most brilliant
administrators in American history. By age 30, he had
established himself as a prominent lawyer specializing in

## Page 390

corporate affairs. Shifting to public service, Root distinguished
himself as secretary of war, secretary of state, US senator, and
ambassador to Russia. In the interest of worldwide peace, he
originated many treaties of arbitration. He was awarded the
Nobel Peace Prize in 1912.
Talk Two: A Lesson on Elementary, Worldly Wisdom as It
Relates to Investment Management and Business
12 Henry Emerson, editor and publisher of Outstanding Investor
Digest, has spent 18 years interacting with some of the world’s
greatest money managers, including both Warren Buffett and
Charlie Munger. His indispensable news letter is designed to
“bring our subscribers the most valuable material that we can—
the calendar be damned.” Emerson’s publication is a must-read
for investors of every stripe.
13 Invited by French aristocrat Chevalier de Méré to help resolve
a gambling dispute in the mid-17th century, mathematicians
Pierre de Fermat and Blaise Pascal laid the foundations for
probability theory in a series of letters. De Méré’s question
concerned bets on rolls of a die that at least one six would appear
during four rolls. From experience, he knew he would win more
often than lose at this game. As a diversion, he changed the game
to a bet that he would get a total of 12, or a double six, on 24 rolls
of two dice. The new game was less proﬁtable than the old one.
He asked the mathematicians to determine why this change
occurred.
14 The C. F. Braun Company, a petrochemical engineering and
construction ﬁrm, rose to prominence in the San Gabriel Valley
in the early to mid-20th century. Along with competitors such as

## Page 391

Fluor, Bechtel, and Parsons, Braun designed and built plants
throughout the world. In the early 1980s, Braun was purchased
by Santa Fe International, ably led by Ed Shannon.
15 Born in Iowa but raised in Wyoming from an early age, W.
Edwards Deming (1900–1993) grew up in a four-room tar-paper
shack. A serious student despite his impoverishment, he earned
a PhD in mathematical physics from Yale. He took a job in the
Department of Agriculture but eventually developed a love for
statistical analysis. During World War II, wanting to help the war
effort, Deming sought to apply statistics to manufacturing.
American companies essentially ignored his ideas. Following the
war, Deming went to Japan to teach Japanese managers,
engineers, and scientists how to build quality into their
manufacturing. Only after Japanese manufacturing skill became
apparent to the rest of the world in the 1980s did Deming gain
fame in his home country. The Deming Prize for quality was ﬁrst
awarded in Japan but is now recognized internationally.
16 Born John Francis Welch Jr. in Massachusetts, Jack Welch
(1935–2020) earned a PhD in chemical engineering before
joining General Electric in 1960. He worked his way up the
corporate ladder, becoming chairman and CEO in 1980. During
his 20 years of leadership at GE, Welch increased the value of the
company from $13 billion to several hundred billion dollars.
17 Ivan Pavlov (1849–1936) was born in central Russia and
attended seminary until age 21, when he abandoned theology in
favor of chemistry and physiology. Earning his MD in 1883, he
excelled in physiology and surgical techniques. Later, he studied
the secretory activity of digestion and ultimately formulated the
laws of conditioned reﬂexes. Pavlov’s most famous experiment
showed that dogs tend to salivate before food is actually

## Page 392

delivered to their mouths. This result led him to a long series of
experiments in which he manipulated the stimuli occurring
before the presentation of food. He thereby established the basic
laws for the establishment and extinction of what he called
“conditional reﬂexes,” later mistranslated from the original
Russian as “conditioned reﬂexes.” He was awarded the Nobel
Prize in 1904 for his work on digestive secretions.
18 Founded in 1962 by Sam Walton with just one store in
Rogers, Arkansas, Walmart expanded to 24 stores in only ﬁve
years. In 1970, Walmart moved its distribution center and
corporate headquarters to Bentonville, Arkansas, its current
home. Growth continued throughout the United States and
abroad to today’s Walmart, which has well over 1 million
employees, better than $250 billion in revenues, and a market
capitalization that exceeds $200 billion. The company is well
known for its slavish dedication to offering low prices to
customers.
19 Dr. John Harvey Kellogg and his brother, William, were
experimenting with new, healthy food items for patients at the
Battle Creek Sanitarium in 1894 when they found that, by
running boiled wheat dough through rollers and baking the
result, they produced cereal ﬂakes. William eventually began
production of the new cereal product and, by 1906, was selling
2,900 cases per day. He continued to create new products and
expanded the company into a breakfast food empire. Today,
sales exceed $9 billion annually.
20 Patent: A grant made by a government conferring upon the
creator of an invention the sole right to make, use, and sell that
invention for a set period of time. An invention protected by such
a grant.

## Page 393

Trademark: A name, symbol, or other device identifying a
product, ofﬁcially registered and legally restricted to the use of
the owner or manufacturer. A distinctive characteristic by which
a person or thing comes to be known.
Exclusive franchise: A right or license that is granted solely
to an individual or group to market a company’s goods or
services in a particular territory under the company’s
trademark, trade name, or service mark, and that often involves
the use of rules and procedures designed by the company and
services (as advertising) and facilities provided by the company
in return for fees, royalties, or other compensation; also, a
business granted such a right or license.
21 In 1884, John H. Patterson founded the National Cash
Register (NCR) Corporation, maker of the ﬁrst mechanical cash
registers. Two decades later, NCR introduced the ﬁrst cash
register powered by an electric motor. In the early 1950s, NCR
branched into computer manufacturing for aviation and
business applications. In the late 1990s, the ﬁrm shifted from a
hardware-only company to a full-solution business automation
provider.
22 The pari-mutuel system is a system of betting on races in
which the winners divide the total amount bet, after deducting
management expenses, in proportion to the sums they have
wagered individually.
23 Frederick W. Smith was a Yale undergraduate student in
1965 when he wrote a term paper about the passenger route
systems used by most airfreight companies. He saw the need for
a system designed speciﬁcally for airfreight to accommodate
time-sensitive shipments. In 1971, Smith bought a controlling
interest in Arkansas Aviation Sales. Smith quickly witnessed the

## Page 394

difﬁculty in getting packages and other airfreight delivered
within one to two days. He did the research necessary to create a
more efﬁcient distribution system. Federal Express ofﬁcially
began operating in 1973 with 14 small aircraft based at
Memphis International Airport; eventually, company
headquarters moved to Memphis as well. Unproﬁtable until July
1975, FedEx soon became the premier carrier of high-priority
goods in the marketplace and the standard setter for the
industry it established.
24 Born in London, Benjamin Graham (1894–1976) migrated
with his family to America when he was very young. His father
opened an importing business that quickly failed. Despite the
challenges of poverty, Graham attended and graduated from
Columbia University. He took a job as a chalker on Wall Street
with Newburger, Henderson & Loeb. His intelligence and
capability were soon apparent, and by age 25, he was a partner
at the ﬁrm. The 1929 market crash almost wiped out Graham,
but he learned valuable lessons about investing. In the 1930s,
Graham published a series of books on investing that became
classics. Among these impressive titles are Security Analysis and
The Intelligent Investor. Graham introduced the concept of
intrinsic value and the wisdom of buying stocks at a discount to
that value.
25 President of the Disney Company until his untimely death in
1994, Frank Wells (1932–1994) was greatly respected. For 30
years he carried a scrap of paper in his wallet that read,
“Humility is the essence of life.”
26 Born in Leeds, England, to Polish immigrant parents, Simon
Marks (1888–1964) spent his formative years roaming around
his father’s retail store, Marks & Spencer. Following his

## Page 395

graduation from the rigorous local grammar school (the
equivalent of high school today), Marks went into the family
business. At age 28, he was appointed chairman and led the
Marks & Spencer Company into many retailing innovations and
considerable ﬁnancial success. Outside of his company
obligations, Marks worked passionately for the reestablishment
of a Jewish state.
27 In 1877, Stilson Hutchins launched The Washington Post.
Three years later, the Post became the ﬁrst daily newspaper in
Washington to publish seven times a week. In 1946, Philip
Graham became publisher; he moved up to president of the
paper in 1959. The Post acquired Newsweek magazine and
established a joint news service with The Los Angeles Times in the
early 1960s.
28 King C. Gillette, a traveling hardware salesman who enjoyed
improving the products he sold, learned early that disposable
items made for big sales. In 1895, Gillette had a revelation: If he
could put a sharp edge on a small square of sheet steel, he could
market an economical razor blade that could be thrown away
and replaced when it grew dull. In 1901, Gillette and William
Emery Nickerson formed the American Safety Razor Company
(soon thereafter renamed for Gillette himself). For the ﬁrst time,
razor blades were sold in multiple packages, with the razor
handle as a one-time purchase. Production began in 1903;
Gillette won a patent for his product the next year.
29 Leo and Lillian Goodwin started the Government Employees
Insurance Company (GEICO) during the depths of the Great
Depression in 1936. Their strategy of direct marketing allowed
the company to charge lower premiums while earning a proﬁt.
The company grew quickly, even though it focused at ﬁrst

## Page 396

primarily on federal employees and military ofﬁcers. GEICO
soon expanded its market to the general public. In 1951, Warren
Buffett purchased his ﬁrst shares of the company. He kept
acquiring stock through the years until, in 1996, GEICO became
a wholly owned subsidiary of Berkshire Hathaway.
30 Aristotle identiﬁed Thales of Miletus (620s–546 BC) as the
ﬁrst person to investigate the idea of a basic originating
substance of matter, a distinction making him the founder of the
school of natural philosophy. Thales of Miletus was interested in
almost everything: philosophy, history, science, mathematics,
engineering, geography, and politics. He proposed theories to
explain many of the events of nature and the cause of change.
His questioning approach to the understanding of heavenly
phenomena was the beginning of Greek astronomy. He founded
the Milesian school of natural philosophy and developed the
scientiﬁc method.
Talk Three: A Lesson on Elementary, Worldly Wisdom as It
Relates to Investment Management and Business, Revisited
31 Adam Smith (1723–1790), born in a small village in Scotland,
was an exceptional student and entered the University of
Glasgow at age 14. He later attended Oxford, returned home to
Glasgow, and began an academic career in logic and moral
philosophy. His seminal work, The Wealth of Nations, remains the
fountainhead of contemporary economic thought. Smith’s
explanation of how rational self-interest drives a free-market
economy greatly inﬂuenced thinkers and economists in his own
day and in the generations that followed. His work forms the
basis of classical economics.

## Page 397

32 The Little Red Hen is a classic fable teaching the value of self-
reliance in connection with important things. Charlie’s advice on
self-learning is reminiscent of Mark Twain’s classic line, “I have
never let my schooling interfere with my education.”
33 Raised in rural central Pennsylvania and possessed of little
formal education, Milton S. Hershey (1857–1945) became one of
America’s wealthiest individuals. He started his own candy
business, Lancaster Caramel Company, in 1876 and failed after
only six years. Undaunted, he tried again and had great success.
In 1893, he learned the art of chocolate making and started the
Hershey Chocolate Company. As the company expanded into
other food products, Hershey began to build the Pennsylvania
town that bears his name. Hershey’s utopian ideas and
principles continue to inﬂuence the company and the town.
34 Value Line’s mission is “to help investors get the most
accurate and independently created research information
available, in any format they choose, and teach them how to use
it to meet their ﬁnancial objectives.” In operation since 1931,
Value Line has a solid reputation for reliability, objectivity,
independence, and accuracy. Best known for the Value Line
Investment Survey, the company publishes dozens of print and
electronic research products.
35 In 1899, grocer E.A. Stuart cofounded the Paciﬁc Coast
Condensed Milk Company in the state of Washington based on
the relatively new process of evaporation. Using a local
tobacconist’s store name, Carnation, he had a brand for his new
milk product. Through attention to processes and clever
marketing, Carnation became associated with its “contented
cows” and high-quality milk products. In 1985, the company was
acquired by Nestlé.

## Page 398

36 Born in Montreal in 1954, Steven Pinker earned a degree in
experimental psychology at McGill University and then moved
on to Harvard for his doctorate. He has taught at Harvard and
MIT at various times and is currently the Johnstone family
professor in the Department of Psychology at Harvard. Pinker is
interested in language and the mind, including the ﬁeld of visual
cognition, which encompasses the ability to imagine shapes and
recognize faces and objects. He specializes in language
development in children and has written many important papers
and books on this and other topics.
37 Michael Faraday (1791–1867), the child of a blacksmith in
England, was apprenticed at age 14 to a bookbinder and
bookseller. He became a voracious reader, and his bookbinding
duties also led him to the study of chemistry, at which he
excelled. He discovered benzene and was the ﬁrst to describe the
compounds of chlorine and carbon. He also experimented with
magnetism and electricity, leading him to produce continuous
rotation using electric current—a necessary precursor to the
electric motor. Faraday is also credited with the discovery of
electromagnetic induction, principles of electrolysis, and a
method to measure electrical charges, the voltameter.
38 Stanley Milgram, born in 1933 in New York, grew up during
World War II, when Nazi atrocities became well-known to the
world. He earned a political science degree from Queens College
and went on to Harvard for a PhD in social relations. He took a
faculty position at Yale, where he conducted a classic experiment
that pitted the subject’s moral beliefs against the demands of
authority. His experiment found that 65 percent of his subjects,
ordinary residents of New Haven, were willing to give apparently
harmful electric shocks to a pitifully protesting victim simply
because a scientiﬁc authority commanded them to, despite the

## Page 399

fact that the victim did nothing to deserve punishment.
Milgram’s results have been used as a partial explanation for the
German atrocities of World War II.
39 Born Burrhus Frederic Skinner in Pennsylvania to an
attorney father and a strong and intelligent mother, B. F. Skinner
(1904–1990) enjoyed school and did well enough to get to
college. Following graduation, he wrote newspaper articles on
labor problems and lived in Greenwich Village. Tiring of a
bohemian lifestyle, he decided to return to Harvard, where he
earned a PhD in psychology. Skinner’s great contributions to
psychology are his experiments in operant conditioning and
behaviorism. Operant conditioning can be summarized as
follows: “A behavior is followed by a consequence, and the nature
of the consequence modiﬁes the organism’s tendency to repeat
the behavior in the future.”
40 Born in Marton, England, James Cook (1728–1779)
developed an early fascination for the sea and taught himself
cartography. He served in the Royal Navy, participating in the
siege of Quebec City and showing a talent for surveying and
cartography. He mapped much of the entrance to the Saint
Lawrence River during the siege. Later, he mapped the coast of
Newfoundland, which brought him to the attention of the Royal
Society, sponsor of many of his great voyages. In addition to
having ﬁrst-class cartographic skills, Cook developed excellent
seamanship and displayed great courage in exploring dangerous
locations. His voyages are chronicled in books that were
extremely popular in his day and remain so today.
41 Serpico (1973) was a popular ﬁlm directed by Sidney Lumet,
based on the book by journalist Peter Maas. The plot concerns
undercover police ofﬁcer Frank Serpico, who does his best

## Page 400

arresting criminals of all types, but especially drug dealers,
despite working in a corrupt police department. Serpico refuses
to accept bribes and becomes sufﬁciently appalled at his shady
colleagues that he testiﬁes against them, thus placing his life in
jeopardy. Al Pacino appeared in the title role and earned an
Academy Award nomination for his acting. The ﬁlm was also
nominated for a screenwriting Oscar.
42 Born András Gróf in Budapest, Hungary, Andy Grove (1936–
2016) earned a bachelor’s degree in chemical engineering from
the City College of New York and a PhD from the University of
California, Berkeley. He worked at Fairchild Semiconductor
before becoming the fourth employee at the nascent Intel
Corporation. He became Intel’s president in 1979, its CEO in
1987, and its chairman and CEO in 1997. Author of several
academic and mass trade books, his 1996 work Only the Paranoid
Survive was hugely popular. It’s on Charlie’s recommended book
list.
43 An autocatalytic reaction (also called autocatalysis) occurs
when a single chemical reaction product is itself the catalyst for
that reaction. For example, tin pest is an autocatalytic reaction of
the element tin; at low temperatures, it causes deterioration of
tin objects. Atmospheric ozone depletion is another example of
an autocatalytic reaction.
44 With the 1976 release of the Apple 1 by Steven Jobs and
Stephen Wozniak, Apple Computer was born. Through a series of
improvements and innovations, Apple built a reputation for
quality and for the user-friendliest computers on the market. In
the early 1990s, Apple began to lose its market share to Intel-
and Windows-based computers. Despite what many observers
maintained was superior technology and performance, Apple

## Page 401

came close to irrelevance because of the marketing heft behind
the Windows-based products. In the late 1990s, Apple’s iMac and
PowerBook products began an impressive resurgence.
45 John Gutfreund (1929–2016), chairman and CEO of Salomon
Brothers, paid a high price for inaction when he was put on
notice of company misdeeds. In 1991, a Salomon trader made an
illegal $3.2 billion bid for US treasury securities. Although the
transaction was reported to top management only days later,
Gutfreund did not take the warning seriously and failed to report
it for more than three months. Gutfreund knew as soon as the
matter came out in the press that his delay in reporting had
torpedoed his 38-year career with Salomon. He called in one of
Salomon’s outside directors, Warren Buffett, to save the company
and restore its reputation. Buffett handled the complicated
project masterfully, and the ﬁrm survived and prospered; it was
later sold for $9 billion to Travelers.
46 Napoleon Bonaparte (1769–1861), emperor of France,
acquired control of most of western and central Europe by
conquest or alliance until his defeat at the Battle of the Nations
near Leipzig in 1813. He later staged a comeback known as the
Hundred Days, before being defeated at the Battle of Waterloo in
1815.
47 The terms “modern Darwinism” and “modern Darwinian
synthesis” describe work in the late 1930s and 1940s that
blended the discoveries of geneticists and natural historians to
determine how changes in genes could account for the evolution
of biodiversity.

## Page 402

48 Born in Germany to a law professor father, Max Planck
(1858–1947) earned his doctorate at age 21. His earliest work on
thermodynamics evolved into an interest in radiation. From
these studies, he was led to work on the distribution of energy in
the spectrum of radiation. Planck’s work on energy emissions
was essential to the ﬁeld of physics and came to be known as
quantum theory. He was awarded the Nobel Prize for Physics in
1918.
49 An ancient Greek mathematician, physicist, engineer,
astronomer, and philosopher, Archimedes (c. 287–212 BC) had
one of the greatest minds in antiquity. He discovered principles
of density, buoyancy, optics, and, most famously, leverage. Of this
last principle, Archimedes said, “Give me a lever long enough
and a fulcrum on which to place it, and I shall move the world.”
Talk Four: Practical Thought about Practical Thought?
50 Galileo Galilei (1564–1642), born near Pisa, Italy, had early
thoughts of joining a monastic order. Ultimately, though, his
interests and education turned to mathematics and medicine,
and he is credited with fundamental ﬁndings in pendulums,
gravity, trajectories, and many other topics. He constructed the
ﬁrst astronomical telescope and used it to discover Jupiter’s
satellites and the Milky Way. In 1633, he was brought before the
Inquisition in Rome, placed under house arrest for the
remainder of his life, and made to renounce his beliefs in solar-
centric Copernican theory. Despite the trying circumstances, he
continued work on his Discourses and mathematical
demonstrations concerning the two new sciences and completed
it in 1638. Smuggled out of Italy and published in Holland, the
Discourses delineates most of Galileo’s contributions to physics.

## Page 403

51 Pythagoras (582–496 BC), an Ionian (Greek) mathematician
and philosopher known as “the father of numbers,” is often
credited with the discovery of irrational numbers. More likely,
though, the credit belongs to one or more of his followers, the
Pythagoreans, who produced a proof of the irrationality of the
square root of two. Pythagoras, believing that numbers were
absolute, rejected irrational numbers and is said to have
sentenced their leading proponent to death by drowning for his
heresy. Generally, an irrational number is any real number that
cannot be written as a fraction a/b, with a and b integers and b
not zero. For a number to be irrational, its expansion in any
given base (decimal, binary, etc.) never ends and never enters a
periodic pattern.
52 The model for Poor Charlie’s Almanack is, of course, Ben
Franklin’s Poor Richard’s Almanack. Franklin, as many know, was a
polymath. Born in Boston and a leader of the American
Revolution, he was a journalist, publisher, author, philanthropist,
abolitionist, public servant, scientist, librarian, diplomat, and
inventor. Using the pseudonym “Poor Richard,” Franklin
published his Almanack from 1733 to 1758. Its contents varied,
including not only many Franklin aphorisms that became
famous but also calendars, weather forecasts, astronomical
information, and astrological data. The Almanack was hugely
popular in the American colonies, selling about 10,000 copies a
year.
53 The drachma was originally a unit of currency in classical
Greece. The word derives from the verb “to grasp.” The drachma
was also used in ancient Rome in the third century BC and later.
Most historians say one Roman drachma was equivalent to a
day’s wages for a laborer.

## Page 404

54 Aristotle (384–322 BC), born at Stagira, a Greek colony, was
son to a court physician for the king of Macedonia. Joining the
Academy in Athens, Aristotle studied under Plato for 20 years.
Diverging from Plato’s teaching, Aristotle ultimately established
his own school, the Lyceum. Following Alexander’s death and the
overthrow of his government, Aristotle faced charges of impiety
and was forced to ﬂee. He died exiled from Athens. Aristotle’s
works include treatises on physics, metaphysics, rhetoric, and
ethics. He is also known for his observations about nature and
the physical world, which formed the basis for the modern study
of biology.
55 Richard Thaler (b. 1945), born in New Jersey, earned his PhD
at the University of Rochester. Serving professorships at Cornell
and MIT in behavioral economics and decision research, he
joined the faculty at University of Chicago in 1995. In addition to
his work on behavioral economics and ﬁnance, he focuses on the
psychology of decision-making.
Talk Five: The Need for More Multidisciplinary Skills from
Professionals: Educational Implications
56 William Tyndale (1495–1536), born in Gloucestershire,
England, earned a degree from Oxford and became a priest. He
found England hostile to his beliefs and spent time in Germany
and Belgium, where he expanded his beliefs and spread the
teachings of Martin Luther. His books having been burned, and
his having become a continuing target of hostility, he
nonetheless continued to publish Bible translations and other
tracts. After months of imprisonment, he was condemned for
heresy, strangled to death, and publicly cremated. Later,
Tyndale’s translation formed the basis of the ﬁrst royally

## Page 405

approved English-language Bible and had great impact on the
development of the English language.
57 Alfred North Whitehead (1861–1947), a British philosopher
and mathematician, worked in logic, mathematics, philosophy of
science, and metaphysics. Whitehead is known for developing
process philosophy, a view holding that fundamental elements of
the universe are occasions of experience. In this view, concrete
objects are actually successions of these occasions of experience.
By grouping occasions of experience, something as complex as a
human being can be deﬁned. Whitehead’s views evolved into
process theology, a way of understanding God. His best-known
mathematics work is Principia Mathematica, cowritten with
Bertrand Russell.
58 Encouraged by his parents to pursue his scientiﬁc interests,
Linus Pauling (1901–1994) was a gifted student in Portland,
Oregon, and won scholarships to Oregon State University. He
went on to earn a PhD in chemistry at the California Institute of
Technology, where he taught and carried out his research for the
bulk of his career. Pauling made many contributions to his ﬁeld,
including applying quantum physics and wave theory to
chemistry. He also made advances in antibody production and
the atomic structure of proteins. Charlie believes he may have
been the greatest chemist of the 20th century. He won Nobel
Prizes for Chemistry (1954) and Peace (1962). Late in life,
Pauling wrote about the role of nutrition in ﬁghting disease and
recommended the use of vitamin C to ward off the common cold.
59 Pierre-Simon Laplace (1749–1827), a French mathematician,
astronomer, and philosopher, discovered many key ideas
relating to inductive reasoning and probability, celestial
movement, and causal determinism. In his great work, A

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Philosophical Essay on Probabilities, Laplace sets out one of his
signature ideas: “We may regard the present state of the
universe as the effect of its past and the cause of its future. An
intellect which at a certain moment would know all forces that
set nature in motion, and all positions of all items of which
nature is composed, if this intellect were also vast enough to
submit these data to analysis, it would embrace in a single
formula the movements of the greatest bodies of the universe
and those of the tiniest atom; for such an intellect nothing would
be uncertain and the future just like the past would be present
before its eyes.”
60 Roger Fisher (1922–2012) earned a law degree from Harvard
in 1948 and stayed on as a faculty member in the law school. He
became director of the Harvard Negotiation Project in 1980. An
expert in negotiation and conﬂict resolution, he coauthored with
Bill Ury Getting to Yes, a classic text in win-win negotiation
techniques.
61 Richard P. Feynman (1918–1988) was born in Far Rockaway,
New York. He earned an undergraduate degree in physics from
MIT and went on to Princeton for a PhD. He worked on the
Manhattan Project and was instrumental in the development of
the atomic bomb. He held faculty posts at Cornell University
until 1951 and then settled at Caltech. Feynman’s major
contribution to physics was in quantum electrodynamics, the
study of the interactions of electromagnetic radiation with atoms
and more fundamental particles. He shared the Nobel Prize in
Physics in 1965. Late in life, Feynman was named to the
commission that investigated the Challenger Space Shuttle
accident. He demonstrated the effect of cold temperatures on
rubber O-rings and showed how the resulting shrinkage allowed
hot gases to escape, causing the explosion.

## Page 407

Talk Six: Investment Practices of Leading Charitable
Foundations
62 John C. Argue (1932–2002) divided his time between
business and philanthropy. Long a senior partner of Los Angeles
law ﬁrm Argue Pearson Harbison & Myers, he was one of the key
reasons that Los Angeles got the 1984 Olympic Games. He also
served on the University of Southern California Board of
Trustees, becoming its chairman in 2000.
63 Bernie Cornfeld (1927–1995), born in Turkey, came to
America and became a mutual fund salesman in the 1950s. In
the 1960s, he started selling his own family of mutual funds,
Investors Overseas Services (IOS), incorporated in Switzerland.
He hired thousands of salespeople, who sold the funds door to
door all over Europe, especially in Germany. IOS raised $2.5
billion while Cornfeld engaged in lavish personal consumption.
64 Long-Term Capital Management, a hedge fund company
founded in 1994 by a well-respected Wall Street bond trader and
two Nobel Prize winners in economics, developed complex
mathematical models to take advantage of arbitrage deals. Using
high levels of debt—about $125 billion by 1998—the fund was
poorly positioned for two consecutive months of negative
returns, combined with Salomon Brothers’ exit from the
arbitrage business, combined with foreign ﬁnancial panics.
Within a few months, the fund lost almost $2 billion in capital. It
became necessary for the Federal Reserve Bank to organize a
bailout of the fund to avoid a chain reaction of liquidity requests
throughout the economy. The debacle reminded the ﬁnancial
community of the potential seriousness of liquidity risk. The

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seminal book on the subject, When Genius Failed, was translated
into many languages.
65 Robert W. Woodruff (1889–1985) was born in Georgia to a
father who was president of a major trust company. Woodruff
had an unremarkable school career, but once in the workforce he
succeeded quickly. Although he started in car sales, by age 33 he
had taken over the Coca-Cola Company. He turned a fairly small
soft-drink manufacturer and bottler into a corporate giant
known worldwide. Over the remainder of his life, Woodruff was
unusually philanthropic and established a large foundation that
now bears his name. Woodruff’s personal creed gives one a good
sense of how he accomplished so much in his long life: “There is
no limit to what a man can do or where he can go if he doesn’t
mind who gets the credit.”
66 Peter F. Drucker (1909–2005), born in Austria, was educated
there and in England. He earned a PhD in public and
international law while working as a newspaper reporter in
Germany. Later, he worked as an economist in a London bank
and came to the United States in 1937. His academic career has
included professorships at Bennington College, New York
University, and, starting in 1971, Claremont Graduate University,
where the graduate management school is named after him. For
decades, he consulted for businesses and nonproﬁt
organizations. Author of some 30 books on management,
philosophy, and other topics, Drucker is considered a seminal
thinker, writer, and lecturer on the contemporary organization.
In 2002, he received the Presidential Medal of Freedom.

## Page 409

Talk Seven: Breakfast Meeting of the Philanthropy Roundtable
67 Founded in the 1970s in Washington, DC, the Philanthropy
Roundtable is an informal network of grant-makers seeking to
promote private, voluntary approaches to individual and
community betterment. Currently, there are more than 600
Roundtable associates.
68 John Maynard Keynes (1883–1946), son of an economics
lecturer at Cambridge University and a social reformist, seemed
destined to become a great economist and political thinker. His
book, The General Theory of Employment, Interest, and Money,
published in 1936, advocated that government stimulate
demand in times of high unemployment, for example by
spending on public works. The book serves as the foundation of
modern macroeconomics.
69 John Kenneth Galbraith (1908–2006), born in Ontario,
Canada, graduated from Ontario Agricultural College and went
on to obtain a PhD from the University of California, Berkeley. In
1949, he joined the economics faculty at Harvard University. A
friend of President John F. Kennedy, Galbraith served as US
ambassador to India from 1961 to 1963. As an economist,
Galbraith held progressive values and wrote accessible books
that often describe how economic theory does not always mesh
with real life. Among his best-known works are American
Capitalism: The Concept of Countervailing Power (1952), The Afﬂuent
Society (1958), and The New Industrial State (1967).

## Page 410

Talk Eight: The Great Financial Scandal of 2003
70 Sophocles (496–406 BC), an ancient Greek playwright,
dramatist, priest, and politician of Athens, is best known as one
of the three great Greek tragedians (the others being Aeschylus
and Euripides, with whom he often competed in dramatic
contests). Sophocles wrote over 100 plays; many scholars,
including Aristotle, considered him to be the greatest playwright
in ancient Greek theater. The most famous of his surviving works
are the tragedies of Oedipus Rex and Antigone.
71 One of the most famous examples of modern ﬁnancial
engineering was the Ponzi scheme, which started in Boston in
1919. Claiming an ability to exploit an unforeseen arbitrage in
international postal coupons, Carlo “Charles” Ponzi attracted
thousands of investors by promising 50 percent interest in 90
days. To build credibility, he used funds from recent investors to
provide returns to earlier participants—a standard pyramid
scheme tactic. Soon, Ponzi had taken in millions. In 1920, The
Boston Post ran a story questioning Ponzi’s practices, which
provoked an independent audit. The audit revealed the fraud,
and investors demanded their money back. In the end, the
average participant had only 37 percent of invested funds
returned, and Ponzi spent several years in prison. Unrepentant,
Ponzi turned up again in the late 1920s selling worthless land in
Florida.
Talk Nine: Academic Economics: Strengths and Faults after
Considering Interdisciplinary Needs
72 Boltzmann’s constant derives its name from Austrian
physicist Ludwig Boltzmann (1844–1906); it deﬁnes the relation

## Page 411

between absolute temperature and the kinetic energy contained
in each molecule of an ideal gas. In general, the energy in a gas
molecule is directly proportional to the absolute temperature. As
the temperature increases, the kinetic energy per molecule
increases. As a gas is heated, its molecules move more rapidly.
This movement produces increased pressure if the gas is
conﬁned in a space of constant volume, or increased volume if
the pressure remains constant.
73 N. Gregory Mankiw (b. 1958) studied economics at Princeton
University, earned a PhD from MIT, and is on the faculty at
Harvard University. In 2003, he was appointed chairman of the
Council of Economic Advisers.
74 Garrett Hardin (1915–2003), born in Dallas, spent his
childhood in the Midwest. He earned an undergraduate degree
from the University of Chicago and a PhD in biology from
Stanford University. In 1946, he joined the faculty at UC Santa
Barbara. His essay “The Tragedy of the Commons” became a
staple of ecological thought. His philosophical and political
positions inﬂuenced debates on abortion, immigration, foreign
aid, and other issues for decades.
75 George Shultz (1920–2021), born in New York City, earned an
undergraduate degree in economics from Princeton University
and a PhD in industrial economics at MIT. Following several
years on the MIT faculty, he moved on to the University of
Chicago. He served as President Richard M. Nixon’s secretary of
the treasury for two years until Nixon was forced to resign.
President Ronald Reagan appointed him secretary of state in
1982; Shultz served both of Reagan’s terms. He is a member of
the Hoover Institution and on the board of directors for the
Bechtel Corporation, Gilead Sciences, and Charles Schwab &

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Company. During Arnold Schwarzenegger’s successful bid to
replace California governor Gray Davis in 2003, Shultz was
named an adviser to Schwarzenegger’s campaign.
76 Far less efﬁcient than Munger’s preferred approach of simply
“reaching down and picking up big nuggets of gold,” placer
mining (pronounced “plass-er”) is an open-pit or open-cast form
of mining in which miniscule amounts of valuable minerals are
extracted from great volumes of earth using water pressure or
surface excavating equipment. The name derives from the
Spanish word placer, meaning “sand bank,” and refers to
precious metal deposits (particularly gold and gemstones) found
in alluvial deposits.
77 Joseph Rudyard Kipling (1865–1936), born in Bombay, India,
to a father who taught at a local art school, attended boarding
school in England. He returned to India and traveled around the
subcontinent as a correspondent. He also wrote ﬁction and
poetry, publishing The Jungle Book in 1894, Captains Courageous in
1897, and “Gunga Din” in 1892. He won the Nobel Prize for
Literature in 1907.
78 Leslie Schwab (1917–2007) was born in Bend, Oregon. After
service in the Air Cadet Corps during World War II, he returned
to Oregon and bought OK Rubber Welders, a small tire shop that
he turned from a $32,000-a-year business into one generating
$150,000 annually. In the 1950s, Schwab began expanding his
business throughout the Paciﬁc Northwest. Through innovations
such as proﬁt sharing, “super market” product selection, and
independence from the tire manufacturing companies, the
company now operates over 300 stores with sales exceeding $1
billion annually.

## Page 413

79 David Ricardo (1772–1823), born in London, began working
with his father at the London Stock Exchange at age 14. His
wealth allowed him to retire young, and he secured a seat in
Parliament. He became interested in economics after reading
Adam Smith’s The Wealth of Nations and made many signiﬁcant
contributions to the ﬁeld. Ricardo is often credited with the
theory of comparative advantage, which explains why it can be
beneﬁcial for two countries to trade even though one of them
may be able to produce every kind of item more cheaply than the
other. The concept was ﬁrst described by Robert Torrens in 1815
in an essay on the wheat trade, but Ricardo explained it more
clearly in his 1817 book The Principles of Political Economy and
Taxation.
80 Adam Smith recorded in An Inquiry into the Nature and Causes
of the Wealth of Nations (1776) his observations at a pin factory. He
found that only 10 workers were able to produce 48,000 pins per
day because of divided and specialized labor. If each worker
handled all the steps required to make a pin, he could only make
20 per day, for a total factory output of 200 pins daily. Smith
recognized and extolled the great productivity gains and
economic progress represented by the pin factory and its
embrace of specialized labor.
81 Ronald Coase (1910–2013), born in a suburb of London,
graduated from secondary school at age 12 and enrolled in the
University of London only two years later. He earned degrees in
law and economics and began research into transaction costs.
He came to the United States in 1951 for an academic career that
started at the University of Buffalo. He settled into the University
of Chicago in 1964 and remains there as professor emeritus. His
work “The Nature of the Firm” (1937) was cited as a major

## Page 414

consideration in his receipt of the Nobel Prize in Economics in
1991.
82 Victor Niederhoffer (b. 1943) studied statistics and
economics, earning an undergraduate degree at Harvard and a
PhD at the University of Chicago. He taught at the University of
California, Berkeley for ﬁve years and simultaneously ran
Niederhoffer, Cross & Zeckhauser, Inc., involved in selling private
ﬁrms to public companies. In the late 1970s, Niederhoffer
started trading futures and options. He founded a trading ﬁrm,
Niederhoffer Investments, in 1980 to provide ﬁnancial
management for institutional clients. He is also a past multiyear
national squash champion.
83 The often-overlooked beneﬁts of comparative advantage
through free trade were famously revealed by David Ricardo in
his 1817 book On the Principles of Political Economy and Taxation:
“In Portugal it is possible to produce both wine and cloth with
less work than it takes in England. However, the relative costs of
producing those two goods are different in the two countries. In
England it is very hard to produce wine, but only moderately
difﬁcult to produce cloth. In Portugal both are easy to produce.
Therefore, while it is cheaper to produce cloth in Portugal than
England, it is cheaper still for Portugal to produce excess wine
and trade it for English cloth. Conversely, England beneﬁts from
this trade because its cost for producing cloth has not changed
but it can now get wine at closer to the cost of cloth.” Frequently
overlooked is that Ricardo’s comparative advantage in delegating
tasks among nations is equally applicable for managers
delegating work. Even if a manager can perform the full range of
tasks better himself, it is still mutually advantageous to divide
them up.

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84 Fra Luca de Pacioli (1445–1517) in 1494 published his
seminal work, The Collected Knowledge of Arithmetic, Geometry,
Proportion, and Proportionality. In one section of the book, Pacioli
described a novel concept, double-entry accounting. This
invention revolutionized business practice and made Pacioli a
celebrity. His was one of the ﬁrst books to be printed on the
Gutenberg press.
85 The South Sea Bubble was an economic frenzy in England
that occurred when speculation in South Sea Company shares
peaked during 1720. The share price rose from £128 in January
to a high of £1,000 in August and then fell back to £150 in
September. The company had been granted exclusive trading
rights in Spanish South America. When results ultimately proved
skimpy, the company engineered a public debt scheme that
appeared to bolster proﬁts. Company leaders and other
shareholders also talked up future revenues, causing the
speculative frenzy. Public outcry following disclosure of the
fraud led to imposition of the Bubble Act of 1720, requiring
publicly traded companies to have a royal charter.
86 Bernard de Mandeville (1670–1733), philosopher and
satirist, published a poem, “The Fable of the Bees: or, Private
Vices, Publick Beneﬁts,” in 1705 as a political satire. Mandeville’s
philosophy suggests that altruism harms the state and its
intellectual progress, and that self-interested human vice is the
real engine of progress. Thus, he arrives at the paradox that
“private vices are public beneﬁts.”
87 Kurt Gödel (1906–1978), a logician, mathematician, and
philosopher of mathematics from Austria-Hungary, wrote a
dissertation for his PhD at the University of Vienna that included
his famous, but somewhat obscure, incompleteness theorems.

## Page 416

The ﬁrst theorem holds that one can use the mathematical
system to construct a statement that can be neither proved nor
disproved within that system. The second theorem, arrived at by
proving the ﬁrst, states that no consistent system can be used to
prove its own consistency.
88 In 1978, nearly two-thirds of California voters passed
Proposition 13, which limits property taxes to 1 percent of a
property’s market value and to 2 percent per year any increase
in the property’s valuation assessment unless the property is
sold. Prior to Proposition 13, there were no real limits on
increases either for the tax rate or property value assessments in
the state of California. Prop 13 set the stage for a broader
taxpayer revolt that contributed to Ronald Reagan’s election as
president in 1980. In the 2003 California gubernatorial recall
election in which Arnold Schwarzenegger was elected,
Schwarzenegger adviser Warren Buffett suggested that
Proposition 13, still very popular with many homeowners, be
repealed or changed to help balance the state’s budget.
Politically, Buffett’s suggestion proved to be highly charged.
Talk Ten: USC Gould School of Law Commencement Address
89 In Confucian thought, ﬁlial piety—a love and respect for one’s
parents and ancestors—is a virtue to be cultivated. More broadly,
ﬁlial piety means to take care of one’s parents; not be rebellious;
show love, respect, and support; display courtesy; ensure male
heirs; uphold fraternity among brothers; wisely advise one’s
parents; conceal their mistakes; display sorrow for their sickness
and death; and carry out sacriﬁces after their death. Confucius
(551–479 BC) believed that if people could learn to fulﬁll their
ﬁlial roles properly, they would be better able to perform their

## Page 417

roles in society and government. To Confucius, ﬁlial piety was so
essential he felt it transcended the law. In fact, during parts of
the Han Dynasty, those who neglected ancestor worship
according to ﬁlial piety precepts were subject to corporal
punishment.
90 Of Human Bondage, William Somerset Maugham’s
autobiographical 1915 novel, is generally considered his
masterpiece. The protagonist, Philip, meets Mildred, a London
waitress, who snubs him. Falling in obsessive love with Mildred,
Philip knows he is foolish and despises himself. He gives Mildred
all his money; she repays him with disgust and humiliation. As
Maugham describes the relationship: “Love was like a parasite in
his legs nourishing a hateful existence on his life’s blood; it
absorbed his existence so intensely that he could take pleasure
in nothing else.”
91 Joseph M. Mirra, MD, is a bone and soft tissue pathologist in
the Department of Pathology and Laboratory Medicine at Cedars-
Sinai Medical Center in Los Angeles. Dr. Mirra’s research interest
is bone pathology, about which he has published more than 150
papers, produced 16 book chapters, and edited two books.
Board-certiﬁed in anatomic and clinical pathology, Dr. Mirra is a
sought-after visiting professor who also speaks nationally and
internationally on bone pathology. He has been active in medical
student teaching throughout his career and has participated in
several symposia on bone tumor pathology.
92 The word “algebra” is derived from the Arabic word al-jabr,
which appears in the treatise The Compendious Book on Calculation
by Completion and Balancing, written in 820 by Persian
mathematician Muhammad ibn Mūsā al-Khwārizmī. The book
provides systematic solutions of linear and quadratic equations.

## Page 418

93 The notion of Mozart as an impoverished composer comes
primarily from a series of letters he wrote from 1788 to 1791 to
his Masonic brother Michael Puchberg asking for loans. Other
evidence suggests Mozart’s income, though subject to
considerable ﬂuctuation, was unusually high for a musician,
placing him during some years in the top 10 percent of all
Vienna inhabitants. Economists William and Hilda Baumol, on
the other hand, calculate that Mozart’s income in the last decade
of his life was middle-class at 3,000–4,000 ﬂorins a year (about
$30,000–$40,000 in 1990).
What happened to Mozart’s money? Mozart’s sickly wife,
Constanze, required regular cures at spring baths used only by
the wealthy. During lean times, the Mozarts continued to live in
their accustomed style, giving themselves cash ﬂow problems.
The situation was exacerbated by their failure to save any money
during ﬂush periods and by a judgment against Mozart in 1791
resulting from a suit brought by Prince Karl Lichnowsky. Some
scholars also cite evidence that Mozart gambled at billiards and
cards.
94 Thomas Charles Munger (1861–1941) was born in Fletcher,
Ohio, on the eve of the Civil War. His parents, itinerant farmers
and schoolteachers, were so impoverished that as a child Judge
Munger recalled trips to the butcher shop with 5¢ in his pocket to
buy the lowest forms of animal parts the butcher had to offer.
Despite this unfortunate beginning, Judge Munger managed to
acquire an outstanding education owing both to his parents’
efforts and his own auto didacticism. He was appointed United
States District Judge by President Theodore Roosevelt in 1907
and became well known for both his industrious approach to
legal research and the clear and concise form of his judicial
opinions.

## Page 419

95 The Pilgrim’s Progress from This World, to That Which Is to Come
(1678) by John Bunyan is an allegory regarded as one of the most
signiﬁcant works of English literature. Told by a dreamer,
Pilgrim’s Progress follows the travels of a man, Christian, through a
series of allegorical places: the Slough of Despond, the House
Beautiful, the Valley of Humiliation, the Valley of the Shadow of
Death, Vanity Fair, Doubting Castle, and so on, to the Celestial
City that he seeks. Valiant-for-Truth is a strong, sword-wielding
pilgrim who drives off three attackers single-handedly and joins
Christian’s group at the end of its journey.
Talk Eleven: The Psychology of Human Misjudgment
96 Andrew Carnegie (1835–1919) rose from a penniless
immigrant to become the wealthiest man on Earth. Selling his
steel empire for $500 million, he created schools, a peace
endowment, New York’s Carnegie Hall, and 2,811 free public
libraries. He also paid for the acquisition and installation of
7,689 church organs. His vision was to create “an ideal state in
which the surplus wealth of the few will become, in the best
sense, the property of the many.”
97 From Luke 18:9–14 (King James Version):
And he spake this parable unto certain which trusted in
themselves that they were righteous, and despised others:
Two men went up into the temple to pray; the one a Pharisee,
and the other a publican. The Pharisee stood and prayed thus
with himself, God, I thank thee, that I am not as other men are,
extortioners, unjust, adulterers, or even as this publican. I fast
twice in the week, I give tithes of all that I possess.
And the publican, standing afar off, would not lift up so much
as his eyes unto heaven, but smote upon his breast, saying, God

## Page 420

be merciful to me a sinner. I tell you, this man went down to his
house justiﬁed rather than the other: for every one that exalteth
himself shall be abased; and he that humbleth himself shall be
exalted.
98 Judith Rich Harris (1938–2018) was an independent
investigator and author. Her signiﬁcant professional
accomplishments include a mathematical model of visual
speech, textbooks in developmental psychology, and many
inﬂuential professional articles. She is best known for The
Nurture Assumption (1998) and No Two Alike (2006).

## Page 421

RECOMMENDED READING
Chernow, Ron. Titan: The Life of John D. Rockefeller, Sr. New York:
Random House, 1998.
Cialdini, Robert B. Inﬂuence, New and Expanded: The Psychology of
Persuasion. New York: HarperCollins, 2021.
Dawkins, Richard. The Selﬁsh Gene. Oxford: Oxford University
Press, 2016.
Diamond, Jared M. Guns, Germs, and Steel: The Fates of Human
Societies. New York: W. W. Norton, 2017.
Diamond, Jared M. The Third Chimpanzee: The Evolution and Future
of the Human Animal. New York: HarperCollins, 1992.
Firestone, Harvey S., and Samuel Crowther. Men and Rubber: The
Story of Business. New York: Doubleday, Page & Company, 1926.
Fisher, Roger, William Ury, and Bruce Patton. Getting to Yes:
Negotiating Agreement without Giving In. London: Random House
Business Books, 2003.
Franklin, Benjamin. The Autobiography of Benjamin Franklin.
North Carolina: IAP, 2019.
Gribbin, John. Deep Simplicity: Bringing Order to Chaos and
Complexity. London: Penguin Books Limited, 2009.

## Page 422

Gribbin, John, and Mary Gribbin. Ice Age. London: Allen
Lane/Penguin Press, 2001.
Grove, Andrew S. Only the Paranoid Survive: How to Exploit the
Crisis Points that Challenge Every Company and Career. New York:
Currency Doubleday, 1996.
Hagstrom, Robert G. The Warren Buffett Portfolio: Mastering the
Power of the Focus Investment Strategy. New Jersey: Wiley, 2000.
Hardin, Garrett. Living within Limits: Ecology, Economics, and
Population Taboos. Oxford: Oxford University Press, 1995.
Herman, Arthur. How the Scots Invented the Modern World: The True
Story of How Western Europe’s Poorest Nation Created Our World and
Everything in It. New York: Crown, 2001.
Landes, David S. The Wealth and Poverty of Nations: Why Some Are
So Rich and Some So Poor. New York: W. W. Norton, 1999.
Partnoy, Frank. Fiasco: The Inside Story of a Wall Street Trader.
London: Penguin Publishing Group, 1999.
Ridley, Matt. Genome: The Autobiography of a Species in 23 Chapters.
New York: HarperCollins Publishers, 2005.
Schwab, Les. Les Schwab Pride in Performance: Keep It Going.
Oregon: Paciﬁc Northwest Books, 1986.
Segre, Gino. A Matter of Degrees: What Temperature Reveals about
the Past and Future of Our Species, Planet, and Universe. London:
Penguin Publishing Group, 2003.

## Page 423

Simon, Herbert A. Models of My Life. London: MIT Press, 1996.
Stone, Irving. Men to Match My Mountains: The Opening of the Far
West, 1840–1900. New York: Berkley, 1982.
Wall, Joseph Frazier. Andrew Carnegie. Oxford: Oxford University
Press, 1970.
Wright, Robert. Three Scientists and Their Gods: Looking for Meaning
in an Age of Information. New York: Times Books, 1988.

## Page 424

ACKNOWLEDGMENTS
This book is a survey of Charles T. Munger: his approach to
learning, decision-making, and investing; his speeches; his
zingers; and more. The impetus for the book came from the
many people who, over the years, have said they wished one
existed—and have done so with ever-increasing vigor at
Berkshire and Wesco shareholder meetings, at dinner parties, on
message boards, and many other places. Hearing this clamor,
your editor, Peter Kaufman, suggested to Warren Buffett that a
book be done and was encouraged to take it upon himself to
make it happen.
Illustrator and caricature artist Ed Wexler produced the
illustrations in the book. The production team included Charles
Belser, Debbie Bosanek, Michael Broggie, Carl Foote, Travis
Gallup, Paul Hartman, Eric Hartman-Birge, Marcus Kaufman,
Peter Kaufman, Pamela Koch, Carol Loomis, Steve Mull, Doerthe
Obert, Scott Rule, Whitney Tilson, Dwight Tompkins, and Ed
Wexler.
If you enjoy reading Poor Charlie’s Almanack half as much as we
enjoyed putting it together, we will consider our efforts a distinct
success. In every respect, but particularly in our interactions
with Charlie, his family, and the Mungers’ wide circle of friends
and associates, we have been favored with calm skies and
smooth sailing in the production of this book. We hope our
efforts have proven worthy of our subject, a good and admirable
man.