Charlie Munger, the less famous (but equally smart) investment partner of Warren Buffett, likes to quote the famous mathematician Carl Jacobi: “invert, always invert!”
Look At Problems From the Opposite Direction
What Munger is saying is, when looking at how to solve a problem or attain a particular goal, invert and look at it from the opposite direction. For example, if you want to be a successful investor, study all the different ways investors lose money and make sure not to repeat any of their mistakes. In fact, Munger has attributed no small part of his and Buffett’s investment success to eliminating common investment errors.
So what have they learned about investment failure? Buffett says he sees two things that commonly ruin people: liquor and leverage. I won’t cover the first, since it’s pretty obvious how it can ruin lives and careers.
Taking On Too Much Debt
The second, well the business sections of newspapers are littered with investors who met their investment waterloo by employing too much leverage (i.e., taking on too much debt/borrowing too much money). Many investors and hedge funds borrow a lot of money to juice up returns. It’s great when the market is moving with you, but horrible when it’s moving against you.
Buffett likes to ask the question: What’s $1 million x 40% x 30% x 50% x 0%? It’s zero. In Buffett’s eyes, using large amounts of leverage is akin to playing Russian roulette; it’s suicidal and one way to die on Wall Street.
Chasing the Latest Trends and Fads
Another way investors get hammered is by chasing fads. There always seems to be some type of trend that takes hold of investors — most recently real estate, and before that, high tech and “dot com” stocks. A particular niche of the market becomes hot, climbs fast, and sucks investors into it partly by greed and also by all the coverage it receives. Well, we know from recent history that chasing hot investment themes often ends badly for investors. Everyone thinks they’re smart enough to get out before disaster happens.
How to Get Rich
And speaking of inverting, Buffett once famously told a class of business students how to get rich. He shut the door and whispered: “Be fearful when others are greedy, and greedy when others are fearful”.
You only need to read a handful of historical books on investing to pretty much discover all the ways to fail. Most of the new ways are often just new takes on old themes. As Mark Twain was fond of saying: “History doesn’t repeat itself but it does rhyme”.
It seems like you can’t open the newspaper for very long without reading about investors who’ve sabotaged themselves by some common investment mistake. Most recently, all those unfortunate Bernie Madoff investors, many of whom sadly lost their entire life’s savings by putting all their eggs in Mr. Madoff’s basket.
Studying failure not only is helpful when it comes to investing, but it’s also helpful in all facets of life. And while it’s also important to study success, studying failure can be just as — if not more — instructive.
George from Seinfeld Knows Best
Munger’s principle of inverting, or doing the opposite of what gets people into trouble, reminds me of a hilarious episode of Seinfeld where George has the epiphany that if every thought and instinct he has is wrong, than the opposite must be right. Here’s a clip.