Deciphering Charlie Munger's Most Practical Wisdom: Backward Deduction and Reverse Thinking

This article is from Qilehui, authored by Forty-Two Chapters.

01 Thinking about problems in reverse makes them easier to solve.

The way to work within complex systems is to 'think in reverse,' and often problems become easier as a result.

This problem-solving method used by Charlie Munger is the opposite of what most people use in their daily lives.

Backward deduction and reverse thinking are two descriptions of this method.

For example, one good way to maintain happiness is to avoid things that cause you pain.

Munger once gave a speech mentioning Johnny Carson, in which Munger said: Carson told him he could not tell graduates how to be happy, but he could use personal experience to tell them how to become miserable.

Carson identified three things that lead to misery:

1) Substances that alter mood or perception;

2) Envy;

3) Resentment.

Carson’s approach is to think about a problem in reverse, studying how to create happiness by considering what actions would cause you pain and avoiding them.

Here’s another example of reverse thinking from Munger: an effective way to remain intelligent is to avoid acting foolishly.

Avoiding foolishness clearly sounds easier than striving to be a smart person, as you can adhere to a few simple principles to avoid certain unwise decisions.

Munger also mentioned, 'Much of success in life and career comes from avoiding certain things, such as premature death or a bad marriage.'

02 Reverse Thinking Helps Understand the Essence of Things

Reverse thinking facilitates understanding the essence of matters, thereby helping you solve many difficult problems.

Munger once joked that he wanted to know where he would die, so he would simply avoid going there.

He also told the following story:

I often pose little puzzles to my family. Not long ago, I gave them the following question: There is a sport in the United States that involves one-on-one matches and has a national championship. One person won the championship in two competitions held 65 years apart. Now, please name the sport.

I have a son who is a physicist, and his way of thinking has been greatly influenced by me. He immediately provided the answer, reasoning as follows: This sport cannot be one that requires hand-eye coordination; no one could win the National Billiards League at the age of 85. It also cannot be chess, as it involves complex rules and demands considerable endurance.

At this point, he thought of checkers and realized that even if you are 85 years old, you can still perform well in this sport as long as you have extensive experience.

Undoubtedly, this was the correct answer.

If the obvious things that everyone knows are usually wrong, then what is right?

Those that defy conventions.

In fact, what most people do not understand or believe is often the best. For example, some investment concepts and methods, because they have not yet been widely accepted, represent opportunities that only those with sufficient insight can seize.

03 Staying Unfoolish in the Long Run Makes Us Better

Charlie Munger once said: 'I think part of the reason Berkshire is popular is that we look like people who have found the 'secret to investing.' In fact, it’s not because we are brilliant; we just avoid being foolish. You might not expect that simply avoiding foolishness could make us perform so well.'

This is also why Warren Buffett says the first and second rules of investing are 'Don't lose money.'

The most challenging aspect of a value investing system lies in emotions and psychology, rather than the comprehension of the system itself.

The long-term advantage of 'staying unfoolish' has been significantly underestimated.

Note that we emphasize 'long-term,' a crucial term because longevity implies that avoiding foolishness is not merely a matter of luck. This state requires humility, particularly when operating beyond your capabilities.

Just as someone using a tool should be aware of its limitations, an investor relying on their own cognition must recognize the boundaries of their understanding.

Throughout your lifetime, you have the opportunity to learn from your inevitable mistakes and those of others. While this process may not yield positive outcomes consistently, it still benefits investment practices.

Humility helps reduce errors stemming from arrogance.

Be greedy when others are fearful, and be fearful when others are greedy.

Munger advocates for a contrarian approach to thinking, applying this method in various contexts.

He once said: 'If I were to answer one question: What constitutes true failure in life? What do you most wish to avoid? I would employ reverse thinking to consider what qualities I most aspire to possess.'

And my answer is: Control primitive irrational emotions. When you experience a significant stimulus, you may exhibit strange behaviors. If you can remain wise during such moments, you will benefit.

Christopher Davis, Chairman of Davis Advisors, said: Munger not only applied inversion in his thinking but also in his emotions. He seems able to reverse sentiment—when others are euphoric, he becomes disinterested; and when others are uncertain or fearful, he becomes engaged.

This is why Munger and Buffett offer such advice: be greedy when others are fearful, and be fearful when others are greedy.

Easier said than done. That’s why successful investing is simple, but not easy.

05 Don’t Be Deceived by High IQ

Investors often have high IQs and therefore believe that tackling difficult investment decisions is advantageous. In fact, even if you attempt to do something difficult, there is no inherent reward.

A high IQ may lead investors to prioritize finding and solving complex problems because they believe their intelligence will provide some benefit—but this is incorrect.

Munger’s perspective on this is: “I classify things into three categories: good, bad, and too difficult. Unless I am certain that I have special insight into a matter, I place it in the ‘too difficult’ category.”

A better strategy is to apply high IQ to problems that are ‘simple but offer good returns.’ Munger likes to work with people who think they have low IQs but actually possess high levels of intelligence.

06 Avoid Doing Things Others Can Do Better

Figure out your strengths.

You must figure out what your own talents are. If others are more gifted in a particular game and you are not, you will lose. You need to identify your strengths and operate within the limits of your abilities.

Act within your circle of competence.

If you genuinely possess certain capabilities, you also need to understand the boundaries of those abilities. In fact, everyone should know their own strengths better than others do, though not everyone achieves this.

This concept is closely related to the idea of a 'circle of competence.' Risks often stem from not knowing what you are doing; therefore, it is wise to ensure that you act within your capabilities.

The concept of a 'margin of safety' also applies here. If you are uncertain about the boundaries of your competence, it is advisable to maintain a sufficient margin of safety. Avoiding the incompetence and recklessness of competitors can provide a significant advantage.

Learn to evaluate yourself appropriately.

Expanding the boundaries of your circle of competence is extremely challenging. What is important here is learning to evaluate yourself accurately.

We all possess certain talents and skills and should strive to enhance them.

However, it is prudent to recognize the limitations of your current skill development.

Especially when the risks are high, it is necessary to be conservative in self-assessment. One of the primary issues arising from human misjudgment psychology is overconfidence.

People tend to be overly optimistic. For instance, a Swedish study showed that 90% of car drivers believe their driving skills are above average. Among investors, almost no one publicly admits to having below-average performance.

Avoid doing things that others can do better.

Munger said, 'Buffett and I avoid doing things that others at Berkshire can do better.'

Life becomes easier and more fulfilling when you let someone better than you take on the task.

For example, Munger focuses his efforts on purchasing moats rather than building them. He leaves the construction of moats to entrepreneurs and venture capitalists, deeming such tasks as 'too difficult'.

Looking to pick stocks or analyze them? Want to know the opportunities and risks in your portfolio? For all your investment-related questions,just ask Futubull AI!

Editor/KOKO