Charlie Munger and Bad Habits

Click here to follow Jason on Twitter.

If you know Berkshire Hathaway (NYS: BRK.B) , then you probably know its vice chairman, Charlie Munger -- Buffett's right-hand man. Munger's book, Poor Charlie's Almanack, collects his speeches and musings, including his intriguing thoughts on the 25 tendencies that lead us humans to make really bad decisions. For your benefit and mine, this series will review each of those ill-fated impulses, the errors they create, and the antidotes that can help make us better investors.

Today, we're on to tendency No. 5: Inconsistency-avoidance tendency.

Human beings are stubborn. Once we get going with something, it's hard to change. Whether a political belief or a bad habit, new ideas are typically not accepted so easily because they're inconsistent with the ideas we already have in place. To put it bluntly, we are creatures of habit. And to take that one step further, we are also creatures prone to collect bad habits over the course of our life.

While this observation may be tough for some to accept, I think Munger is spot-on. I know I'm a creature of habit. I don't know if part of it is that I'm too lazy to change or I just really know what I like and don't care about much else, but it's true. But isn't this scary? Munger makes a great reference to Charles Dickens' A Christmas Carol on this point when he says: "When Marley's miserable ghost says, 'I wear the chains I forged in life,' he is talking about chains of habit that were too light to be felt before they became too strong to be broken.'"

In other words, we need to be careful of this tendency or before we know it, it'll be too late to change anything at all. And that could be fatal in life and investing. (I'm on the fence as to which one is worse.)

So why don't we change our thinking even after there is enough evidence to prove that we may be wrong? Munger refers to three evolutionary points:

  • Habits facilitated faster decisions when speed was essential to survival;

  • Habits facilitated survival advantages gained by cooperating in groups (it would be more difficult for groups as a whole to make it if everyone was always changing their minds); and

  • Habits were simply the best solution to get us to this point in time as a species.

As an investor, there are all sorts of bad habits we can get into. Too much trading is one. Taxes and other frictional costs can really eat away at gains over the course of time. And if you think about it, overtrading is more or less a form of market timing -- basically flipping a coin. It's a lot easier to perform diligent research and invest wisely for the long haul. That's not to say you should never sell, but you should certainly be aware of when and why you would sell. In other words, have a sell strategy in place.

Netflix's (NAS: NFLX) stock has been on a tear reaching upward of $300 as every quarter brought higher subscriber bases and more revenue. But when management announced yesterday that it was revising domestic subscriber guidance down by about 1 million subscribers, investors couldn't get out fast enough, and at the end of the day the stock finished down 19% -- its largest single day drop in three years. Many had a sell strategy all right: When it started looking like the growth could be slowing down, sell. But are they right? I guess time will tell.

Another bad habit could be investing in things we don't understand (while denying that we in fact don't understand them). Rather, take the opportunity to learn something new and decide whether it is welcome in your circle of competence. To paraphrase Buffet, there is nothing wrong with throwing something in the "too difficult to understand" pile.

Take for example my most recent Rising Star purchase, Masimo (NAS: MASI) . I needed to dig in to and learn a lot about Masimo before pulling the trigger. Am I an expert on pulse oximetry today? Nope. But after my research, I have a strong enough understanding of what founder and CEO Joe Kiani was after in starting the company to be able to invest. And even more I'm excited and interested to follow the company and its progress.

The greatest takeaway of all from this lesson is that bad habits are a lot easier to not start at all than to stop. Munger in this case aptly refers back to one of Benjamin Franklin's most recognized quotes from Poor Richard's Almanack "An ounce of prevention is worth a pound of cure." No doubt this is true.

Read the other installments so far in this series:
Charlie Munger and the Psychology of Human Misjudgment
Charlie Munger and the Psychology of Human Misjudgment, Continued
Why Charlie Munger Thinks Hate Creates Opportunity Another Lesson Courtesy of Charlie Munger

At the time thisarticle was published Stock Advisor analyst Jason Moser owns shares of Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway and Masimo. Motley Fool newsletter services have recommended buying shares of Netflix and Berkshire Hathaway. Motley Fool newsletter services have recommended buying puts in Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.