Peter Kaufman on The Multidisciplinary Approach to Thinking: Transcript

Last week I had the great pleasure of attending a talk by Peter Kaufman on the Multidisciplinary Approach to Thinking.  I would like to thank Mr. Kaufman for delivering such an engaging and insightful talk.

Mr. Kaufman does not normally allow his talks to be on the record, but is making a rare exception in this case.  He believes the message within this talk – that it is possible to succeed in business, yet fail in life – is critical for anyone interested in living a full, meaningful life, with minimal regret in later years.  He hopes that “going positive and going first”, “win/win”, and “going far by going together” are ideas that aspiring money managers will take to heart in their own lives.

I transcribed the full event from my audio recording which you may listen to on SoundCloud.  Throughout the transcript you will find;

  1. Time stamps, each linked to its corresponding recording location.
  2. Links to relevant supporting information.

Furthermore, I’d like to thank Spencer Hoff, President of the Cal Poly Pomona Economics Club, who graciously invited the Latticework Investing Community to attend.  I would also like to thank the Cal Poly Pomona Economics Club for hosting such a great event.

Transcript: Peter Kaufman on The Multidisciplinary Approach to Thinking

0:00 Talk Begins

Spencer Hoff: Thank you for coming. Today we’ve got Mr. Peter Kaufman, CEO of Glenair, who wrote this book, Poor Charlie’s Almanack about Charlie Munger. It’s an excellent book, the best book I’ve ever read, by far, in my life. He serves on the board of Daily Journal with Mr. Charlie Munger and he’s going to give us a few words today. So please welcome Mr. Peter Kaufman everybody.

0:26

Peter Kaufman: Thank you. Now I’m happy to talk about a subject. I was asked to talk about the multidisciplinary approach to thinking. So I’ll start out with that. But if you guys get bored or something and say ‘Well I thought we were supposed to have fun listening to this today.’ You can raise your hand and say ‘Could you talk about leadership or team building or business strategy or ethics or something else?’ I gave a talk recently at Google, in fact I’ve given three talks at Google. And the first talk I gave they said ‘What are you going to talk about?’ And I said, ‘Well, what do you want to talk about?’ They said, ‘About whatever you want. What do you usually talk about?’ Well I usually talk about leadership, culture, team building, strategy, ethics. And they said, ‘We don’t want to hear about that team building crap. We get that all the time. We want to hear about self-improvement.’ So I will mix in with our multidisciplinary topic a little bit of self-improvement as well. Is that OK? OK.

So why is it important to be a multidisciplinary thinker? The answer comes from the Austrian philosopher Ludwig Wittgenstein (link 1, 2, 3) who said, ‘To understand is to know what to do.’ Could there be anything that sounds simpler than that? And yet it’s a genius line, to understand is to know what to do. How many mistakes do you make when you understand something? You don’t make any mistakes. Where do mistakes come from? They come from blind spots, a lack of understanding. Why do you need to be multidisciplinary in your thinking? Because as the Japanese proverb says, ‘The frog in the well knows nothing of the mighty ocean.’ You may know everything there is to know about your specialty, your silo, your “well”, but how are you going to make any good decisions in life…the complex systems of life, the dynamic system of life…if all you know is one well?

2:33

So I tried to learn what Munger calls, ‘the big ideas’ from all the different disciplines. Right up front I want to tell you what my trick was, because if you try to do it the way he did it, you don’t have enough time in your life to do it. It’s impossible. Because the fields are too big and the books are too thick. So my trick to learn the big ideas of science, biology, etc., was I found this science magazine called Discover Magazine. Show of hands, anybody here ever heard of Discover magazine? A few people. OK. And I found that this magazine every month had a really good interview with somebody from some aspect of science. Every month. And it was six or seven pages long. It was all in layperson’s terms. The person who was trying to get their ideas across would do so using good stories, clear language, and they would never fail to get all their big ideas into the interview. I mean if you’re given the chance to be interviewed by Discover Magazine and your field is nanoparticles or something, aren’t you going to try your very best to get all the good ideas into the interview with the best stories etc. OK. So I discovered that on the Internet there were 12 years of Discover Magazine articles available in the archives. So I printed out 12 years times 12 months of these interviews. I had 144 of these interviews. And I put them in these big three ring binders. Filled up three big binders. And for the next six months I went to the coffee shop for an hour or two every morning and I read these. And I read them index fund style, which means I read them all. I didn’t pick and choose. This is the universe and I’m going to own the whole universe. I read every single one. Now I will tell you that out of 144 articles, if I’d have been selecting my reading material, I probably would have read about 14 of them. And the other 130? I would never in a million years read six pages on nanoparticles. Guess what I had at the end of six months? I had inside my head every single big idea from every single domain of science and biology. It only took me 6 months. And it wasn’t that hard because it was written in layperson’s terms. And really, what did I really get? Just like an index fund, I captured all the parabolic ideas that no one else has. And why doesn’t anybody else have these ideas? Because who in the world would read an interview on nanoparticles? And yet that’s where I got my best ideas. I would read some arcane subject and, oh my god, I saw, ‘That’s exactly how this works over here in biology.’ or ‘That’s exactly how this works over here in human nature.’ You have to know all these big ideas. Or there is an alternative, find somebody who did what I did and just get all the ideas from them. Now when I was your age and I was in school I thought the asymmetry of it was very unfair because I had to do all the work. So every time I go back and meet with a group of students I change the asymmetry around. I did all the work for you…

6:15

I have (multiple examples) of models that I derived from what I call my ‘three buckets’. Let’s see if I’ve got my three buckets in here. I do. I do have my three buckets. Ok. So this is how I use ideas that no one else in the world uses and yet I can be comfortable that they’re right. A statistician’s best friend is what? A large, relevant sample size. And why? Because a principle derived from a large relevant sample size can’t be wrong can it? The only way it could be wrong is if the sample size is too small or the sample itself is not relevant. So I want to tell you what my three buckets are where I derive my models, my multidisciplinary models. Number one is 13.7 billion years. Is that a large sample? It’s the largest one in the whole universe. There is no larger sample. Because what is it? It’s the inorganic universe. Physics. Geology. Anything that’s not living goes in my bucket number 1. 13.7 billion years.

Bucket number 2 is 3.5 billion years. It’s biology on the planet Earth. Is that a big sample size? Is it relevant? We’re biological creatures. Let me ask you this, inorganic, bucket number one, is it relevant? We live in it. So bucket number one we live in, 13.7 billion years. Bucket number two is what we’re part of, biology. 3.5 billion years. And number three is 20,000 years of recorded human history. That’s the most relevant of all. That’s our story. That’s who we are.

So we’re going to take a couple of examples here of multidisciplinary thinking. We’ll ask this question, is there a simple two word description that accurately describes how everything in the world works? That would be very useful wouldn’t it if you know how everything works in just two words? So we go to bucket number one. How does everything work? We go to Newton’s Third Law of Motion. We’re getting very multidisciplinary here. Does anybody in the room know what Newton’s Third Law of Motion says? (Answer: “For every action there will always be an equal and opposite reaction.”) That’s beautiful. He wins one of my pens here for answering that question correctly. I always give out rewards. It’s like operant conditioning from psychology, right? So there you go.

Yes if I put this bottle of water on this table, Newton’s Third Law of Motion says that if the bottle pushes down on the table with ‘force x’, and it also strangely says that the table pushes back with equal ‘force x’. That’s very strange. But you know how long that’s been true? 13.7 billion years that’s been true. Now what if I push down twice as hard, what does the table do? Well if I push down twenty one and a half times as hard? What does the table do? Twenty one and a half! OK. Now is there a good word, a catchall word to describe what we’re talking about here when this pushes down and this thing pushes back? Yeah, it’s reciprocation isn’t it? But it’s not mere reciprocation. It’s perfectly mirrored reciprocation. The harder I push, the harder it pushes back. Does everybody buy that? That’s bucket number one. That’s how the world works. It’s mirrored reciprocation. Everything in the inorganic universe works that way.

We go to bucket number 2. I’m going to introduce a little humor into this. Even though this is a dog, pretend it’s a cat. OK? This is a cat for the time being. Mark Twain said that a man who picks up a cat by its tail will learn a lesson he can learn in no other way. What is this cat going to try to do? It’s going to do what? (Answer: “Attack you.”) Yeah it’s going to try and scratch me with its sharp claws. And why? It doesn’t find being picked up by its tail very agreeable does it? Now what if I start swinging this cat around by its tail. What does the cat do now? Now it’s trying to scratch my eyes out. It said, ‘You escalated on me pal, I’m going to escalate back on you.’ Does that sound a lot like mirrored reciprocation? But what if instead of doing something disagreeable with this cat we do something very agreeable with this cat? And this cat’s sitting here and we come over and we gently pick it up by its tummy and we put it in the crook of our elbow and we gently stroke it. Does the cat try and scratch us? What does it do? It licks our hands. And as long as I sit here and stroke it, it’s going to continue to try and lick my hand. It wants to show me what? ‘I like this. This is agreeable. You’re a good guy. Keep it up man!’ It is mirrored reciprocation isn’t it? If I act in a disagreeable way to the cat, the cat acts in a disagreeable way back, and mirrored. If I act in an agreeable way, what do you think we’re going to find when we go to bucket number three? It’s exactly the same thing isn’t it? Your entire life. Every interaction you have with another human being is merely mirrored reciprocation. Now you’re going to say to yourself ‘This is too simple. It can’t be this simple.’ It is this simple! It doesn’t mean it’s not sophisticated. This is a very sophisticated model we just derived isn’t it? We did it in a multidisciplinary fashion didn’t we? We looked into the three largest sample sizes that exist, the three most relevant, and they all said exactly the same thing. Do you think we can bank on that? 100 percent we can bank on that.

13:04

So, if you think about things being complex as being sophisticated like most people do, you think the more complex it is, the more sophisticated it is. I want you to remember, as best you can, what I’m about to say. It’s very, very important. Albert Einstein once listed what he said were the five ascending levels of cognitive prowess. Now there’s nobody in this room that doesn’t want to be level number one. Right? That’s why we’re here. You don’t want to be level number five. You want to be level number one. Wait until you hear what these levels are, it’s going to blow your mind. So number 5 he said, at the very bottom, was smart. OK. That’s the lowest level of cognitive prowess is being smart. The next level up, level 4, is intelligent. Level 3, next up, is brilliant. Next level up, level 2 he said is genius. What? What’s higher than genius? He must have that backward. No he doesn’t. Wait until you hear what number one is according to Albert Einstein. We just demonstrated it. Number one is simple. Simple transcends genius.

Why is simple, the right kind of simple, better than genius? Because you can understand it! I bought this book I usually take it when I’m giving a talk like this. It’s the Ethics by Spinoza. Spinoza’s ethics book was written by a true genius. And guess what? You can’t understand anything in it. But can you understand what I walked you through, mirrored reciprocation? OK.

14:59

Now, because this is an economics club, right, everybody here is interested in economics? So let’s give an example of a model derived, multidisciplinary, same way we did before, but is just about as pure an economic model as you can find. So now we’re going to ask the question, what’s the most powerful force that we as human beings, both as individuals and groups, can potentially harness towards achieving our ends in life?

Ok. We go to bucket number one. We ask, what’s the most powerful force in bucket number one? I’m going to quote Albert Einstein again. He said, ‘The most powerful force in the universe is compound interest.’ But that’s not all he said about compound interest. He not only said that it’s the most powerful force in the universe, he said it’s the greatest mathematical discovery of all time. He said it’s the eighth wonder of the world. And he said that those who understand it get paid by it and those who don’t pay for it. He said all these things, Albert Einstein, about compound interest. Now what’s a good working definition of compound interest? I will propose one. You can have your own, but this is mine. I say compound interest is dogged incremental constant progress over a very long time frame. Is that a fair definition? Alright? I think that’s the answer from bucket number 1. The most powerful force that could be potentially harnessed is dogged incremental constant progress over a very long time frame.

We go to bucket number 2. 3.5 billion years of biology. What’s the most powerful force in three and a half billion years of biology? It’s the machine of evolution. How does it work? Dogged incremental constant progress over a long time frame. This is the beauty of deriving things multidisciplinary. You can’t be wrong! You see these things lined up there like three bars on a slot machine. Boy do you hit the jackpot.  

What do you think we’re going to find when we go to bucket number three? 20,000 years of human experience on earth. You want to win a gold medal in the Olympics. You want to learn a musical instrument. You want to learn a foreign language. You want to build Berkshire Hathaway. What’s the formula? Dogged incremental constant progress over a very long time frame. Look how simple this is. This is above genius. It’s absolutely above genius because you can understand it. This isn’t somebody drawing all these formulas and things up here about, you know, how numbers multiply and amplify over time. The problem that human beings have is we don’t like to be constant. Think of each one of those terms. Dogged incremental constant progress over a very long time frame. Nobody wants to be constant. We’re the functional equivalent of Sisyphus pushing his boulder up the mountain. You push it up half way, and you go, ‘Aw, I’ll come back and do this another time.’ It goes back down. ‘I’ve got this great idea, I’m going to really work hard on it.’ You push it up half way and,’ Aw, you know I’ll get back to this next month.’ This is the human condition. In geometric terms this is called variance drain. Whenever you interrupt the constant increase above a certain level of threshold you lose compounding, you’re no longer on the log curve. You fall back onto a linear curve or God forbid a step curve down. You have to be constant. How many people do you know that are constant and what they do? I know a couple. Warren Buffett and Charlie Munger. Everybody wants to be rich like Warren Buffett Charlie Munger. I’m telling you how they got rich. They were constant. They were not intermittent.

19:37

Let me give you an example of why intermittency is perhaps the most important thing in your lives whether you realize it or not. We’ll begin with the example of bringing home a puppy from the pet shop. Brand spanking new puppy from the pet shop. And the kids are so excited, they’re so excited. What’s your goal of bringing home this puppy to your household? I say it’s to have an engaged, contributing, all-in, new member of your household. And night number one, how are we doing? It’s a disaster. This thing’s over in the corner shaking like a leaf. It’s anything but engaged. It’s anything but contributing and it’s anything but all-in. It’s shaking like a leaf. Human beings are really good at solving this problem. We know we need to create a calm, reassuring, secure, and safe environment.

We know that even though this puppy can’t understand what we’re saying, we need to communicate in soothing tones. And we also know that we need to provide food and water for this puppy. But underlying all these things, stitching them all together, we really know we have to be constant don’t we? You can’t not feed the puppy one day or what happens? Well, the puppy freaks out. The puppy becomes a neurotic puppy. It doesn’t know whether it can trust you or not. This trust that this puppy needs to go all-in is dependent upon you being constant in these behaviors. Does everybody accept that? So, if we are constant, usually in about seven days more or less, if we are constant this little puppy will trot over to our side and it will attach itself to us. And for the rest of its life it will be willing to die for us. That puppy just went all-in, didn’t it? Now did it go all-in because it’s our idea that we want an engaged contributing all-in new member of our household? It doesn’t even know what our idea is, does it? Why did it just go all in? It was the puppy’s idea!

21:57

Now let me tie this to your lives. I did this at Google and they really couldn’t figure out what I was doing. And then afterwards they said ‘You know that was really good. Your eight dollar crystal ball that’s really a good trick. So I’ll do my eight dollar crystal ball trick. And I told them…I had rows bigger than this one, full of the smartest people in the world. And I said guess what I’m going to do with my eight dollar crystal ball? I said, I’m going to do a psychic reading of anybody in this room. Anybody. And I said to Google, ‘If you think that I’ve got a stooge in the room where I’ve got this prearranged. I don’t. Go out in the corridor and bring somebody in. I’ll do the psychic reading.’ This eight dollars I spent on Amazon is the best money I ever spent. So I’m going to select you. What’s your name? (Answer: “Emily”) We’re going to take Emily, we’re going to do a psychic reading of Emily right in front of you. You’re not going to believe this. I’m going to nail this. You’re all going ‘This guy’s a nutcase.’ Spencer’s going, ‘Man why did I invite this guy?’ Just be patient Spencer, this is good stuff. I’ll pull it off. So I’m going to tell Emily what she’s been looking for her whole life. Is there anybody here who thinks I can do this? Well wait until you hear my answer and then for the rest of your life you’re all going to go, ‘I know what everybody in the world is looking for.’ Emily, your entire life you’ve been on a quest, an odyssey, a search for that individual that you can 100 percent absolutely and completely trust. But who’s not just trustworthy, but principled, and courageous, and competent, and kind, and loyal, and understanding, and forgiving, and unselfish. I’m right aren’t I? (Answer: “Dead on”) You know what else my eight dollar Crystal Ball tells me? If you ever think you may have encountered this person, you are going to probe and probe and test and test to make sure that they are real, that you’re not being fooled. And the paradox is that it looks like you’re probing for weakness but you’re not. You’re probing for strength. And the worst day of your life is if instead of strength you get back weakness. And now you feel betrayed. You know why? You’ve got to start your search all over again. It’s the worst thing in the whole world isn’t it? Does everybody here agree with me on this? Look how simple this is.

24:53

Here’s your 22 second course in leadership. That’s all it takes. You don’t have to go to business school. You don’t need books. You don’t need guest speakers. All you have to do is take that list that’s in Emily’s head, and every single other person in this room, every single other person in the whole world, has this list in their head – trustworthy, principled, courageous, competent, loyal, kind, understanding, forgiving, unselfish, and in every single one of your interactions with others, be the list!  Remember how that puppy went all in? You do this with the other human beings you encounter in life. They’re all going all-in and not because it’s your idea. Most people spend all day long trying to get other people to like them. They do it wrong. You do this list, you won’t be able to keep the people away. Everybody’s going to want to attach to you. And be willing to do what? Just like them puppy, they’d be willing to die for you. Because you are what they’ve been looking for their whole lives. This is pretty profound isn’t it?

Look at this picture. I love this picture. Does this woman look like she’s having a good time? OK. So I helped teach this high school class in Los Angeles, and the first class of each semester, a brand new group just like you guys, and I make them go through the following exercise. And believe me just like my eight dollar crystal ball, afterwards you’re going to go ‘I’m really glad I heard that. Because now I really understand things at a level I didn’t understand them before.’ And to understand is to what? To know what to do.

This will clear up all your blind spots about yourself and other human beings. I asked the group, show of hands, how many of you think all human beings are alike? Why? (Answer: “We all have the same basic needs. We express them differently. Tremendous diversity in how we go about meeting them, but ultimately we all have the same needs.”) You get two pens! That’s a beautiful answer. So we’re going to identify what those needs are. What’s your name? (Answer: “Craig”) Craig nailed it. Show of hands. How many of you want to be paid attention to? I mean is there really anybody here who doesn’t want to be paid attention to? You’re a different kind of human being if you are. OK. How many of you want to be listened to? How many of you want to be respected? How many of you want meaning satisfaction fulfillment in your life in the sense that you matter? And then I tell the high school kids, number five. I put it number five, even though it’s the most important of the five I put it last, because if I put it first you wouldn’t raise your hands because it’s awkward. They’re just going to think I’m weird. But then they do raise their hand because I soften them up. How many you want to be loved? Everybody’s exactly the same. The only difference is, as Craig said, is the strategy the that they’re employing to try to get to fulfill those needs. OK.

28:30

Now I’m going to tell you the strategy that dogs use. The dog is going to be very unhappy with me for telling you this. I’m ratting them out. So when your dog is in the backyard and he goes to the fence between your house and the next house and he talks to the dog next door, I’m going to tell you what he says, no one has ever divulged this before. You’re the first group to hear this. Your dog says to the dog next door, ‘Can you believe how easy it is to manipulate human beings and get them to do whatever you want them to do for you?’ And the dog next door goes, ‘I know it’s a piece of cake.’ And your dog says ‘Yeah. All you have to do is every single time they come home, you greet them at the door with the biggest unconditional show of attention that they’ve ever gotten in their whole life. And you only have to do it for like 15 seconds and then you can go back to doing whatever you were doing before and completely ignore them for the rest of the evening.’

However, you do have to do this every single time they come home. And what will the person do? They’ll take care of them. They’ll do anything for this dog. OK? Now do you think that this woman feels she’s being paid attention to? And listened to? And respected? Do you think she’s getting meaning, satisfaction, and fulfillment? Do you think she matters to this dog? And do you think she thinks this dog loves her? And what does the dog get in return? Everything.

All you have to do, if you want everything in life from everybody else, is first pay attention, listen to them, show them respect, give them meaning, satisfaction, and fulfillment. Convey to them that they matter to you. And show you love them. But you have to go first. And what are you going to get back. Mirrored reciprocation. Right? See how we tie this all together? The world is so damn simple. It’s not complicated at all! Every single person on this planet is looking for the same thing. Now why is it that we don’t act on these very simple things?

31:08

So I have an example I use with the class, my elevator example. I’m famous for my elevator story. You’re standing in front of an elevator. The doors open. And inside the elevator is one solitary stranger, you’ve never met this person before in your whole life. You walk into the elevator you have three choices for how you’re going to behave as you walk into this elevator. Choice number one you can smile say ‘good morning’. And I say, at least in California, if you do that 98 percent of the time the person will smile say good morning back. You can test it. OK. My guess is you’re going to find that 98 percent of the time that people say ‘good morning’. Choice number two, you can walk in and you can scowl and hiss at this stranger in the elevator. And they have no idea why you’re scowling and hissing at them. And I say 98 percent of the time, they may not hiss back at you, but they will scowl back at you. And option number three. This is where the wisdom comes. You can walk into the elevator and you can do nothing. And what do you get 98 percent of the time if you walk into an elevator and you do nothing from that stranger in the elevator? Nothing. It’s mirrored reciprocation isn’t it? But what did you have to do? You have to go first. And you’re going to get back whatever you put out there.

This is why these bars are full of people at 2:00 a.m. drowning their sorrows. Knocking down these drinks. ‘When’s the world going to give me something man? When am I going to get mine?’ Well what did you ever do? Did you ever get up of the morning and smile at the world? No. You either did nothing or you scowled and hissed at the world. You’re getting back exactly what you would expect to get back if you understood how the world really works. Which is why we study multidisciplinary things right? We can’t be wrong on this can we? It’s all mirrored reciprocation. So what do you want to do? You want to go positive, you want to go first. What’s the obstacle? There’s a big obstacle. This is an economics club. Certainly you have all heard of Daniel Kahneman, Nobel Prize winner in economics. Behavioral economics. And what did he win his Nobel Prize for? For answering the question, why would people not go positive and not go first when there’s a 98 percent chance you’re going to benefit from it, and only a 2 percent chance the person’s going to tell you to ‘screw off’ and you’re going to feel horrible, lose face, and all the rest of that. And that’s real. That’s why we don’t do it. He said there’s huge asymmetry between the standard human desire for gain and the standard human desire to avoid loss. Which one do you think is more powerful? 98 percent versus 2!

34:14

Now I gave this same talk at Fairfax up in Toronto, Prem Watsa’s outfit. It’s the Berkshire Hathaway of Canada. And I said ‘Of all people in the whole world, you guys should not be making this mistake.’ Why? Because you’re in the insurance business. How does insurance work? You’re supposed to spend 2 percent to protect 98 percent, right? Look what you’re doing. You’re spending 98 percent to protect against the 2 percent probability that somebody makes you look foolish. Lou Brock set the Major League record for stolen bases with the St. Louis Cardinals many years ago. And he once said, ‘Show me a man who is afraid of appearing foolish and I’ll show you a man who can be beat every time.’ And if you’re getting beat in life, chances are it’s because you’re afraid of appearing foolish. So what do I do with my life? I risk the two percent. I was so proud the other day, I was reading Bono on Bono. Bono’s the lead singer of U2. He’s the only other person I’ve ever encountered in my entire life, and I asked all my cronies, ‘Has anybody else ever encountered this elevator model before?’ ‘No. No that’s yours Peter.’ And I said, ‘You know how I said 98-2? Guess who’s got the exact same model? Bono! Well he doesn’t have 98-2, he’s got 90-10.’ Those are his numbers 90-10. Can I be wrong on this? That guy is really squared away. I hope some day I’m as squared away as he is. It’s incredible to think, he figured it out. That’s why that guy’s had such a great life. He goes, ‘You know, I know 10 percent of people are going to screw me. That’s OK. If I’m not willing to be vulnerable and expose myself to that 10%, I’m going to miss the other 90%.’ Does that make sense? Now Charlie Munger one day, you know he turned my whole life upside down. I was over at his house one day and he said, ‘Peter, I’ve been hearing about you going around giving all these talks. You don’t have to go around the country telling people how to make more money.’ I said, ‘Well that’s not what I do Charlie.’ I was very nimble on my feet. I said there’s a catch. I do tell how to make more money but, by the way, if you do these things that get people all-in and whatnot, you’ll make all the money there is to be made. You really will. That’s not why I’m here. I’m here to give you the second half of the message, which is how to be a good person!  What’s your name? (Answer: “Albert”) Albert, How many lifetimes do you have Albert? (Answer: “One”) That’s correct, you get a pen. You see Albert lucked out, he got an easy question. Is your lifetime important to you Albert? (Answer: “One of the most important. Absolutely)

37:15

Now what do we know in economics, it’s an economics model, what do we know we need to use as our decision making prism whenever something is both finite, like one, and important like your life? How do we have to make decisions? You had Mankiw here right? He didn’t talk about opportunity cost? Have you all heard of opportunity cost? It’s the classic illustration of opportunity cost. You have a finite number of something, it’s important. If you’re doing ‘A’ with it, it means what? It means you’re not doing B or C or D or E. What do you have to do? You have to evaluate all the different alternatives and pick the one that’s most optimal. Is that fair? So you’ve got one lifetime. How do you want to spend your one lifetime? Do you want to spend your one lifetime like most people do, fighting with everybody around them? No. I just told you how to avoid that. And in exchange have what? A celebratory life. Instead of an antagonistic fighting life. All you have to do is go positive, go first, be patient enough.  You know we have to be patient for a week with this puppy. Do you know how long it usually takes for a human being to do all the probing and testing that Emily was going to do and to find out that you’re for real? It takes six months. This is why nobody does it. ‘Oh it takes too long.’ Compared to what? Look at the plan B that everybody uses. It’s terrible! It doesn’t work. They spend their whole lives fighting with everybody.

39:01

The three hallmarks of a great investment are superior returns, low risk, and long duration. The whole world concentrates on Category 1. But if you’re a leader of any merit at all, you should be treating these three as what? Co-priorities. How do you get low risk and long duration? Win-Win. This is the biggest blind spot in business. People are actually proud of a win-lose relationship. ‘Yeah we really beat the crap out of our suppliers.’ You know, ‘We’ve got these employees for…you know, we’ve got them on an HB1 visa, they can’t work anywhere else for three years.’ They’re proud of it! Total Win-Lose. You take game theory (link 1, 2) and you insert the word lose in any scenario in game theory and what do you have? A suboptimal outcome. What happens you insert win-win in any game theory scenario, what do you get? Optimal every time. What must you necessarily do if you’re interested in achieving win-win frameworks with your important counterparties in life? You must understand the basic axiom of clinical psychology, which I know because I’m multidisciplinary. I also learned psychology. The basic axiom of clinical psychology reads, ‘If you could see the world the way I see it, you’d understand why I behave the way I do.’ That’s pretty good isn’t it? Now there’s two corollaries to that axiom. And I say if you buy the axiom, which you should, you must buy the two corollaries as well because they’re logical extensions. They’re undeniable. Corollary number one, if that axiom is true and you want to understand the way someone’s behaving, you must see the world as they see it. But corollary number two, if you want to change a human being’s behavior and you accept that axiom, you must necessarily, to get them to change, change how they see the world. Now this sounds impossible. It’s not really that hard. You take a business. Most employees of a business see the world as employees. What if you could get them to see the world instead through the eyes of an owner? Do you think that’s going to change how they behave? It totally changes how they behave. Employees don’t care about waste. Owners do. Employees don’t self-police our place. Owners do.

42:05

This is the secret to leadership. The secret to leadership is to see through the eyes of all six important counterparty groups and make sure that everything you do is structured in such a way to be win-win with them. So here are the six. Your customers, your suppliers, your employees, your owners, your regulators, and the communities you operate in. And if you can truly see through the eyes of all six of these counterparty groups and understand their needs, their aspirations, their insecurities, their time horizons. How many blind spots do you have now? Zero. How many mistakes are you going to make? You’re going to make zero. People don’t think this is possible. It’s really easy. To understand is to know what to do. So I’m going to wrap up here because I’ve only got two minutes. There’s this great African proverb. It’s the definition of win-win. ‘If you want to go quickly go alone, if you want to go far, go together.’ Live your life to go far together. Don’t live it to go quickly alone. Most people grow up wanting to go quickly alone. It doesn’t work. You wind up like Ebenezer Scrooge in A Christmas Carol. You get to the end of your life. Yeah you’re rich, you’re powerful, you’re famous, and you want a do over because you realize at the end of your life, ‘I didn’t live my life right.’ I don’t have what really matters. What really matters is to have people pay attention to you, listen to you, and respect you, show you that you matter, and to love you. And to have it be genuine, not bought. Does that makes sense?

44:00

And I’ll leave you my last bit of wisdom. There’s another proverb, it’s a Turkish Proverb. ‘No road is long with good company.’ The essence of life is to surround yourself, as continuously as you can, with good company. Like I have today. You’re marvelous company. But how did I get that? I had to earn it, didn’t I? I’m not just some guy you picked off the street. I earned the privilege of coming here and the privilege of being with you. It gives me what? It gives me meaning in my life. It makes me feel I matter. To have people listening to me. This is my strategy for getting those five thing. You can develop your own strategy and I hope it involves going positive and going first. Thank you.

End of Transcript

Thank you for reading. I hope you all thoroughly enjoyed the transcript. If you found any errors, kindly let me know and I will fix them.

Furthermore, if you’d like to be informed of future posts, transcripts, or events, please subscribe.

Sincerely,

Richard Lewis, CFA
White Stork Asset Management LLC
Partner, Investments

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Charlie Munger: Full Transcript of Daily Journal Annual Meeting 2017

This week I had the great pleasure of hearing Charlie Munger speak at the Daily Journal Annual Meeting for the second time.  For two hours Charlie  captivated the audience with an abundance of whit, wisdom, and stamina.  It was a fantastic performance.  He truly is 93 years young.

I transcribed the full event from my audio recording which you may find below.  At each question throughout the transcript, I provided a clickable link to the precise spot where the question begins in an excellent video recording of the event posted on YouTube.  If you’d like an audio recording of the event I recommend my recording on SoundCloud.  Furthermore, Charlie provided a handout to the attendees.  I scanned them into a PDF document which you can access here.

I would like to thank Mr. Munger for energetically entertaining our questions and graciously sharing his wisdom, insights, and time with all of us.

I hope you all enjoy!

(Note: You will find that I frequently summarized the questions to Charlie, but as for Charlie’s and Gerry’s answers to the questions, I translated them verbatim and as accurately as possible.)

Charlie Discussing the Daily Journal Corporation:

Charlie: I usually talk a little bit before we take the questions.  And the essence of what’s going on here of course is that we have a corporation that was in a branch of the newspaper business.  And our branch of the newspaper business like most newspaper businesses has gone to hell compared to what it was in its peak years, and almost every other newspaper business is going to hell with no pardon, they’re just disappearing.  What we have is this computer software business where we’re serving the same customers to some extent except now they’re all over the country, even some of them outside the country, with this…we were selling software to all these courts and public agencies whereas before we were giving information to lawyers and other people, and publishing public notices and our software business is of a type where it’s a long tough slog.  But we’re slogging very well and we really love the people who are doing it for us, we’ve got a lot of wonderful people in our software business; the implementers, and the computer programmers, and people who deal with the public agencies, and the ethos of the place is very admirable.  Everybody is trying to get ahead here by doing the work right and serving the customers right, and having a lot of financial wherewithal where money is never a problem, and doing what we’re suppose to do.  It’s a pleasure to, people like Rick Guerin and myself, to watch all these young people doing this and of course we were very glad to be able to do it when we should be dead. (laughter)

A lot of you people came into this because Berkshire was successful and Guerin was successful and for various odd reasons of history, and most of you are accidentally in the software business, and I am too because Guerin did it when I wasn’t paying much attention.  I don’t do this kind of venture capital stuff.  And he doesn’t either, but he did it here.  So if there’s anything wrong with what happens in our software business, you’re looking at a man who caused it all over here. (laughter)  I’ll take credit for any successes.  But if there’s failure you’re looking at the man here who got us into this.

It is amazing to me, some of the things that are happening in our software business.  We just are getting a contract from South Australia.  Now if anybody told me when I was young, that the Daily Journal Company would be automating the courts of South Australia, I mean, I hardly know where it is.  Anyway, it’s amazing what’s happening and it’s a fair amount of fun to watch.  Probably because we’re doing more winning than losing.  I’ve never been able to enjoy losses the way some people do.  I would much rather win.  And I really like to work with good people instead of the opposite.  And we’ve got a lot of good employees in our software business.  We’ve got a bunch of implementer in Utah who are really good at it and we really trust.  And who our customers like, and we’ve got all these computer programmers and so forth around here, and a game of service like that when it’s complicated, what you have to do is minimize your glitches and (crawl out of them very rapidly in a way that your customers trust you.)  Our people were good at that and they get better and they’re trying to get ahead by being good at the service, not by hiring some politician as a consultant.  Some of our competitors do that kind of stuff.  But we’re trying to slog our way out by doing the work right.

When I was a lawyer, there was a saying that I’ve always used, “The best business-getter any lawyer ever has is the work that’s already on his desk.”  And that’s the basic ethos of our software business.  If we just keep doing it right, I don’t think we have to worry about the future.  Not that we won’t have down drafts and our failures, but we are actually grinding ahead slowly in that software business.  And it’s very interesting because Guerin and I know practically nothing about it.  And Gerry didn’t come up as a software engineer, so we’re basically doing something that’s quite difficult, we’re judging people because we don’t understand what the people do.  That’s what Andrew Carnegie did.  He didn’t know anything about making steel.  But he knew a lot about judging whether the people he was trusting were good at making steel.  And of course that’s what Berkshire’s done if you stop and think about it.  We have a lot of businesses at Berkshire that neither Warren our I could contribute much to, but we’ve been pretty good at judging which people are capable of running those businesses.

But this is pretty extreme here.  The little Daily Journal building going into the computer software business.  It’s a long slow kind of business.  RFPs.  The first time we contact a customer until we start making money may be 5 years.  So it’s like deciding to start prospecting for oil in Borneo or something.  And they just keep doing that over and over again, and the money goes out and the effort goes out, and it starts coming in five years from now.  I love that kind of stuff, not when I think we’re taking territory, it doesn’t look good when we write it off and we don’t report wonderful numbers or anything.  But if it makes sense in the long-term, we just don’t give a damn what it looks like over the short term.  And we know we’ve collected a bunch of shareholders that share our ideas.  After all we’re running a cult not a normal company.  And I think most of you feel that you’re willing to wait.

I lived all my life with people who were into deferred gratification.  In fact most of them will never have any fun.  They just defer gratification all the way to end, that’s what we do.  And it does cause you to get rich.  So we’re going to have a lot of rich dead people. (laughter)  We can excite a lot of envy.  A lot of you when the people walk by your grave and there will be this nice grave with this nice monument and they’ll say, “God what a great grave, I wish I were under.”  But at any rate, deferred gratification really does work if what you’re doing is growing a business that gets better and better and getting yourself so that your grave can look nice to outsiders.  Guerin and I have never taken any money out of this company in all these years.  We don’t take salaries, we don’t take directors fees.  We’re a peculiar example.  I wish our example spread more, because I think if you’re wealthy and own a big share of a company, and you get to decide what it does and whether it liquidates or whether it keeps going, that’s a nice position to be in, and maybe you shouldn’t try and grab all the money in addition.  That’s my theory of executive compensation.  And some of the old-fashioned guys like Carnegie never took any salary to speak of.  Cornelius Vanderbilt didn’t take any, of course he owned the whole place, practically, and he would have considered it beneath him, he lived on the dividends like the shareholders did.  So there’s a lot of that old fashioned ideas here in the Daily Journal Company.

Charlie Begins Q&A:

Charlie: I’ll first take a bunch of questions about the Daily Journal, and after that we’ll take question on anything you want to talk about.

Question 1: At last year’s meeting you talked about the milestone of getting the L.A. court system here at Journal Technologies and I was wondering, in the last year, as it has gone by, what good milestones have happened and what bad things have happened.

Charlie: Gerry you take that one.  I’ll answer it (shortly), it’s going fine.

Gerry: We have three case types for Los Angeles.  One case type went live last April, another case type will go live this coming July, and the third case type about 10 to 12 months later after that.  We have to work with the Los Angeles schedule, after all they have a lot of people to train.  And that becomes and very important factor.  Training is critical because if the end users aren’t trained properly, virtually everything falls apart.  And so that’s the schedule.  We discussed it this morning.  We meet with the court about 3 miles from here virtually every day.  We have a good team from the court and I think they’re very excited about what they’re doing, and that’s critical to us that the court feels good about the system.

Charlie: One good thing about what we’re doing is it’s slow and it’s agony in the delays between the first customer contact and finally getting into a decent revenue stream.  But once you succeed, it’s very sticky business.  Very sticky business.  And the fact that it’s difficult to do means it’s difficult for people to change much.  So if you go slog through all this tough territory where it’s (slogging through), there’s a reward out there somewhere, and we’re not in a small business.  It has way more potential than the original print business we had giving information about the (cases).  It’s a big market.  And the people have no option but to charge ahead.  These courts and district attorneys, public defenders, all these people were serving…they’re over-whelmed with options…better systems and more software.  So it’s a huge market.  And the fact that it’s so often to grind through.  It means that the people who want easy gratification don’t come in.  If it seems slow and painful to you, we kind of like it that way.

Questions 2: Your thoughts on Tyler Technologies.  How do you think your competitive position versus Tyler is doing.

Charlie: Well Tyler is an extremely aggressive company.  They were bigger faster and so on.  I like our ethos of operation better than I like theirs.  If I were buying software, I’d rather buy ours than theirs.  Our system is to keep fighting the game.  I wish all the customers I had in life were like Tyler.

Question 3: The rate of revenue growth is going down a little bit, while expenses are going up.  Any major milestones in the next 3 to 5 years that you think you’d like to get that you think would really help things along.

Charlie: I’ll take your first question.  It looks like we’re proceeding slowly, but we bought a bunch of contracts, in effect, for money, and we knew they were going to end, so we’re amortizing the cost of those contracts.  But really it was an anticipated decline that we got big revenues up front for taking.  So we’re getting ahead, there’s a little blip in the figures.

(Response to second question) Every contract that’s significant is a major jump.  The business is so big they’re whole states.  I mean this is a huge business and everybody is just scrambling at the first parts of something that’s going to grow bigger and bigger and last and last.  As long as we’re doing the work right, why it’s likely to work out right.

Question 4: Can you comment on Wells Fargo?

Charlie: Well of course Wells Fargo had a glitch.  The truth of the matter is that they made a business judgment that was wrong.  They got so caught up in cross-selling and so forth and having tough incentive systems that they got the incentive systems so aggressive that some people reacted badly and did things they shouldn’t.  And then they used some misjudgment in reacting to the trouble they got in.  I don’t think anything’s fundamentally wrong for the long-pull.  Wells Fargo, they made a mistake.  It was an easy mistake to make.

The smartest man I ever knew made a similar mistake.  Henry Singleton, who was the smartest single human being I knew in my whole life.  And Henry Singleton of Teledyne also had very aggressive incentive systems, like Wells Fargo.  And his customer in many of his subsidiaries was the government.  And of course it’s not that hard to cheat the government.  But his very aggressive incentive systems, 2 or 3 out of 20 subsidiaries cheated the government.  So all of a sudden he’s got three scandals at once.  It wasn’t that Henry was trying to cheat the government.  He just got a little aggressive in applying the incentives and he got blindsided.

That can happen to anybody.  I don’t regard getting the incentives a little aggressive at Wells Fargo as a mistake.  I think the mistake there was, when the bad news came, they didn’t recognize it rightly.  They made a mistake.  But what happens in a tough system like capital, you make a mistake like that and pretty soon you’re gone.

Question 5: For Gerry or Charlie.  Congratulations for inverting and not doing things wrong in regards to Daily Journal.  What’s your insight into the Alemeda court system and the problems that Tyler’s having over them.

Charlie: No, but I’m not dissatisfied with it.  I don’t think I want to criticize Tyler any more than I have.  One of our customers, you’ll be sad to know is having some problems with pleasing a customer…You can see the salt tears running down my cheeks. (laughter)

Question 6: Question on software fees in terms of your revenue lines.  What portion of that business is recurring?

Charlie: That is so complicated that I’m not even going to try to answer it.  I’m just going to answer it in substance.  There’s a lot that’s reoccurring if we stay in there.

You can’t look at our financial statements and make very good judgments about what’s going to happen.  It’s the nature of our game that’s confusing.  It confuses us a little bit.  So we’re not holding back on purpose, it’s a very complex, confusing, system.  You’ve got all these RFPs.  It’s very complicated.

Question 7: You purchased the building in Logan, which I believe is used exclusively in Journal Technologies, but in accounting, it’s under the traditional business, I’m wondering why?

Charlie: Gerry I give you that one.  He says, why is Logan, somehow in the traditional business?  It shouldn’t be.

Gerry: The Daily Journal purchased the building and they own the building.  And Journal Technologies pays rent to the parent company for that and the amount of rent is not, what we would consider, material from that perspective.  And because it’s owned by the Daily Journal that’s how we originally classify it.  No real significant reasons.  All the expenses on the Journal Technologies books.

Charlie: That’s some quirk of accounting.  It doesn’t really matter.

Question 8: Follow up on the question of incentives.  You were explaining at Wells Fargo you don’t have a problem with aggressive incentives.  Can you expand on that a little more?

Charlie: Well how do you know they’re aggressive until you try?  They didn’t react enough to the bad news fast enough.  And of course that a very dangerous thing to do.  I don’t think it impairs the future of Wells Fargo.  As a matter of fact, they’ll be better for it.  The one nice thing about doing something dumb is that you probably won’t do it again.

Question 9: Question in regards to someone early in their career trying to figure out which of several paths to pursue.  Two thoughts that seem helpful for this purpose are 1) figuring out which work you have the possibility to become the best at and 2) ascertaining which line of work would most help society.  Do you think these ideas are the right ones to focus on, and if so, how would you go about answering them.

Charlie: Well, in terms of picking what to do, I want to report to all of you, that in my whole life I’ve never succeeded much in something that I wasn’t interested in.  So I don’t think you’re going to succeed if what you’re doing all day doesn’t interest you.  You’ve got to find something you’re interested in because it’s just too much to expect of human nature that you’re going to be good at something that you really dislike doing.  And so that’s one big issue.  And of course you have to play in a game where you’ve got some unusual talents.  If you’re 5 foot 1, you don’t want to play basketball against some guy whose 8 feet 3.  It’s just too hard.  So you gotta’ figure out a game where you have an advantage and it has to be something that you’re deeply interested in.  Now you get into the ethical side of life, well of course you want to be ethical.  On the other hand, you can’t be just dreaming how you think the world should be run and that it’s too dirty for you to get near it.  You can get so consumed by some ideological notion particularly in a left-wing university.  It’s like you think you’re handling ethics and what you’re doing is not working.  And maybe smoking a little pot to boot.  This is not the Munger system.

My hero is Maimonides.  And all that philosophy and all that writing, he did after working 10 or 12 hours a day as a practicing physician all his life.  He believed in the engaged life.  And so I recommend the engaged life.  You spend all your life thinking about some politician who wants it this way or that way you’re sure you know what’s right, you’re on the wrong track.  You want to do something every day where you’re coping with the reality.  You want to be more like Maimonides and less like Bernie Sanders.

Question 10: Is American Express value proposition more in terms of payment or service and rewards?

Charlie: Well I’m going to give you an answer that will be very helpful to you because you’re somewhat confused about what the exact future of American Express will be…and I want to tell you, I’m confused too.  I think that if you understand exactly what’s going to happen to payment systems ten years out, you’re probably under some state of delusion, it’s very hard to know.  So if you’re confused, all I can say is “welcome to the club”.  They’re doing the best they can, they’ve got some huge advantages that they’re…it’s a reasonable bet.  But nobody knows.  I don’t know if IBM is going to sell that much of Watson.  I always say I’m agnostic on the subject.  You’re talking about payment system 10 years out, I’m agnostic on that too.  I think if you keep trying to do the right thing and you play the game hard, your chances are better.  But I don’t think those thing are knowable.  Think about how fast they changed.

Question 11: Do you think that domestic natural gas, exploration and production, is a good business despite the capital intensity?

Charlie: Well that’s a different subject, I have a different feeling about the energy business than practically anyone else in America.  I wish we weren’t producing all this naturally gas.  I would be delighted to have the condensate that’s coming out of our shale deposits just lie there untapped for decades in the future and pay a bunch of Arabs to use up their oil.  But nobody else in America seems to feel my way.  But I’m into deferred gratification.  Oil and gas is not going away and I think it’s just as important as the top soil in Iowa.  If any of you said, “oh goodie, I found a way to make money, we’ll ship all our top soil from Iowa to Greenland!”  I wouldn’t think that was a very good idea.  And so I don’t think that hastening to use up all of our oil and gas is a good idea.  But I’m practically the only one in the country that feels that way.  There’s not enough deferred gratification in it to please me.  But I don’t see any advantage…I regard our oil and gas reserves just as chemical feed stocks that are essential in civilization. (Leave aside) their energy content.  I’d be delighted to use them up more slowly.  By the way, I’m sure I’m right and the other 99% of the people are wrong.

But no, I don’t know…The oil and gas business is very peculiar.  The people who success in most other businesses are doing way more physical volume than they did in the past.  But a place like Exxon, the physical volume goes down by two thirds, it’s just that the price of oil goes up faster than the physical volume goes down.  That is a very peculiar way to make money.  And it may well continue, but it’s confusing, we’re not use to it.

Question 12: As an 18 year old interested in many disciplines, I was wondering how you can thrive as a polymath in a world that celebrates specialization.

Charlie: Well that’s a good question.  I don’t think operating over many disciplines as I do is a good idea for most people.  I think it’s fun, that’s why I’ve done it.  I’m better at it than most people would be.  And I don’t think I’m good at being the very best for handling differential equations.  So it’s in a wonderful path for me, but I think the correct path for everybody else is to specialize and get very good at something that society rewards and get very efficient at doing it.  But even if you do that, I think you should spend 10 or 20% of your time into trying to know all the big ideas in all the other disciplines.   Otherwise…I use the same phrase over and over again…otherwise you’re like a one legged man in an ass-kicking contest.  It’s just not going to work very well.  You have to know the big ideas in all the disciplines to be safe if you have a life lived outside a cave.

But no, I think you don’t want to neglect your business as a dentist to think great thoughts about Proust.

Question 13: Question about Lollapalooza effects.  What current event is causing you concern and how can you use that inter-disciplinary approach to spot them?

Charlie: Well, I coined that term the “Lollapalooza effect” because when I realized I didn’t know any psychology and that was a mistake on my part, I bought the three main text books for introductory psychology and I read through them.  And of course being Charlie Munger, I decided that the psychologists were doing it all wrong and I could do it better.  And one of the ideas that I came up with which wasn’t in any of the books was that the Lollapalooza effects came when 3 or 4 of the tendencies were operating at once in the same situation.  I could see that it wasn’t linear, you’ve got Lollapalooza effects.  But the psychology people couldn’t do experiments that were 4 or 5 things happening at once because it got too complicated for them and they couldn’t publish.  So they were ignoring the most important thing in their own profession.  And of course the other thing that was important was to synthesize psychology with all else.   And the trouble with the psychology profession is that they don’t know anything about ‘all else’.  And you can’t synthesize one thing you know with something you don’t if you don’t know the other thing.  So that’s why I came up with that Lollapalooza stuff.  And by the way, I’ve been lonely ever since. (laughter)  I’m not making any ground there.  And by the way, I’m totally right.

Question 14: My question relates to a comment you made some years ago about Warren Buffett.  I think you said that he has become a significantly better investor since he turned 65, which I found a remarkable comment.  I was wondering if you could share information about that, that maybe we haven’t heard before.  I know you’ve commented he’s a learning machine and we all know the aversion to retail that came out of the Diversified episode, and so on.  I’d just be interested if there’s something that’s changed about his risk assessment or his horizons or any color there would be fantastic to hear.  Thank you.

Charlie: Well, if you’re in a game and you’re passionate about learning more all the time and getting better and honing your own skills all the time, etc. etc.  Of course you do better over time.  And some people are better at that than others.  It’s amazing what Warren has done.  Berkshire would be a very modest company now if Warren never learned anything.  He never wouldn’t have never given anything back. I mean any territory he took he was going to hold it.  But what really happened was, we went out into the new fields of buying whole businesses and we bought into things like Iscar that Warren never would have bought when he was younger. Ben Graham would have never bought Iscar.  He paid 5 times book or something for Iscar.  It wasn’t in the Graham play.  And Warren who learned under Graham, just, he learned better over time.  And I’ve learned better.  The nice thing about the game we’re in, is that you can keep learning.  And we’re still doing it.  Imagine we’re in the press…for all of a sudden (buying) airline stocks?  What have we said about the airline business?  We thought it was a joke it was such a terrible business.  And now if you put all of those stocks together we own one minor airline.  We did the same thing in railroads, we said “railroads are no damn good, you know there’s too many of them, truck competition…”  And we were right it was a terrible business for about 80 years.  But finally they got down to four big railroads and it was a better business.  And something similar is happening in the airline business.

On the other hand, this very morning I sat down in my library with my daughter-in-law and she booked a round trip ticket to Europe including taxes, it was like 4 or 5 hundred dollars.  I was like, “we’re buying into the airline business?” (laughter)  It may work out to be a good idea for the same reason that our railroad business turned out to be a good idea, but there’s some chances it might not.  In the old days, I frequently talked to Warren about the old days, and for years and years and years, what we did was shoot fish in a barrel.  But it was so easy that we didn’t want to shoot at the fish while they were moving.  So we waited until they slowed down and then we shot at them with shotgun.  It was just that easy.  And it has gotten harder and harder and harder.  And now we get little edges…before, we had totally cinches.  It isn’t any less interesting.  We do not make the same returns we made when we could run around and pick this low hanging fruit off trees that offered a lot of it.

So now we go into things…We bought the Exxon position…You know why Warren bought Exxon?  As a cash substitute!  You would never have done that in the old days.  We had a lot of cash and we thought Exxon was better than cash over the short term.  That’s a different kind of thinking from the way Warren came up.  He’s changed.  And I think he’s changed when he buys airlines.  And he’s changed when he buys Apple.  Think of the hooting we’ve done over the years about high tech, ‘we just don’t understand it’, ‘it’s not in our central competency’, ‘the worst business in the world is airlines’.  And what do we appear in the press with?  Apple and a bunch of airlines.  I don’t think we’ve went crazy.  I think the answer is, we’re adapting reasonably to a business that’s gotten very much more difficult.  And I don’t think we have a cinch in either of those positions.  I think we have the odds a little bit in our favor.  And if that’s the best advantage we can get, we’ll just have to live on the advantage we can get.  I use to say you have marry the best person that will have you, and I’m afraid that’s a  rule of life.  You have to get by in life with the best advantage you can get.  And things have gotten so difficult in the investment world that we have to be satisfied with the type of advantage that we didn’t use to get.  On the other hand the thing that caused it to be so enormously difficult was when we got so enormously rich.  And that’s not a bad trade off.

Question 15: At last year’s meeting you said Donald Trump was not morally qualified to be President, and now that he is President, do you still agree with that, do you think he’s qualified in any capacity?

Charlie: Well I’ve gotten more mellow. (laughter)  I always try and think about the good as along with what’s not good.  And I think some of this stuff where they’re re-examining options about the whole tax system of the country, I think that’s a very constructive thing.  When Donald Trump says he wouldn’t touch Social Security when a lot of highfalutin Republicans have all kinds of schemes for (rising) Social Security, I’m with Donald Trump.  If I were running the world I would have his exact attitude about Social Security.  I wouldn’t touch it.  So he’s not wrong on everything and just because he isn’t like us…roll with it.  Accept a little danger.  What the hell, you’re not going to live forever at any how.

Question 16: What was the most meaningful thing you did with your life?

Charlie: Well, I think the family and children is the most meaningful thing most people do with their life.  And I’ve been reasonably fortunate…I don’t think I’ve been a perfect husband. I’m lucky to have had as much felicity as I got.  And I always needed a certain amount of toleration from the fair sex.  I started wrong and I never completely fixed myself.  I can tell this group…you come here as a cult to talk to a cult-leader?  I want to take you back in history, you’ll see what an inferior person you’re now trusting.

When I was a freshman in Omaha Central High, there was a friend of the family, a girl my age.  She had gone off to summer camp the year before and she met a blonde goddess.  A voluptuous 13 year old.  And I was a skinny under-developed whatever and so forth. ‘You gotta take my blonde goddess to this dance’.  And so I wanted to impress this ‘blonde goddess’ and so I pretended to smoke which I didn’t.  And she was wearing a net dress and I set her on fire!  (big laughter) But I was quick whittled and I through Coca-Cola all over her and in due time the fire was out.  And that’s the last I saw of the blonde goddess.

And then I said, ‘well I’ve gotta make more time with the girls’.  And I wanted to get a letter at Omaha Central High.  Of course I was no good at any sport.  So I went down to the rifle range and learned they gave letters in rifle shooting.  And I was so skinny that I could shoot a 100 in the sitting position by sitting cross-legged and putting one elbow on each foot.  Try it, you’ll break your neck.  But I could shoot a hundred every time.  So I was a good rifle shooter and they gave me a letter.  But I was so skinny and short and underdeveloped that it went from one arm pit to the other.  And I walked down the hallway trying to impress the girls and they wouldn’t turn their head.  What they said was, ‘how did a skinny little unattractive runt like that get a letter?’

And then I had another experience.  There was a girl I still remember, Zibby Bruington.  She was a senior and a very popular senior.  And I was a nerd sophomore.  And somehow she agreed with me to go to a party in one of the out-buildings at the Omaha Country Club.  Perhaps because she liked one of my friends who was a big strapping fellow.  So I took Zibby to this party in my 1934 Ford, and it sleeted and got rainy, and so forth.  And I managed to stick the Ford in the mud and I couldn’t get out of it.  And Zibby and I had to walk for several miles through sleet.  That was the last I ever saw of Zibby Bruington.  And then my car stayed in the mud and I neglected to put in anti-freeze and the temperature went way down suddenly and the block broke!  Because it was too expensive to fix.  I lost my car and my father wouldn’t by a new one because my father said, ‘why should I buy a new car for someone whose dumb enough not to put anti-freeze in it?’  This is the person you’re coming all this way to see!

My life is just one long litany of mistakes and failure.  And it went on and on and on.  And politics!  I ran to be the president of the DSIC in grade school, The Dundee School Improvement Association.  I had the most popular boy in school as my campaign manager.  I came in second by miles.  I was a total failure in politics.  There’s hardly anything I succeeded at.  Now, I tell you all this because I know a nerd when I see one.  And there are a lot of nerds here who can tell stories like mine. (big laughter)  And I want to feel it’s not hopeless.  Just keep trying.

Oh yeah, Guerin wants me to repeat the story of Max Plank.  According to the story, Max Plank when he won the Nobel Prize was invited to run around Germany giving lectures.  And a chauffeur drove him.  And after giving the lecture about 20 times, the chauffeur memorized it.  And he said, ‘you know Mr. Plank, it’s so boring, why don’t you sit in the audience and I the chauffeur will give your talk.’  And so the chauffeur got up and gave Max Plank’s talk on physics and some professor got up and asked some terrible question.  And the chauffeur said, ‘Well I’m surprised that in an advanced city like Munich, people are asking me elementary questions like that.  I’m going to ask my chauffeur to answer that!’ (laughter)

While I’m telling jokes I might tell one of my favorite stories about the plane that’s flying over the Mediterranean.  The pilots voice comes on and says, ‘A terrible thing just happened.  We’re losing both engines, we’re going to have to land in the Mediterranean.’  And he says, ‘The plane with stay afloat for a very short time, and we’ll be able to open the door just long enough so that everybody can get out.  We have to do this in an orderly fashion.  Everybody who can swim go to the right wing and stand there.  And everybody who can’t swim go to the left wing and just stand there.  Those of you on the right wing, you’ll find a little island in the direction of the sun.  It’s two miles off.  And as the plane goes under, just swim over to the island, you’ll be fine.  For those of you on the left wing, thank you for flying Air Italia.” (big laughter)

Question 17: With regard to the proliferation of index funds, do you think there will be an issue with liquidity any time we go through another large crisis?  Do you think that will create large discrepancies between the price of the index fund and the value of the securities underneath?

Charlie: Well, the index funds of the S&P is like 75% of the market.  So I don’t think the exact problem you’re talking about is going to be a big problem because you’re talking about the S&P index.  But.  Is there a point where index funds theoretically can’t work a course?  If everybody bought nothing but index funds, the whole world wouldn’t work as people expect.  There’s also the problem…one of the reasons you buy a big index like the S&P.  Is because if you buy a small index, and it gets popular, you have a self-defeating situation.  When the nifty-fifty were the rage, JP Morgan talked everybody into buying just 50 stocks.  And they didn’t care what the price was, they just bought those 50 stocks.  Of course in due time, their own buying forced those 50 stocks up to 60 times earnings.  Where upon it broke and everything went down by about two-thirds quite fast.  In other words, if you get too much faddishness in one sector or one narrow index, of course you can get catastrophic changes like they had with the nifty-fifty in that former era.  I don’t see that happening when the index is three-quarters of the whole market.

The problem is that the whole thing can’t work perfectly forever.  But it will work for a long time.  The indexes have caused just absolute agony among the intelligent investment professionals.  Because basically 95% of the people have almost no chance of beating it over time.  And yet all the people expect if they have some money, they can hire somebody who will let them beat the indexes.  And of course the honest sensible people know they’re selling something they can’t quite deliver.  And that has to be agony.  Most people handle that with denial.  They think if we’re better next year…they just don’t want to think about that.  I understand that, I mean I don’t want to think of my own death either.  But it’s a terrible problem beating those indexes.  And it’s a problem that investment professional get didn’t have in the past.  What’s happening of course is the prices for managing really big sums of money are going down, down, down, 20 basis points and so on.  The people who rose in investment management didn’t do it by getting paid 20 basis points.  But that’s where we’re going I think in terms of people who manage big portfolios of the American Equities in the equivalent of the S&P.  It’s a huge, huge, problem.  It makes your generation of money managers to have way more difficulties and causes a lot of worry and fretfulness.  And I think the people who are worried and fretful are absolutely right.

I would hate to manage a trillion dollars in the big stocks and try and beat the indexes.  I don’t think I could do it.  In fact if you look at Berkshire, take out a hundred decisions, which is like two a year.  The success of Berkshire came from two decisions a year over 50 years.  We may have beaten the indexes, but we didn’t do it by having big portfolios of securities and having subdivisions managing the drugs, and subdivisions…and so, the indexes are a hell of a problem for you people.  But you know, why shouldn’t life be hard?  It’s what had to happen, what’s happened now.  If you take these people doing some of those early trading by computer algorithms that worked.  Then somebody else would come in and do the same thing with the same algorithm and play the same game.  And of course the returns went down.  Well that’s what’s happening in the whole field.  The returns you’re going to get are being pushed down by the progress of the sons.

Question 18: First question: What books or experiences were most formative to you in your early career? Second question: Where and how do you tell your most ambitious grandchildren to look for business opportunities.

Charlie: Well I don’t spend any time telling my grandchildren what business opportunities to look for.  I don’t have that much hope. (laughter)  I’m going to have trouble getting my grandchildren to work at all!  Anyway, I don’t think there’s an easy way to handle a problem of doing better and better with finances.  Obviously if you’re glued together and honorable and get up every morning and keep learning every day and you’re willing to go in for a lot of deferred gratification all your life, you’re going to succeed.  It may not be as much as you want.  But you’re going to success.  And so the main thing is to just keep in there, and be glued together, and get rid of your stupidities as fast as you can.  And avoid the bad people as much as you can.  And you’ll do reasonably well.  But try teaching that to your grandchildren.  I think the only way you’ve got a chance is sort of by example.  If you want to improve your grandchildren the best way is to fix yourself.

Oh books.  You cultist send me so many books that I can scarcely walk into my own library.  So I’m reading so many now because I never throw one away, I at least scan it.

I’ve just read this new book by Thorp, the guy who beat the dealer in Las Vegas.  And then he did computer algorithm trading.  And I really liked the book.    For one thing, the guy had a really good marriage and he seemed grateful for it.  And it was touching.  For another he was a very smart man.  He was a mathematician using a high IQ, to A) beat the dealer in Las Vegas and so forth and the B) use these computer algorithms to do this massive trading.  I found it very interest and since some of you people are nerds, and maybe you might like a love story.  I recommend Thorp’s new book.

It’s an interesting thing to do to beat the dealer in Las Vegas…wearing disguises and so on.  And Peter Kaufman told me a story about somebody he knows that did the same thing as Thorp did, but he did it more extreme.  He wore disguises and so forth.  He won four million dollars I think, in the casinos.  And that was hard to do because casinos don’t like playing against people who might win.  And then he went into the stock market where he made four billion dollars!  Again, clever algorithms.  You know, these people are mathematically gifted.  It’s still going on.  And I don’t think many of you are going to do it.  There can’t be many people who are mathematically gifted enough, manipulate statistics and everything else so well that they find little algorithms that will make them four billion dollars.

But there are a few.  And so some of them started just like Thorp.  And so Thorp’s book is interesting.  So I recommend it for you.

Question 19: Question on Filial piety.  In this generation, how can we fulfill our filial duties?

Charlie: I like filial piety.  They worship old men.  Rich old men.  That is my kind of a system. (laughter) But I think the idea of caring about your ancestors and caring about your traditions, I think all that stuff is a big part of what’s desirable.  I really admire the Confucians for that notion that it’s not a game that’s played just in one life.  It’s a game where you’re handing the baton off and you’re accepting the baton from your predecessor.   So if filial piety is your game, why I think it’s a very good thing.  Think about how rootless we’d be if we had no families at all, no predecessors, no decedents, it would be a very different life.  Think what we owe to people who figure out things in the past that make our civilization work.  So I’m all for filial piety and its close cousins.

Question 20: You’ve said, “any year in which you don’t destroy one of your best loved ideas is a wasted year.” It’s well known that you helped coached Warren towards quality which was a difficult transition for him.  I was wondering if you could speak to the hardest idea that you’ve ever destroyed.

Charlie: Well I’ve done so many dumb things.  That I’m very busy destroying bad ideas because I keep having them.  So it’s hard for me to just single out from such a multitude.  But I actually like it when I destroy a bad idea because I think I’m on the…I think it’s my duty to destroy old ideas.  I know so many people whose main problem of life, is that the old ideas displace the entry of new ideas that are better.  That is the absolute standard outcome in life.  There’s an old German folk saying, “We’re too soon old and too late smart.”  That’s everybody’s problem.  And the reason we’re too late smart is that the stupid ideas we already have, we can’t get rid of!  Now it’s a good thing that we have that problem, in marriage that may be good for the stability of marriage that we stick with our old ideas.  But in most fields you want to get rid of your old ideas.  It’s a good habit and it gives you a big advantage in the competitive game of life…other people are so very bad at it.  What happens is, as you spout ideas out, what you’re doing is you’re pounding them in.  So you get these ideas and then you start agitating them and saying them and so forth.  And of course, the person you’re really convincing is you who already had the ideas.  You’re just pounding them in harder and harder.  One of the reasons I don’t spend much time telling the world what I think about how the federal reserve system should behave and so forth.  Because I know that I’m just pounding the ideas into my own head when I think I’m telling the other people how to run things.  So I think you have to have mental habits…I don’t like it when young people get violently convinced on every damn cause or something.  They think they know everything.  Some 17 year old who wants to tell the whole world what ought to be done about abortion or foreign policy in the middle east or something.  All he’s doing when he or she spouts about what he deeply believes is pounding the ideas he already has in, which is a very dumb idea when you’re just starting and have a lot to learn.

So it’s very important that habit of getting rid of the dumb ideas.  One of things I do is pat myself on the back every time I get rid of the dumb idea.  You could say, ‘could you really reinforce your own good behavior?’  Yeah, you can.  When other people won’t praise you, you can praise yourself.  I have a big system of patting myself on the back.  Every time I get rid of a much beloved idea I pat myself on the back.  Sometime several times.  And I recommend the same mental habit to all of you.  The price we pay for being able to accept a new idea is just awesomely large.  Indeed a lot of people die because they can’t get new ideas through their head.

Question 21A: My perception is that the (oil and gas) industry itself has continuously gotten more complex and technical, and as the economy expands and you have more division of labor and specialization, it seems to me that it can be very hard for investors unless there’s more specialization.  (Charlie interjects)

Charlie: Of course.

Question 21B: Do you think that capital allocators are going to need to become more specialized going forward?

Charlie: Well you petroleum people of course have to get more specialized because the oil is harder to get and you have to learn new tricks to get it.  And so you’re totally right.  Generally, specialization is just the way to go for those people.  It’s just I have an example of something different.  It’s awkward for me because…but I don’t want to encourage people to do it the way I did because I don’t think it will work for most people.  I think the basic ideas of being rational and disciplined and deferring gratification, those will work.  But if you want to get rich the way I did, by learning a little bit about a hell of a lot, I don’t recommend it to others.

Now I’ve get a story there that I tell.  A young man comes to see Mozart, and says, “I want to compose symphonies.”  And Mozart says, “You’re too young to compose symphonies.”  He’s 20 years old and the man says, “But you were composing symphonies when you were 10 years old.”  And Mozart says, “Yeah but I wasn’t running around asking other people how to do it.”

I don’t think I’m a good example to the young.  I don’t want to encourage people to follow my particular path. I like all the general precepts, but I would not…if you’re a proctologist, I do not want a proctologist who knows Schopenhauer, or astrophysics.  I want a man whose specialized.  That’s the way the market is.  And you should never forget that.  On the other hand, I don’t think you’d have much of a life if all you did was proctology. (laughter)

Question 22: Warren and you are known for saying that if you worked with a small sum of capital, $10 million, Warren publicly said that he could guarantee that he could compound that at 50%  a year.  So my question is, can you provide some examples?  And I would kindly ask that you provide as many examples as possible, and be specific as possible.

Charlie: Well, the minute I hear somebody that really wants to get rich, at a rapid rate, with specifics.  That is not what we try and do here.  We want to leave some mystery so that you yourself can amuse yourself finding your own way.  You know the good ideas that I’ve had in my life are quite few.  But the lesson I can give you is a few is all you need and don’t be disappointed.  When you find the few of course, you’ve got to act aggressively.  That’s the Munger system.  And I learned that indirectly from a man I never met.  Which was my Mother’s maternal grandfather.  He was a pioneer when he came out to Iowa and fought in the Blackhawk Wars and so on.  And eventually after enormous hardship, well he was the richest man in town and he owned the bank and so on.  As he sat there in his old age, my mother knew him because she’d go to Algona, Iowa where he lived and had the big house in the middle of town.  Iron fence, capacious lawns, big barns.  What Grandpa Ingham use to tell her is, ‘there’s just a few opportunities you get in a whole life’.  This guy took over Iowa when the black topsoil in Iowa was cheap.  But he didn’t get that many opportunities.  It was just a few that enabled him to become prosperous.  He bought a few farms every time there was a panic you know.  And leased them to thrifty Germans, you couldn’t lose money with leasing a farm to a German in Iowa.  But he only did a few things.  And I’m afraid that’s the case…you’re not going to find a million wonderful ideas.  These people with the computer algorithms do it, but they have a computer sifting the who world.  It’s like placer mining.  And of course every niche they’re in, if somebody else comes in, the niche starts leaching away.  And I don’t think it’s that honorable to make a living that way.  I’d rather make my money in some other way than outsmarting the trading system so I have a little computer algorithm that just leaches a little out of everybody’s trade.  I always say that those people have all the social utility of a bunch of rats in a granary.  It’s not that great a way to make money.  I would say if you make your money that way that you should be very charitable with it because you’ve got a lot to atone for. (laughter) I don’t think it’s an ambition we should encourage.

The rest of us who aren’t just leaching a little off the top because we’re great at computer science, and that’s what this room is full of.  And if you’re not finding it harder now, you don’t understand it.  That’s my lesson.

Question 23: What’s your favorite industry and why is it your favorite?

Charlie: Well, my favorite industry is taking care of my own affairs. (laughter) And it’s fun it’s creative, it’s the job that life has given me, and I think that you should do the job well that life gives you.  A lot of the places where the industries are doing a great job for the world, it’s very hard to make money out of it.  Because these wild enthusiasms come into it.  I don’t have a favorite industry.

Question 24: Is there any current monkey-business in corporate America that worries you?

Charlie: Well the answer is yes, but not as extreme as Valeant.  That was really something.  That was really something.  I probably should have done that. (laughter)  But you people come so far, and since you’re cult members you like being here.  And I feel an obligation to tell you something sort of interesting and I just went straight into Valeant that year.  It was really pretty disgusting.  What’s interesting is how many high-grade people that took in.  It was too good to be true.  There was a lot wrong with Valeant.  It was so aggressive.  It was drugs people needed.  It was just…take the difference between Valeant and the Daily Journal Company.  When the foreclosure boom came, we had 80% of the foreclosure business in our area.  It’s a big area, Southern California and Northern California too.  It would have been very easy for us to raise the prices and make, I don’t know, $50 million more or something like that, when all these people are losing their houses.  A lot of them are very decent people.  It didn’t ever…the idea that just right in the middle of that we’d make all the money we could?  Which some of our competitors did by the way.  We just didn’t do it.  I don’t think capitalism requires that you make all the money that you can.  I think there are times when you should be satisfied based on...just ideas of decency And at Valeant they just look at it like a game like chess.  They didn’t think about any human consequences, they didn’t think about anything but getting what they wanted which was money and glory.  And they just stepped way over the line.  And of course in the end they were cheating.

But I don’t have a new one.  I got a lot of publicity over that Valeant thing.  I’m not looking for…I don’t want this room to have twice as many people next year.  And I don’t want me not to be here either. (laughter)

Question 25: My question relates to a talk you gave to the foundation of financial officers in 1998 here in California.  And in that talk, you were critical of the complexity and the expense of many foundation portfolios and you said specifically, “An institution with almost all wealth invested long-term in just three fine domestic corporations, is securely rich.”  And you gave as your example the Wicker Foundation and Coca-Cola.  So if you had a foundation today with let’s say a billion dollars, would you be comfortable with it being invested in just three stocks?

Charlie: Well, let’s take the foundation…I’ll change your question around (in the way that I want to answer it). (laughter)  Am I comfortable with a non-diversified portfolio?  Of course…if you take the Munger’s, I care about the Munger’s.  The Munger’s have three stocks.  We have a block of Berkshire, we have a block of Costco, we have a block of Li Lu’s fund, and the rest is dribs and drabs.  So am I comfortable?  Am I securely rich?  You’re damn right I am.  Could other people be just as comfortable as I who didn’t have a vast portfolio with a lot of names in it?  Many of whom neither they or their advisors understand? Of course they’d be better off if they did what I did.  And is three stocks enough?  What are the chances that Costco’s going to fail?  What are the chances that Berkshire Hathaway’s going to fail?  What are the chances that Li Lu’s portfolio in China’s going to fail?  The chances that any one of those things happening is almost zero.  And the chances that all three of them are going to fail?

That’s one of the good ideas I had when I was young.  When I started investing my little piddly savings as a lawyer,  I tried to figure out how much diversification I would need if I had a 10% advantage every year over stocks generally.  I just worked it out.  I didn’t have any formula, I just worked it out with my high school algebra.  And I realized that if I was going to be there for thirty or forty years, I’d be about 99% sure to do just fine if I never owned more than three stocks and my average holding period is 3 or 4 years.  Once I’d done that with my little pencil, I just…I never for a moment believed this balderdash they keep…why diversification…diversification is a rule for those who don’t know anything.  Warren calls them ‘know-nothing investors’.  If you’re a ‘know-nothing investor’ of course you’re going to own the average.  But if you’re not a know-nothing investor, if you’re actually capable of figuring out something that will work better, you’re just hurting yourselves looking for fifty when three will suffice.  Hell one will suffice if you do it right.  One.  If you have one cinch, what else do you need in life.

And so the whole idea that the ‘know-something’ investor needs a lot of diversification.  To think that we’re paying these investors to teach this crap to our young.  And people think they should be paid for telling us to diversify.  Where it’s right, it’s an idiot decision.  And where it’s wrong, you shouldn’t be teaching what’s wrong.  What’s gone on in corporate finance teaching is that people are getting paid for dispensing balderdash.  And since I never believed that it was a great help to me, it helps if you’re out in the market and the other people are believing balderdash and you know what the hell’s going on.  It’s a big help.  So of course you don’t want a lot…if you’re Uncle Horace who has no children has an immense business which is immensely secured and powerful.  And he’s going to leave it all to you if you come to work in the business.  You don’t need any diversification.  You don’t need any corporate finance professors, you should go to work for Uncle Horace.  It’s a cinch.  You only need one cinch!  And sometimes the market gives you the equivalent of an Uncle Horace.  And when it does, step up to the pie-cart with a big pan.  Pie carts like that don’t come very often.  When they do you have to have the gumption and the determination to seize the opportunity shrewdly.  I was lucky.  Imagine learning that from your dead great-grandfather, at a very young age.  But you know I spent my whole life with dead people.  They’re so much better than many of the people I’m with here on earth.  All the dead people in the world, you can learn a lot from them.  And they’re very convenient to reach.  You reach out and grab a book.  None of those problems with transportation. So I really recommend making friends among the immanent dead.  Which of course I did very early.  And it’s been enormously helpful.  Some of you wouldn’t have helped me.  But Adam Smith really did.

Question 26: Question on Irish economy and Irish banking.  Berkshire Hathaway was a shareholder in Irish banks pre-2008.  Could you comment on how the Irish economy and Irish banking system proceeds with the U.K. not being part of the European Union going forward.

Charlie: Well, that of course was a mistake, and it was a mistake we shouldn’t have made because both Warren and I know that you can’t really trust the figures put out by the banking industry.  And the people who run banks are subject to enormous temptations that lead them astray because it’s easy to make a bank report more earnings.  By a thing that any idiot could do which is make it a little more gamey.  And of course that’s dangerous.  And the temptation are very great.  So we shouldn’t have made that mistake, but we did.  And that’s a good lesson too, that even if you’re really good at something you will occasionally drift into a dumb mistake.  And now that’s the question about the bank.  They went crazy in Ireland…the bankers.  And we went crazy when we trusted the damn statements.  And it was a mistake.

Now what Ireland has done was very smart…in reducing all of these taxes.  Now they have English speaking people with practically no taxes.  And there’s a fair amount of charm and so forth in Ireland.  It’s not like it’s a terrible place to be.  They just sucked in half the world into Ireland where they got these…Gates went there very early with Microsoft, and so on.  And they took a place that was really a backward place that had a sort of internal civil war for 60 or 70 years, and bad opportunities, and they really brought in a lot of prosperity.  And they did that by this competitive lowering of taxes and so on.  So it worked for Ireland.  I think Ireland deserves a lot of credit for the way they advanced their country.  And of course they were going to have a thing where all the countries keep trying to reduce their taxes to suck in the foreign…but it won’t work for everybody.  But it did work for Ireland.  I think Ireland deserves a lot of credit, and of course they recovered very well from a very major collapse.  Irish are like the Scottish.   I always think that those Gallic’s are pretty unusual people.  And I’m very glad that I had a Scottish-Irish great-grandmother.

Question 27: My question is in regards to Lee Kuan Yew.  You’ve on several occasions spoken about the economic miracle that is Singapore and how it’s been transferred on by Deng Xiaoping to China.  What are your thoughts about India that’s going through a similar change with the prime minister who also idolizes his people and wants to create a similar sort of situation.  I’d like you’re thoughts on that.  Thank you.

Charlie: Well that’s a very intelligent question, and I’m not saying all the other questions weren’t. (laughter)  I regard Lee Kuan Yew…may have been the best nation builder that ever lived.  He took over a malarial swamp with no assets.  No natural resources.  Surrounded by a bunch of Muslims who hated him.  In fact he was spat out by a Muslims country.  They didn’t want a bunch of damn Chinese in their country.  That’s how Singapore was formed as a country, the Muslims spat it out.  And so hay, here he is, no assets, no money, no nothing.  People were dying of malaria.  Lots of corruption.  And he creates in a very short time, by historical standards, modern Singapore.  It was a huge, huge, huge success.  It’s such a success that there’s no other precedent in the history of the world that is any stronger.  Now China’s more important because there are more Chinese, but you can give Lee Kuan Yew a lot of the credit for creating modern China.  Because a lot of those pragmatic communist leaders, they saw a bunch of Chinese that were rich when they were poor, and they said, ‘to hell with this!’  Remember the old communist said, ‘I don’t care whether the cat is black or white, I care whether he catches mice.’  And he wanted some of the success that Singapore got and he copied the playbook.  So I think the communist leadership that copied Lee Kuan Yew was right, I think Lee Kuan Yew was right.  And of course I have two busts of somebody else in my house.  One is Benjamin Franklin, and the other is Lee Kuan Yew.  So, that’s what I think of him.

Now you turn to India.  And I would say, I’d rather work with a bunch of Chinese than I would the Indian civilization mired down, case system, over-population, assimilated the worst stupidities of the democratic system, which by the way Lee Kuan Yew avoided, it’s hard to get anything done in India.  And the bribes are just awful.  So all I can say is, it’s not going to be easy for India to follow the example of Lee Kuan Yew.  I think that India will move ahead.  But it is so defective as a get-ahead…the Indians I know are fabulous people.  They’re just as talented as the Chinese, I’m speaking about the Indian populace.  But the system and the poverty and the corruption and the crazy democratic thing where you let anybody who screams stop all progress?  It mires India with problems that Lee Kuan Yew didn’t have.  And I don’t think those Indian problems are always easy to fix. Let me give you an example. The Korean steel company, POSCO, invented a new way of creating steel out of lousy iron ore and lousy coal.  And there’s some province in India that has lots of lousy iron ore and lot of lousy coal.  Which is there’s not much use for.  And this one process would take their lousy iron ore and the coal and make a lot of steel.  And they got a lot of cheap labor.  So POSCO and India were made for each other.  And they made a deal with the province to get together and use the POSCO know how and the India lousy iron ore and lousy coal.  And 8 or 9 or 10 years later with everybody screaming and objecting and farmers lying down in the road, or whatever’s going on, they canceled the whole thing.  In China they would have just done it.  Lee Kuan Yew would have done it in (Singapore).  India is grossly defective because they’ve taken the worst aspects of our culture, allowing a whole bunch of idiots to scream and stop everything. And they copied it!  And so they have taken the worst aspects of democracy and they forged their own chains and put them on themselves.  And so no I do not like the prospects of India compared to the prospects of…and I don’t think India’s going to do as well as Lee Kuan Yew.

Question 28: What happened 1973 and 1974 when your investment firm lost over half?

Charlie: Oh, that’s very simple.  That’s very easy.  That’s a good lesson.  That’s a good question.  What happened is the value of my partnership where I was running, went down by 50% in one year.  Now the market went down by 40% or something.  It was a once in 30 year recession.  I mean monopoly newspapers are selling at 3 or 4 times earnings.  At the bottom tick, I was down from the peak, 50%.  You’re right about that.  That has happened to me 3 times in my Berkshire stock.  so I regard it as part of manhood.  If you’re going to be in this game for the long pull, which is the way to do it, you better be able to handle a 50% decline without fussing too much about it.  And so my lesson to all of you is conduct your life so that you can handle the 50% decline with aplomb and grace.  Don’t try to avoid it. (applause)  It will come.  In fact I would say if it doesn’t come, you’re not being aggressive enough.

Question 29: Regarding biases of human misjudgment.  How do you evaluate, handle, and manage people, knowing they might exhibit and suffer from biases that you are not?  And how have you and Mr. Buffett become such good judges of character and not just skills and abilities?

Charlie: Well I think partly we look smart because we pick such wonderful people to be our partners and our associates, even our employees.  And that’s going on right here.  Gerry Salzman is not normal.  He looks normal, but he’s a damn freak.  Gerry does things across 2 or 3 disciplines that are almost beyond human.  And he’s always been that way.  By the way he’s just another mid-westerner.  He’s come out of the soil back there.  So we’ve been very lucky to have his wonderful people.  I wish…I’m not quite sure…I think one thing we’ve done that’s helped us to get wonderful people, I always say the best way to get a good spouse is to deserve one.  And the best way to get a good partner is to be a good partner yourself.  And I think Warren and I have both done good with that.  But whatever the reason we’ve had these marvelous partners, and they make us look a lot better than we are.  You wouldn’t even be here if Gerry Salzman weren’t here.  We did not have a number two choice to run the Daily Journal.  And by the way that happens to me all the time.  We have an executive search or something.  The difference between the number one and number two is like going off a cliff.   And we really…we need one, but there aren’t three good ones to pick, where they’re all good and one’s a little better.  Every executive search I’ve have, it seems there’s one guy whose fine and everybody else is a pigmy.  I think good people are hard to find.  And people like Warren and I have had wonderful people who we’ve worked with all our lives time after time.  That’s one of the reasons Warren says he tap dances to work…you’d tap-dance too if you interfaced with people Warren interfaced with all day.  They’re wonderful people and they win all the time instead of losing.  Who doesn’t like winning in good company?  If you can duplicate that, why you’ve got a great future.  I think we were a little lucky.  And I can’t give you any luck.

Question 30: We have a Chinese platform that focuses content on people trying to invest capital outside of China.  They haven’t been able to invest (outside China) because of capital controls.  But that day will come.  Since they’re at least a half-century behind in terms of investing.  What would be the first thing that you would tell the Chinese person who wants to invest in the U.S.?  What should they do with their money when they’re making their initial investment outside.

Charlie: Well, you’ve made an assumption I don’t follow.  If I were a Chinese person of vast intellect, talent,  discipline, all the good qualities…I would invest in China, not the United States.  I think the fruit is hanging lower there.  And some of the companies are more entrenched.  So I don’t agree with your proposition.  I think they have a tendency to think, ‘we were backwards therefore when we get rich, we should go over and invest in America.’  I think it’s always a mistake to look for a pie in the sky when you’ve got a big piece of pie right in your lap.  And so if I were…at current prices, I think an intelligent person would do better investing in China.

Question 31: You’ve said, everyone should spend 10-20% on some big ideas.  What are one or two big ideas that you are talking about. Meaning, specialize, but spend time working on some big ideas.

Charlie: Well the big ideas, I think you should be intelligent in improving yourself.  You’re way better to take on a really big important idea that comes up all the time than some little tiny idea that you might not face.  I always tried to grab the really big ideas in every discipline.  Because, why piddle around with the little ones and ignore the big ones.  Just all the big ideas in every discipline are just very, very, very useful.  Frequently, the problem in front of you is solvable if you reach outside the discipline you’re in and the idea is just over the fence.  But if you’re trained to stay within the fence you just won’t find it.  I’ve done that so much in my life it’s almost embarrassing.  And it makes me seem arrogant because I will frequently reach into the other fellows discipline and come up with an idea he misses.  And when I was young it caused me terrible problems.  People hated me.  And I probably shouldn’t have been as brash as I was.  And I probably wouldn’t be as brash as I am now.  I haven’t completed my self-improvement process.  But, it’s so much fun to get the right idea a little outside your own profession.  So if you’re capable of doing it, by all means learn to do it.  Even if you just want to learn it defensively.  I do not observe professional boundaries.  My doctor constantly writes, PSA test, prostate specific antigen, and I just cross it out. And he says, ‘What the hell are you doing?  Why are you doing this?’  And I say, ‘Well I don’t want to give you an opportunity to do something dumb.  If I’ve got an unfixable cancer that’s growing fast in my prostate I’d like to find out 3 months in the future, not right now.  And if I got one that’s growing slowly, I don’t want to encourage a doctor to do something dumb and intervene with it.  So I just cross it out.’  Most people are not crossing out their doctor’s prescriptions, but I think I know better. I don’t know better about the complex treatments and so forth.  But I know it’s unwise for me to have a PSA test.  So I just cross it out.  I’m always doing that kind of thing.  And I recommend it to you when you get my age.  Just go cross out that PSA test.  Now the women I can’t help.

Question 32A: How would you invest in a money manager you like?  Through a limited partnership, that would flow through the taxes, and the other way is through a corporation that would pay taxes on the gains and the dividends.  So basically, the corporation would serve no other function though than paying taxes.  So I think you’d be crazy to say that those two ways are equally desirable. (Charlie interjects)

Charlie: You’re certainly right about that.  It’s plumb crazy, and it’s exactly the way people who buy Berkshire are investing.  It’s plumb crazy to have a big common stock portfolio in a corporation and pay taxes compared to a partnership that doesn’t.  And that’s just the way the Berkshire shareholders have invested and they have made, whatever it is, 25% a years since we were there.  But you’re right, it’s not the logical way to do it.

Question 32B: So my question is, if you have to decide, to invest in pool A or pool B, how would you decide on what method you would use to figure out what discount would make you indifferent to whether you would invest in the corporate tax-paying structure when it flows to the… (Charlie interjects)

Charlie: I think it is totally asinine to invest in a portfolio of common stocks through a corporate taxed under the internal revenue code under sub chapter c or something.  It’s totally asinine.  At Berkshire, the public securities keep going down and down as a percentage of the total value, so it doesn’t matter, we’re getting to be sort of a normal corporation.  But I don’t think anybody’s right mind should invest through a corporation in a puddle of securities.  In fact the disadvantage is so horrible.  And so, I wouldn’t even consider it.  In other words…and I regard it as a minor miracle that we were able to get where we did.  So of course you’d invest in a partnership.

Question 33C: So when anyone who invests in Berkshire has to decide the discount to put on a pool of securities that has a future tax lien on the gains…do you have any mental model for…

Charlie: Yeah, my model is to avoid it.  We don’t want to invest in a portfolio of securities in somebody else’s corporation.  You’re totally right.  Which you already knew by the way.

Question 34: What’s your new findings of China?  Also, what’s your take on Ray Dalio’s statement that the U.S. election could unleash a new animal spirit which could lead to a better U.S. economy?  Do you buy this theory?

Charlie: Well, I’m not sure I understood that completely, but I’ll do my best.  What I like about China is that they have some companies that are very strong and still selling at low prices.  And the Chinese are formidable workers and they make wonderful employees.  There’s a lot of strength in that system.  And the Chinese government really tries to help its businesses, it is not behave like the government of India which I don’t think runs it’s country right at all.  And so, that’s what I like about China.  Or course I have to admire taking a billion and half people in a state of poverty up that fast.  That was never done in the history of the world.  And I admire the…you go to China and all the bullet trains go right to the heart of the city…what they’ve done is just an incredible achievement.  And they’ve done it not by borrowing money from Europe the way we did when we came up.  They have taken a poor nation with a lot of poverty and what they did is save half their income when they were poor and drive their nation way up with a lot of deferred gratification.  So it was unbelievably admirable and unbelievably effective.  So I admire that part of the Chinese picture.  China has one problem.  The problem with the Chinese people is they like to gamble and they actually believe in luck.  Now that is stupid.  What you don’t want to believe in is luck, you want to believe in odds.  And China there’s some reason in the culture, too many people believe in luck and gamble.  And that’s a national defect.

Question 35: If the world changes a lot in my lifetime, by the time I’m closer to your age, what do you think will not change about what makes a good successful business?

Charlie: What will not change is that it won’t be that damned easy.  There will be lots of…people will die that you love.  You’ll have close breaks where it goes against you.  There’s a lot of trouble that’s sure to come.  And at the end you’ll know that it’s all over, and that’s the game.  It’s a very funny game when you know when you start you have to lose.  See a dog doesn’t have to do that.  We know from the start we can’t win.  (Somebody) said the law of thermodynamics ought to be restated.  You can’t win, you must lose and you can’t get out of the game.  So we all face this ultimate difficultly. But once you’ve accepted the limitations, you’ve got the problem, how to get through your allot and expand reasonably well.  And I don’t think that’s that hard to figure out.  Because if you do pretty well, considering what you started with an so forth.  And you stand at the end and you’ve done credibly, you’ve helped other people who needed help because you had the capacity and intelligence to do it, and so on, and so on.  Set a reasonable example.  It’s a pretty good thing to do and it’s quite interesting.  And the difficulties make it interesting.

And something else happens that is really weird.  We were talking about, in our director’s meeting that proceeded this meeting, you always get glitches in something as complicated as a new software program going into a big new area.  And you suddenly have reverses and troubles and you’re scrambling.  And what I said is, that I’ve noticed in a long lifetime that the people who really love you, are the people where you scramble together with difficulty and you’ve jointly gotten through.  And in the end, those people will love you more than somebody whose just shared in an even prosperity through the whole thing.  So this adversity that seems so awful when you’re scrambling through, actually is the sinew of your success, your affection, every other damn thing.  And if you didn’t have the adversity you wouldn’t have the bonds which are so useful in life that are going to come from handling adversity well.  The idea that life is a series of adversities and each one is an opportunity to behave well instead of badly is a very, very, good idea.  And I certainly recommend it to everybody in the room.  And it works so well in old age because you get so many adversities you can’t fix.  So you better have some technique for welcoming those adversities.

Question 36: Do you believe that the 0,6, 25 high watermark fees structure that the Buffett Partnership popularized is the fairest structure for both limited partners and the manager themselves?  And what fee structure did you employ during your partnership.

Charlie: Well, I did copy the Buffett formula more or less, and I do think it’s fair and I think it’s still fair.  And I’m looking at Mohnish who still uses it.  I think it is fair and I wish it was more common.  I basically don’t like it where they’re just scraping it off the top.  If you’re advising other people, you ought to be pretty rich pretty soon.  Why would I take a lot of advice from somebody who couldn’t himself get pretty rich pretty soon?  And if you’re pretty rich why shouldn’t you put your money alongside your investors?  And go up and down with them.  And if there’s a bad stretch, why should you scrape money off the top when they’re going down enough?  So I like the Buffett system.  But it’s like so many things I like, it’s not spreading very much.  My net influence in the world, even Warren’s, has been pretty small.  Imagine how much copying we have in our executive compensation methods.  It’s about three examples.  Yes, I think it’s a fine system.

Question 37A: You spoke earlier about natural gas and the shipping of natural gas, and that activity…  (Charlie interjects)

Charlie: If I were running the world as a benign despot, I wouldn’t be shipping any natural gas outside of the United States.

Question 37B: So to tap into that view, you’ve been active in two states big in agriculture, Nebraska and California produce.  What are your thoughts on the agriculture industry and subsidies?

Charlie: Well the interesting thing about agriculture is what’s happened in my lifetime.  Which is the productivity of land has gone up about 300%.  And if it weren’t for that there would be a lot of starvation on earth.  The ag. system is one of the most interesting things that has happened in the last 60 or 70 years.  And we literally tripled the (productivity) of the land.  And we did it all over the world.  And there was just a few people who did it, the Rockefellers, Borlaug, and so forth.  It was one of the most remarkable things in the whole history of the earth and we need another doubling, and we’re probably going to get it.  And it’s absolutely incredible how well we’ve done.  And it’s amazing how efficient our farmers are.  We don’t have much socialization in farming.  We’ve got a bunch of people who own the farms and manage them themselves.  There’s not much waste and stupidity in farming.  Now people complain that we’re using up the top-soil, which I think we are, and I think that’s more of a mistake.  I would fix that if I were a benign despot.  Leaving aside using up the topsoil too fast, I think farming is one of the glories of civilization.  So I think it’s been wonderful what’s happened in farming.

Now in terms of subsidies.  It matters to the farmers where they get their subsidies.  And there’s no question about the fact that we’ve protected our farmers with subsidies and the farmers we’re protecting are getting richer and richer because the farms are owned by fewer and fewer people.  Own more and more acres per person.  So it’s very peculiar that we’re subsidizing people who are already filthy rich, to use up our topsoil a little faster.  And create stuff which we turn into ethanol.  Which is one of the stupidest ideas the world ever…you know I’m a specialist in stupid ideas (links: 1,2), but I would say turning corn into gasoline is about stupid an idea.  I would almost rather jump out of a 20 story building and think I could fly than turn corn into motor fuel.  It’s really stupid.  And yet that’s what our politics does.  I’ve got no cure for the stupidity of politics.  If I (did) the world it would be quite different.  I think that’s pretty minor whether we have subsidies or not.  The main thing that’s happening that has enabled the present population of the world to stay alive is this agricultural revolution and this very good managing of our farmlands.  And the improving agricultural standards in the rest of the world.  It’s gone on quietly that we’ve hardly noticed it.  How many of you are just deeply aware of the fact that grain per acre has gone up by 3 or 4 hundred percent.  That’s a huge stunt.  And by the way, if you take those miracle seeds and don’t use hydrocarbons, the yields are lousy.  We’re feeding ourselves because we know how to turn oil into food.  That’s one of the reasons I want to hold onto the oil.  Something that can be turned into food is quite basic.  And so I don’t mind conserving the oil instead of producing every last drop as fast as one can.  It’s odd that my idea hasn’t spread to more of people.  I may have three or four other people who agree with me in this room.  But you’re a bunch of admirers, and in the rest of the world, I’m all alone. (laughter)

Question 38: You’ve talked on emotions, discipline, and facing adversity.  Can you flesh out more about the spiritual side of this.  How you deal with the struggles and life.

Charlie: Well, just because you don’t have a specific theology, and I don’t…you know when I was a little kid and my grandfather sent me to Bible school and they told me there was a talking snake in the Garden of Eden?  I was very young but I didn’t believe them.  And I haven’t changed.  It doesn’t mean I am not spiritual, it’s just, I don’t need a talking snake to make me behave well.  And I would say that the idea that came down to me, partly through my family, was that rationality is a moral duty.  If you’re capable of being reasonable, it’s a moral failure to be unreasonable when you have the capacity to be reasonable.  I think that’s a hair-shirt that we should all take on, even if we’re pretty stupid.  Because it’s good to be less stupid.  So I think rationality is a moral duty.  And we all have a duty to get better.  And of course we also have to adjust to the other people who are going through our journey with.  I think it would be crazy not to have a social safety net when you’re as rich and successful as we are.  Now I don’t think it has to be as dumb as the one we have, but of course we need a solid social safety-net.  And it’s a moral idea.  So I’m all for morality…without the talking snakes.

Question 39: What are your thoughts on the MLP structure?  And do you have any preliminary thoughts on the border adjustment tax?

Charlie: Let me take the last question first.  We do not know what the boarder adjustment tax is.  I don’t think the people proposing it know what it is.  And I don’t think Trump and the Republicans in Congress have agreed on anything.  So I think we’re just talking about…But do I think some deep revision of the tax system might be a really good idea?  The answer is ‘yes’.  Do I think we should rely on consumption tax more?  The answer is ‘yes’.  Do I really care if somebody piles up a lot of money and leaves it to some foundation.  That’s not my idea of a big evil.  If they do want to live high on their private airplanes and their three hundred dollar dinner checks, I’m all for taxing the people who are living high.  So I like the idea of bigger consumption taxes.  And I think there’s a lot to be said for a different kind of a tax structure.

Question 40: You highlighted this idea of ‘deferred gratification’ a lot today.  In what areas of life is it most valuable?  And where should you enjoy things now vs. grind away and invest in the future?

Charlie: Well, I don’t think you should use up your body by being stupid in handling it.  And I don’t think you should be stupid in handling your money either.  And I think there are a lot of things where the only way to win is to work a long time towards a goal that doesn’t come easily.  Imagine becoming a doctor.  That is a long grind.  All those night shifts in the hospital and so and so on.  It’s deferred gratification.  But it’s a very honorable activity being a doctor.  By and large our doctors are very nice people and they’ve been through a lot.  I tend to admire the life of a doctor more than I admire the life of a derivatives trader.  And I hope all of you do.  And I think deferred gratification in the way our doctors behave is a very good thing for all the rest of us.

Question 41: Question about the circle of competence.  How do you know its limits.  And does it get redrawn from time to time.  Does it always expand, or does it contract?

Charlie: Well of course you know some things that aren’t so, and of course if you’re dealing with a complex system, the rules of thumb that worked in the complex system in year 1 may not work in year 40.  So in both cases it’s hard.  The laws of physics you can count on, but the rules of thumb in a complex civilization changes as the civilization changes.  And so you have to live with both kinds of uncertainty and you have to work longer.  It’s not a bad thing.  It’s interesting.  We’re all the same here…who would want to live in a state of sameness, you might as well be dead.

End of Transcript

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Richard Lewis, CFA
White Stork Asset Management LLC
Partner, Investments

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Event Notes: Cybersecurity Challenges & Preparedness for Emerging Managers

Cybersecurity is not a subject that comes racing to mind when thinking about hedge funds.  I certainly hadn’t given it much thought before today.  But upon discovering an HFA event on this topic, I was eager to expand my understanding.

Hosted at the British Consulate General in San Francisco, I was fascinated to learn about cybersecurity and some of the real issues that face fund managers today.  Here are my 12 takeaways:

  1. Firms should guard against “Reputational Risk”. i.e. the risk that a client’s trust in a firm or institution is irreparably damaged with a hack.
  2. Even mere pieces of client information is valuable on the dark web, where it can be pieced together to build a more complete, and potentially damaging profile.
  3. The Average hack takes 208 days.
  4. Hackers can potentially frame, bribe, or coerce employees into participating.
  5. Some hacks aren’t what you’d expect.  For example:
    1. One hacker actually took over a corporations’s infrastructure in order to produce Bitcoin.
    2. Another hacker broke into a firms biometric system to add finger prints to the system.
    3. And yet another involved vending machines at a company that uploaded employee information to the cloud without the firm’s knowledge or approval.
  6. Insurance on hacks can be purchased “quite cheaply”
  7. It’s surprising how many people keep passwords in files or documents named, “passwords”.
  8. A specific hedge fund was using cybersecurity as a way to differentiate themselves.
  9. AITEC: This is a society for hedge fund CTO’s.  Who knew?
  10. If you get hacked, contact the FBI right away.  There’s no reason not to.  And there’s a much higher chance of catching the hacker if you do.
  11. The number of “attack surfaces” is multiplying.  Particularly due to smart devices.
  12. Various Recommendations:
    1. Disable automatic links.  That link to 1-800-Flowers you see may be a trap.  Copy and Pasting URL’s creates an extra step with which to prevent hacks.
    2. Use encrypted emails with clients to guard against sensitive information.
    3. Use two cell phones.  One for Uber and one for sensitive information.
    4. Password Keeper has been shown to be an effective tool.