[Everything extracted from Speech]
But even with this amazingly active, would-be-polymathic new layer of consultant- choosing consultants, the individual investment counselors, in picking common stocks, still rely to a considerable extent on a third layer of consultants. The third layer consists of the security analysts employed by investment banks. These security analysts receive enormous salaries, sometimes set in seven figures after bidding wars. The hiring investment banks recoup these salaries from two sources: (1) commissions and trading spreads born by security buyers (some of which are rebated as "soft dollars" to money managers), plus (2) investment banking charges paid by corporations which appreciate the enthusiastic way their securities are being recommended by the security analysts.
Human nature being what it is, most people assume away worries like those I raise. After all, five centuries before Christ Demosthenes noted that: "What a man wishes, he will believe." And in self appraisals of prospects and talents it is the norm, as Demosthenes predicted, for people to be ridiculously over-optimistic. For instance, a careful survey in Sweden showed that 90% of automobile drivers considered themselves above average. And people who are successfully selling something, as investment counselors do, make Swedish drivers sound like depressives. Virtually every investment expert's public assessment is that he is above average, no matter what is the evidence to the contrary.
But, you may think, my foundation, at least, will be above average. It is well endowed, hires the best, and considers all investment issues at length and with objective professionalism. And to this I respond that an excess of what seems like professionalism will often hurt you horribly — precisely because the careful procedures themselves often lead to overconfidence in their outcome.
The hedge fund known as "Long Term Capital Management" recently collapsed, through overconfidence in its highly leveraged methods, despite I.Qs. of its principals that must have averaged 160. Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go around in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods.
But most good things have undesired "side effects," and thinking is no exception. The best defense is that of the best physicists, who systematically criticize themselves to an extreme degree, using a mindset described by Nobel Laureate Richard Feynman as follows: "The first principle is that you must not fool yourself and you're the easiest person to fool."
I wish to say that I agree with Peter Drucker that the culture and legal systems of the United States are especially favorable to shareholder interests, compared to other interests and compared to most other countries. Indeed, there are many other countries where any good going to public shareholders has a very low priority and almost every other constituency stands higher in line. This factor, I think is underweighed at many investment institutions, probably because it does not easily lead to quantitative thinking using modern financial technique. But some important factor doesn't lose share of force just because some "expert" can better measure other types of force. Generally, I tend to prefer over direct foreign investment Berkshire's practice of participating in foreign economies through the likes of Coca-Cola and Gillette.
via: Charlie Munger Speech
