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Today, we're going to look at Charlie Munger's decision-making technique to help avoid big mistakes.

This technique helps us avoid negative outcomes in our investing (and life) and make better decisions by reverse-engineering results.

What is it?

It's the “Principle of Inversion” and Munger highly recommended it:

"Invert, always invert."

So, we're first going to look at what Inversion means and then examine 5 ways to apply it to our investing process.

Let's get started.

What is the Principle of Inversion?

Inversion entails looking at a problem or decision from the opposite perspective.

Munger's famous line on this idea was: "All I want to know is where I’m going to die, so I’ll never go there."

It's often best to solve problems “backward”:

Rather than focusing on actions to take to achieve a goal, inverting shifts our focus on first looking at what we want to avoid.

And one thing we all want to avoid: making big mistakes.

So, let's look at 5 common investor mistakes and how to avoid them.

5 Ways to Apply Inversion to Avoid Investing Mistakes

1. Focus on Internal Metrics

Many investors tend to look at market prices to gauge the quality of their investing decisions…

But emotional investors can create market prices that are detached from intrinsic value—giving us distorted feedback.

Rather, we can gauge the quality of our decisions like Munger and Buffett:

2. Downside Focus

Many investors look at a new stock and think about its potential—they imagine everything that could go right…

And neglect to consider what might go wrong.

As Joel Greenblatt explains:

"If you don't lose money, most of the remaining alternatives are good ones."

We might first consider a stock's worst-case scenario. As Buffett and Mohnish Pabrai put it:

3. Avoid Echo Chambers

The first thing most investors do when they find a stock they like is search for supporting evidence—aka, they end up finding an echo chamber.

Inverting calls for avoiding echo chambers. Rather, we need to look for any information that would weaken our investing hypothesis.

The more our hypothesis stands up to scrutiny, the more confidence we gain:

And Munger always did this:

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4. Consider Errors of Omission

Munger is famous for studying his past mistakes:

“You can learn to make fewer mistakes than other people—and how to fix your mistakes faster when you do make them.”

But these aren't just actions he took: Errors of Commission

It's also opportunities he failed to take: Errors of Omission

To improve faster than most other investors, we can look at what opportunities we missed.

Buffett also reviews the costs of what he calls his “thumb-sucking”:

5. Minimize Forecasting Error

Jeff Bezos once shared that one of the questions he got asked the most was:

"What's going to change in the next 10 years?"

In investing, nearly everyone defaults to the same line of thinking: trying to forecast what's going to happen. What's going to change…

But there's a more valuable question:

What's going to stay the same?

In other words, what will thrive in a wide variety of future scenarios?

Bezos explains:

"Because you can build a business strategy around the things that are stable in time…"

So, our time spent thinking about companies & products that will do well regardless of the future is probably much more valuable than attempting to predict the future.

And for added measure, we should avoid those who proclaim they can forecast the future with any degree of accuracy:

Summary

Those are 5 ways to use Charlie Munger's Inversion technique to avoid mistakes and improve our decision-making.

Let's recap:

1. Focus on Internal Metrics (Rather than Market Pricing)

2. First Consider Worst-Case Scenarios (Instead of Best-Case)

3. Avoid Echo Chambers (Welcome Counter-Arguments)

4. Consider Errors of Omission (Not just Errors of Commission)

5. Minimize Your Need to Forecast (And Avoid Market Forecasters)

Well, that's all for this week.

I hope you found it valuable.

See you next Saturday.

Two resources I think you might like:

1. Book Summaries: One of the most important lessons from Charlie Munger is to strive to become a little bit wiser each day. To accelerate my learning on everything from investing & decision-making to negotiating & habit-building, I use Blinkist (I don't receive any compensation from Blinkist currently). Blinkist offers easily readable book summaries to help you get the most valuable ideas from the most popular books. You can check out Blinkist here.

2. Mental Exercises: To paraphrase Morgan Housel, the common factor among elite investors is they have complete control over the space in between their ears. Financial news networks and social media can create a lot of "noise" for investors. To stay focused and calm, I like to use Headspace (I don't receive any compensation from Headspace currently). Headspace offers mindset and breathing exercises to help you keep control over the space between your ears. You can check out Headspace here.

Disclaimers

This material is not investment advice. No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading this material can be accepted by the publisher. Additional disclaimers here.