OtherToday's guest has been firmly identified with Warren Buffett, not just in returns butalso in charity.He invested $100,000 in seed capital from his savings to start his business, TransTech.This returned a cool $20 million when he sold out in 2000.His value investing equity fund performance returned a cumulative 517% from 2000 whenhis astounding yield was disclosed publicly by Forbes in 2013.The comparable return to S&P 500 index investors over the same period was a paltry 43%.Born in Mumbai to the son of an itinerant magician, he was nearly frightened out ofgoing into business on his own by his father's ill-fated attempts at entrepreneurship.This phobia persisted even after finishing a valuable engineering degree at Clemson University.We owe our gratitude to his father who pushed him to go out on his own, for if not, I wouldnot have the great honor to say that the University of Puerto Rico Student Alumni Associationwelcomes one of the greatest value investors in the world, Monish Pabrai.
OtherThank you for the warm welcome.
OtherI wish my kids and wife were here to hear that.
OtherThey've gotten me some brownie points.
OtherWell, it's a pleasure to be here and a true honor and it's always great to be in San Juan.What I wanted to do today is, in some ways, you guys are guinea pigs because I've nevergiven this talk before, which kind of makes it interesting for me.As Professor Scott mentioned, I'm a huge fan of Warren Buffett and Charlie Munger, especiallyCharlie Munger.And Charlie Munger talks about something known as the latticework of mental models.And these are kind of idiosyncrasies in our brains which kind of distort reality for mostof us because we've gone through millennia in terms of evolution.And it's a huge advantage if you are aware of these distortions and can leverage them.So Charlie's given a speech called The Psychology of Human Misjudgment and there's a video onYouTube and PDFs on the web, so I encourage you to go through those.What I wanted to do today is, I think Charlie talks about maybe 30 mental models.I'd like to go into three mental models, none of those 30.These are three that have had a significant positive impact on my life.And none of the three were kind of obvious to me when I got going.So I hope some of them are valuable to you and can hopefully have some trajectory changein terms of kind of how you go about life, if you will.So the first mental model, and I think I encountered this probably close to 19 or 20 years ago.
QuestionerAnd I read a book and it's a very kind of unusual book called Power Versus Force. It was written by kind of a new age guy in Arizona, David Hawkins. And he had an unusual thesis in the book. And what he said was that if I lie to you and in your conscious state you don't know I'm lying to you, in your subconscious state you do. And what happens is that, what David Hawkins said is that if we put some kind of meters on your body, you would register an impact to your muscles going weak, what he called going weak, when I'm lying to you or when someone is lying to you. And the reverse of that is that if someone is saying the truth to you, then you tend to feel really good being around that person. And I don't know, I've never tested whether the muscular reactions are actually there or not. But we actually know some of this to be true kind of anecdotally. So for example, if I go to buy a used car from some used car dealer, I don't know what part of what he's telling me is a lie, or whether all of it is a lie. But what I do know is I don't feel great being around that person, okay? And if I go meet, let's say, the Dalai Lama, I probably feel very nice being around the person. Even if he's not saying much, I feel good. And in many ways, I've experienced that with people like Warren Buffett and Charlie Munger and such. So what Hawkins said is that there is a, you can say, a log scale in terms of lies versus truth. So if I buy into what he's saying, for example, he would say that if I dyed my hair or put on a toupee or something, it's a lie. And it'll probably make the people I'm interacting with be slightly less positive about the interaction. If I wear fancy clothes, it's a lie. So basically, the lies and truth is not so much related to just what we say. It's about the entire experience. And the flip side is that when you say the truth, then people really kind of go strong, and they like it. And one of the, so first of all, I found the whole theory of this lies versus truth kind of interesting. And what I started doing about 20 years ago is I started running experiments just around people around me. And so one of the changes I made is I was generally, I would say, a pretty truthful person. But I tried to get rid of what I would call the small white lies, if you will. And I found that they were very huge positive impacts. And so for example, let's say my wife and I are about to go out for a dinner movie date.
OtherAnd she gets dressed, and she says, how do I look?And let's say, for example, I'm not wild and crazy about the dress she's wearing.The old Monish would have said, you look great, let's go.And the new Monish says, well, the dress,you could put on a different one, it could be better, blah, blah.And then, of course, the immediate impact of saying something like that isthe date might be history, we might not be going out.And that happened, that happened a few times.But what also happened is what I realized is thatthe relationship actually became stronger.Because now, I think that most times when I'm asked something by her,she has a very high degree of confidence that usually she's going to geta very, very straight answer, even if it's not the answer she wants to hear.And so one of the quirks of all these lies and truth is thathumans don't care, and this is kind of strange, but humans don't carewhat the truth is, they care that you do say the truth.So let's say, for example, and what I mean by this is we,as humans, understand that all of us are flawed, that all of us make mistakes.And that all of us have our bad habits and such.And to the extent that we are transparent about them,it makes the humans that you're interacting with,in David Hawkins' terms, go strong.So for example, let's take an extreme kind of example of that.The extreme example would be, let's say someone killed someone,commits murder.And in court, they're honest and say, something happened,for the moment there were fashions flying high, whatever,explains what happened and owns the crime.And says, I did this, I'm sorry, whatever, but it's all exactly what they truly feel.Versus someone who does the same act and goes in court andtells the court what his lawyer tells him to tell him, which is,either plead the fifth or I have nothing to say or I didn't do anything.And humans are much more able to forgiveeven very egregious crimes if the person coming forth is honest.And what I've repeatedly found, so for example, in 2008,my funds during the financial crisis were down a lot.We actually lost two-thirds of our value, much more than the indices in that year.And when I was writing my letter to partners, saying what happened,I could have taken two approaches.One approach I could have taken would have been, let's say the oldmonitor said, look, there's the financial crisis, everything's been marked down.All our stuff got marked down, things will recover.
OtherOkay, that's one way I could kind of present it,which is put the blame on some external event.The second way I could deal with it, which is the truth, which is yes,we had the financial crisis, which led to a decline in our values.But there are also these mistakes I made.And go into some detail of the mistakes and kind of what happened.And so it's not black and white that it happened because of an external event.I was personally responsible forstupid things that I did which caused these losses, right?And so obviously I took the latter approach because I've been testing thistheory for a long time.And I hadn't committed murder, like I just told you.It's a much lower crime than murder.And quite frankly, the reaction I found was extremely benign.I think there's like 450 or 500 families that have invested with us.I probably got like two phone calls andmaybe a couple of emails about the whole thing.And even those were mostly supportive and whatever.So I didn't really kind of get much in terms of people being upset orwhatever else, and I don't want to make this talk political.But we have, I think,an event which is going to have more viewership than the Super Bowl tonight.And so we'll carefully tread into politics for a second.So I think Donald Trump's made a statement along the lines of that he could go onFifth Avenue and shoot a bunch of people, and it would have no impact on his ratings.I may be missing the quote somewhat, but he's made some statements.And he's made many statements which sound outrageous, if you will.And he's right.What happens is his ratings don't get affected.You can call him the Teflon candidate, bounces right off.And why does it bounce right off?Well, my theory of why it bounces right off is plays into the same power versusforce, which is humans are sick and tired of politicianskind of giving them political, well-packaged talk about what's going on.And with my theory, if you will, of David Hawkins theory,most of them can see through it.And so what they appreciate, I think the folks who are Trump supporters,I think what they appreciate is the breath of fresh air.They appreciate the candor.And so Trump is exactly right that what people appreciate is thathe's not saying whatever he's saying because some PR firm told him,that's what you should say.In fact, he does the exact opposite.The PR firm tells him whatever to say, andthen he just goes there and does whatever he wants to do.
OtherAnd I'm sure if I was advising the Donald, I would tell him, tonight, just be yourself. Don't try to be someone else, be yourself. And amazingly, President Obama gave two words of advice to Secretary Hillary Clinton, and he told her just two words. He said, be yourself. And I think that if she is herself, which may be somewhat difficult for her, but let's say if she is, I think she'll get a lot of points for being like that. And so we actually, in my opinion, we're seeing that kind of play out in the real world. And so there's a lot of students here, which is great. And so what I wanted to say to the students about the truth versus lies is the thing that you should start experimenting with, because at your age, you can actually make changes, is start getting rid of the small white lies. And basically, sometimes it's uncomfortable, sometimes you are afraid you might offend someone, bite the bullet. So what I've always done is, not always, but for at least a couple of decades, if I have to choose between truth and diplomacy, I choose the truth. And it's painful at times, it's uncomfortable at times, but it has huge payoffs. And the second is that the world doesn't run based on contracts or written legal documents, I know my lawyers here, it doesn't run on that basis. But it runs on trust, almost everything in the world works on trust. And what happens is that as you go up the log curve, the truth log curve, and you become more and more and more truthful, what happens is that you become more and more trustworthy. And trustworthiness is a huge advantage in the world. So to have, and it takes time, it may take someone knowing you for five, ten, twenty years to finally understand this is a very highly trustable person. And the difference between someone who lies ten out of a hundred times, versus one out of a hundred times, versus one out of a thousand times, is exponential in the rewards. So if you're lying one out of a hundred times versus one out of a thousand, the impact on your life would be exponential in terms of what the payoffs are. So what I would encourage you to do is give it a try, which is that as you go about living your life, just try to push the boundaries of your comfort level. Especially when you're asked questions which either a lie or a white lie or a diplomatic answer or a non-answer kind of gets you out of it. Try to kind of confront it head on and you might be surprised. So that's the first model and I found it has huge positive impacts.
OtherAnd what I've seen is that there's a compounding effect.So I've been doing this for, I would say I was a pretty honorable guy even beforethese changes, but after the changes what has happened is thatthe degree of trust that people havehas been a huge tailwind and it continues to be a tailwind.So it's something that's very easy and simple to do andI'd encourage you to do that.So the three models I'm going to present are not really particularly connectedto each other, but I thought they were all three thatmight add some value to the folks in the room.So that's the first model.The second model is the model on compounding.So Einstein said that compounding was the eighth wonder of the world and it is.So we all learn about interest rates andgrowth of things over time and different things like that.But I think that it is a huge advantage if you can understand the power ofcompounding and if you can do a bunch of math related to compounding in your head.So what I'm going to do is just kind of throw out some terms andsome of the math actually that we're going to do, I've not done myself, soI'll be doing it on the fly, which will be kind of fun.So I'll take one example from a letter Warren Buffett wrote to hisinvestors in the 1950s, I think it was like 58 or 59.And he said that the Indians, the American Indians who were based in Manhattan,what was Manhattan in New York, in 1626 it's rumoredthat they sold the island of Manhattan to the Dutch for $24.That was the sale price.And of course, when people hear that, they say $24,the Indians got taken for a ride and such.But let's say the Minuet Indians, I think it was the Minuet Indians who did that.Let's say the Minuet Indians had some kind of trust officer orinvestment officer in 1626 and the Dutch came to him andthis deal was on the table of $24 and you could sell this undeveloped island.So he would probably think, well, what are my alternative uses if we don't do the dealor what else can we do?And he'd probably run some numbers andhe would have probably concluded there was a fantastic deal.And why is it a fantastic deal?So let's say that $24 in 1626,the Indians were able to take that andinvest it at something like 7% a year, for example.What would that $24 be today if it were invested at 7%?So let's do the math without any pencil or paper.So we have something known as the rule of 72, which some of you may be familiar with,
Otherwhich is that if I have a 7% interest rate, I can take 72 divided by 7.It's approximately 10, which says that in 10 years,at a 7% interest rate, the money would double, okay?
So basically, if in 1626 they sold for $24,in 1636 they would have $48, in 1646 they'd have $96 and so on.It'd keep doubling every 10 years.So basically, if you take a 100 year period, you get 2 to the power of 10.2 to the power of 10 is a good number to know, it's 1,024.And let's throw away the 24 because that makes the math a little harder.So we have 1,000.So in 100 years, whatever they got increases 1,000 times.So if in 1626 they got 24, in 1724 they have 24,000, okay?
And in 1823 or whatever they have, or 1825, they have 24 million.And by 1925, they have 24 billion.And 2025, which is nine years from now, they have 24 trillion, right?
Now, we are about 10 years away from the 24 trillion and 10 years of the double.So today, they would have about 12 trillion, right?
So we did the math without a calculator, which is great.Well done, Monish, okay?
And the thing is, you can do the math yourself also.And the important thing with compounding is to have the fluency to do it in yourhead, because it's very important to be able to do this in your head,because it has huge impacts.So $24 in 1626, 7% compounded, is today 12 trillion.So what is the value of undeveloped, so let's say Manhattan today,the land of Manhattan, if it had no buildings on it?
Or let's say, let's put it this way.If I were to go and offer to buy everything in Manhattan, andthen I subtract the cost of the buildings, which is the land value,because it's undeveloped land, would the land be at 12 trillion, right?
And the answer to that also is very simple.So the entire wealth of the planet, every man, woman,child, everything they own, is 300 trillion.The entire wealth of the United States is 80 trillion.It is very unlikely that something like 15% of that80 trillion is just Manhattan land, and in fact,I think Warren calculated that, I think he calculated in the 1960 or something.It was 12 and a half, or 12 billion or something.Actually, it was less than 12 billion, something like 10 billion.So you might get to a few hundred billion, maybe, in value on a good day.So the Indians basically sold Manhattanat a rate where if they had held today,they had held that land till today, and they did the deal today,they would have basically lost several trillion in value by not doing the deal.
OtherNow, of course, the trust office of the Minute Indians was an idiot in terms of investing, and he didn't get them to 12 trillion, but that's a different story. We'll get to that later. So how do we get $24 to become 12 trillion, right? So let's break that apart. Let's break that apart. There are two factors that lead to the 12 trillion. The first factor is the length of time, okay? Length of time is a very important variable in how much your money grows. And the second factor is the rate at which it grows, right? And what we found is that even at a not a very high rate, 7% is actually below what the S&P has done, you get some astounding results. Now, recently, I don't know whether you saw in the news, there was some older gentleman who passed away in some way in the Northeast. He was a librarian, just middle class librarian all his life. And when he passed away, he gave the college where he worked $4 million. And everyone was surprised that this guy, who was very much a middle class ordinary guy, had actually got $4 million saved up. And of course, these journalists who wrote the article don't know how to do math, and they didn't attend the lecture that we're just having. So they didn't understand kind of how things work with get to 4 million. So let's take a situation, okay? So let's say there's an 18-year-old. And let's say this 18-year-old has very few skills, and he can only get a minimum wage job, right? And so he's making something like $15,000 per year, working 2,000 hours or so. And let's say, for example, he's able to save something like 10%, maybe hard, but let's say he's living at home, etc. Saves 10% of that $15,000 before taxes, because he can put it in the IRA or something. And so his actual kind of after-tax income might decline by 1,000 if he's working someplace where there's an employer match. Some of you students will get employer matches and such in retirement accounts, so you might have to save less to get more. So if this person is 18 years old, saves $1,500. And let's say he keeps putting the $1,500 every year into a retirement account. And let's say, for example, that he gets something like a 7% return on that money. And let's say that his income goes up very modestly. Like his income is only going up by 2% a year. And when it goes up by 2% a year, his savings go up by 2% a year. So instead of saving 1,500 next year, he saves $1,530. So it goes up very slowly. And when he retires 50 years from now, which is at the age of 68,
Questionerhe is at that point, 50 years later, making less than $50,000 a year.Didn't have any significant growth in income,just barely kept up with inflation and such.What would that person have at the age of 68?Well, let me make it easy for you.The first year, when he saves the 1,500, he's got 50 years.We know it's 7%.We know it doubles every 10 years.We know it's 2 to the power of 5.We know 2 to the power of 5 is 32.And we know what 1,500 times 32 is.So he's got $48,000.So what he saves at 18 at the age of 68 is $48,000.Age of 19, maybe somewhere similar to that,but you get the point as you go on.The end result, just to make it simpler for you,is a little over $1 million.So the librarian is not making $15,000.He's got a white-collar job.He's probably making somewhere less than $100,000 and maybemore than $40,000 or $50,000, somewhere in that range.And he paid attention when they were talkingabout compounding in math class.And if he makes four times what the guy with the minimum wagemakes without doing anything esoteric,he ends up with a very significant net worth.So the question is, why doesn't everyoneend up wealthy when we retire?Because there's not much required to become wealthy.You just have to follow a certain game plan,and you'll be there.And in fact, at the age of 68, the guywho's making less than $50,000, hecould start withdrawing $50,000 or more per yearfrom that account, and it would outlast the rest of his life.Because he'd have a 5% withdrawal rate,and he's got a 7% earnings rate.So the money would actually keep growing.He'd probably end up making a $4 milliondonation to another school or something.So compounding is a very important element to understand.And again, what matters is it makes a huge differenceif that person starts at the age of 18 versus 28.Huge difference.And my daughter, my younger daughter, last year,she interned at a place.And she got paid close to $5,000 during the internship.She had no expenses and such, so the moneywas just sitting there.So I said, you can open an IRA.And so I got her to open an IRA.And then I said, if you trust me,you can give me power of attorney,and I can invest the money for you.And one time, she was flying back from New York.She was very tired.And I just said, you know that $5,000you gave me at the age of 18, I put it into one stock.Because we can take some risks because you're just 18.You don't need the money.
QuestionerAnd probably that stock doubles or triplesin the next two, three years because my best stock pick.And so I said, let's say it doesn't even double or triple.Let's say it goes at 15% a year or something.So 15%, rule of 72, every five years things double.And I ran the math for her.And I said, what does the $5,000 become at the age of 68?So you've got 50 years to the power of 10.So you've got 10 doubles.You've got 1,000.You get to 1,000 times the $5,000, which is $5 million.So I said, Momachi, you worked one summer.And at the age of 68, you'll have $5 millionfrom the summer work.But then the next summer, you're going to work again.And that'll become $5 million at the age of 69.And at some point, you're going to graduate.And you might make more than $5,000 in a year.And you might actually save a few thousand dollars.And I said, what's your net worth at the age of 68?And I gave her some number.And it was like 2 in the morning I picked her from the airport.And she was asleep.And she was wide awake.She said, oh, how did that happen?And what's going on?Very, very, very focused.And so the thing is, it's the two pieces.The length of the runway is really important.So 50 years, number of doubles.It's all about the number of doubles.This is how Buffett thinks about it.How long did it take things to double?So if you ask Warren Buffett, Mr. Buffett,I'm the genie from Aladdin.You can have any wish you want.What would you like?So you know what he would say?He says, I only want one wish, whichis that when I'm dead and they look at me,they say, man, he was old.So he just wants to not die for as long as possible.And it's not like he loves all of us on planet Earth.It's why he doesn't want to die.He wants to compound.And he wants to keep compounding for as long as he can.And I think in his case, he's 86.And he started his compounding journey at the age of 11.And he actually understood compounding,I think, at the age of 9 or 10.And I think at 24 or something, hetold his wife that we are going to be wealthybeyond our dreams.We're going to have more money than wewant to know what to do with it.And so we've got a plan for what are we goingto do with all this extra cash.And his wife thought, this guy is,I want to buy a house.We don't have money to buy a house.He thinks we're going to get super wealthy.What's going on?And of course, they did.So compounding is a very important element,no matter what your profession or calling in life
Otherends up being.It's very important to have the fluency in math,very important to understand the concept of a runwayand the length, time it takes to double, and compounding rate.And don't take the retirement account of 401k or IRA,pull out the money and go on vacation.The time value destruction of that is huge.So that's the second model.And very quickly, the third modelis that the key, like Professor Brown mentioned,the key to, I would say, a lot of the things relatedto developing your full potentialor reaching some of your goals may be relatedto being an entrepreneur, at some pointbeing able to do things on your own and that sort of thing.And of course, one of the difficultiesthat comes up in being an entrepreneuris that most of us don't have any resources.We don't have a rich uncle.I just told you put the money away into this account.Don't put it out.And so we don't have anything to really go out and createthings.So how do we get a business off the ground?And it's important to know how to get a business offthe ground.And I used this model when I was tryingto get my first business off the ground.So there are 168 hours in a week, 24 times 7.And if you go to work for some company,typically they expect you at least 40 hours a week.You might have another five or seven hours or soin commute time and so on, maybe 50 hours a week.There's still 118 hours left in the week.And in fact, if you take out time for eating and sleepingand other things, you will find that there is clearlyat least another 40 hours available to you,which can be used in a number of different ways.And when you're thinking of startingyour entrepreneurial journey, one simple thing you can dois, so one of the biggest things I tell peopleis when you're going to start a business,do not quit your job.That is the dumbest thing you can do.Someone is paying your rent.Someone is paying for the groceries.Someone is paying for those dinner dates.Keep it going.Don't turn off the faucet.But what you do is you start working on your startupon the second 40 hours.So you have weekends.You have evenings.You have mornings before you go to work.You have all kinds of time.Do that.And at some point, when the businessis getting some traction, where you thinkyou can see the light and you've got revenue and cash flowand all of that, then you can go and hand in your designation.And so I was, I think, 24 years oldwhen I had an idea for my first business.
OtherAnd I didn't have any money.So I was basically just working on my businesson evenings and weekends.But one of the things I decided isI used to always get great performance reviews.I was doing a good job.I said, I no longer care about performance reviews.That's irrelevant to me.So I said, what is my objective?My objective is, and I hope my staff is not listening to this,but my objective is to work just enough so I don't get fired.Be just slightly above firing level.Like, you know, I don't need to really burn the midnight oil.I don't need to go way overboard.I just need to make sure that they feel he's not so bad.We want to get rid of him.But he's not a star, right?And so I did this.It took 11 months from the time I started working on businesstill the time I was ready to hand in my designation.We had clients and projects and all that.So I was ready to hand.So I went to my boss.And I told him, hey, you know, I have this business.And it was not competitive with what they were doing.And it's working now.And I'm going to resign.And so I had a meeting with my boss and his boss.And they said, you know, Monish, for 11 months,we were wondering what happened to you.Like, we said, there's this guy who's a great star doingsomething.We couldn't figure out, like, what was going on.And I said, yeah, my idea was to bejust above firing level, right?He said, exactly.We discussed, should we get rid of you?And we said, no, he's not so bad.So I said, exactly.I calibrated it just above the levelthat you would get rid of me.And of course, they were, of course, very supportive.And I was very honorable.I had to give two weeks notice.I wanted to leave in two weeks.But I told them, listen, I'll stayas long as you want me to.And they said, can you stay a month to do transitions?I said, no problem.So we did that.And actually, the thing is, I left that company in 1991.I started Pabrai Funds in 1999.And I think in 2001, both my boss and his boss,they became investors in Pabrai Funds.And it was 10 years after I had left the company.Of course, I stayed in touch with them.But that goes back to the first model, whichis the trust model, that you have to.And of course, even when I was leaving,I was very honest with them about, hey, yeah,it's exactly right.I was a useless worker, but meeting slightlyabove your firing criteria and such.So that's the third thing, which is that.And I tell this to my daughters, that if you ever
Ted Weschlerdecide to go into business for yourself,you can do this second 40-hour thing five times.And you can fail five times.And that's perfectly fine, because Ihad tried two or three times before when I was 24.Nothing ever got traction.But there was no downside.I still had my job.Maybe I'd spent $3,000 or $4,000.We shut whatever we were doing down.And then a few months later, there was another idea.And eventually, one idea had traction and went from there.So the idea is that you find people,like Warren says, you like, admire, and trust.You figure out ideas that you think make sense.You can obviously work on them.And it's a high probability that if youkeep doing that a few times, one of those will hit.And there's no risk, because you have most thingsthat most young people will do todayis technology-related, IT-related, app-related,iPhone-related, et cetera.None of these things need capital.It used to be, in previous businesses,you need a lot of capital.A lot of businesses you can start todaydon't take capital.They take what's between your ears.So that's the third model, is that use the 168 hoursand then take it from there.So that's really the three thoughtsI wanted to share with you.And I hope I didn't go too far over.So thank you very much.Thank you.