Friday, May 23, 2014

Charlie Munger on Opportunity Costs

From the 2005-2013 collection of Munger notes:
I just wanted to do the best I could reasonably do with the talent, time and resources I had available. That’s what I was doing then and now. Everything is based on opportunity costs. Academia has done a terrible disservice: they teach in one sentence in first-year economics about opportunity costs, but that’s it. In life, if opportunity A is better than B, and you have only one opportunity, you do A. There’s no one-size-fits-all. If you’re really wise and fortunate, you get to be like Berkshire. We have high opportunity costs. We always have something we like and can buy more of, so that’s what we compare everything to.

All of you are in the game of taking the lot you have right now and improving it based on your opportunity costs. Think of how life is simplified if you approach it this way.

From Munger's Harvard-Westlake talk, which I've posted before:
Berkshire Hathaway is constantly kicking off ideas in about two seconds flat. We know we’ve got opportunity X, which is better than the new opportunity. Why do we want to waste two seconds thinking about the new opportunity? Many of you come from places that don’t do that. You’ve got to have one horse, one rabbit, one something or rather, and that rabbit is going to be thinking about something which would be ruled out immediately by an opportunity cost available generally to the place – but, it’s a different department. You have to be diversified and so on and so on. It’s easy to drift into this idea that opportunities don’t matter, you’ve got so many different ways of doing things that are better. It isn’t better.

The right way to make decisions in practical life is based on your opportunity cost. When you get married, you have to choose the best [spouse] you can find that will have you. The rest of life is the same damn way.

And a related discussion from this year's Berkshire Annual Meeting (more extensive notes HERE, in case you've missed them):
Buffett: Charlie and I view our cost of capital as what can be produced by our second best idea. 

Munger: I've never heard an intelligent cost of capital discussion. Warren's way of having every dollar retained having to produce at least a dollar of market value is the best way to describe our cost of capital. But that's not what people mean when they say it, especially in business schools. But it's simple; our way is right and their's is wrong.