Munger uses the pari-mutuel system at the racetrack as a model for stock markets and decision-making generally. In a pari-mutuel system, the odds adjust to what people bet — “any damn fool can see that a horse with a wonderful win rate is way more likely to win, but if you look at the damn odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it’s not clear which is statistically the best bet.” The house takes seventeen percent off the top, so “not only do you have to outwit all the other bettors, but you’ve got to outwit them by such a big margin” that you can still profit after the vig.
The solution: “The one thing all those winning bettors in the whole history of people who’ve beaten the pari-mutuel system have is quite simple: they bet very seldom.” It’s the same in investing: “It is not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it — who look and sift the world for a mispriced bet — that they can occasionally find one. And the wise ones bet heavily when the world offers them that opportunity.” Munger reports that “the top ten insights account for most of” Berkshire’s accumulated billions, despite Buffett devoting a lifetime to it with extreme discipline.
Buffett’s thought experiment crystallizes it: give an investor a card with only twenty slots for lifetime investments. “Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do so much better.” This connects to Circle of competence determines where you can win — concentrated betting only works when you stay inside your circle. It also connects to Incentive-caused bias makes good people rationalize harmful behavior — most investment managers don’t operate this way because “if you invested Berkshire-style, it would be hard to get paid as well as they’re currently paid.”