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CHAPTER 10

LIVING LIFE ACCORDING TO THE INNER SCORECARD

To be yourself in a world that is constantly trying to make you something else is the greatest accomplishment.

—Ralph Waldo Emerson

The path to true success is through authenticity.

—Guy Spier

According to Warren Buffett, there are two kinds of people in life: those who care what people think of them, and those who care how good they really are.

Buffett always remains true to himself and never compromises on his values. He has never cared about luxurious possessions, and he still lives in the modest house he bought for $31,500 in 1958. As an investor, Buffett thinks entirely for himself and invests only according to his personal investment philosophy. During 1999, in the midst of the Internet bubble, Buffett was being humiliated by some of the leading financial commentators of the time and Berkshire’s stock price was getting hammered. But Buffett always kept in mind what he had been taught by his father—that the only scorecard that counts is your inner scorecard.

In December 1999, Barron’s put Buffett on its cover with the headline “Warren, What’s Wrong?” The accompanying article said Berkshire had “stumbled” badly. Buffett was facing a kind of negative press like nothing he had ever experienced. Many longtime value investors who followed Buffett’s style had either shut down their firms or given in and bought technology stocks. Buffett did not. What he called his inner scorecard—a toughness about personal decisions that had infused him for as long as anyone could remember—kept him from wavering, and he steadfastly adhered to his long-held principles. He never forgot his teacher Ben Graham’s words: “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”¹

Don’t live a life based on approval from others. Be authentic—act in accordance with who you are and what you believe in, or one day your mask will fall off. If Buffett was living by the standards others followed, he would not have been able to maintain the firm independence of mind that has helped him avoid many financial bubbles and the subsequent personal misery. It is a significant lesson for all investors. A contrarian isn’t one who always takes the opposite path just for the sake of it. That is simply a conformist of a different sort. A true contrarian is one who reasons independently, from the ground up, based on factual data, and resists pressure to conform.

If, in your heart, you know who you really are and that the choice you made was absolutely right, then the criticism of others should be considered and analyzed to see whether it truly has any merit, but it should not be given permission to belittle what you are trying to achieve. Let your life be guided by internal principles, not external validation. Self-respect beats social approval. Every time. We are not perfect, nor should we pretend to be, but we always should endeavor to be the best version of ourselves.

Buffett’s operating principles during the Buffett Partnership years provide many lessons for fund managers—and all those who should always occupy the high ground in the interest of their clients.

The Buffett Partnership Years

In 1956, when he was just twenty-five years old, Warren Buffett formed Buffett Partnership Ltd. with $105,100 in capital and seven limited partners: his mother, sister, aunt, father-in-law, brother-in-law, college roommate, and lawyer. He charged no management fee, took 25 percent of any gains beyond a cumulative 6 percent, and agreed to personally absorb a percentage of any losses. You will rarely find such an equitable fee structure in the investment management industry today.

By 1969, $100,000 invested in the Buffett Partnership in 1957 would have become $1,719,481. If you had invested the same amount in the Dow, it would have grown to only $252,467. For more than a decade, Buffett achieved a compound annual return of 24.5 percent, net of fees (29.5 percent before fees). The compound annual return of the Dow over the same time, with dividends, was 7.4 percent.

And yet, despite all this success, Warren Buffett announced to his limited partners, in May 1969, that he would be closing down the Buffett Partnership.

Buffett was young, he was having extraordinary success, and he was having to actually turn away investors.

Why did Warren Buffett decide to close down his investment partnership in 1969?

Because he possessed certain virtues. Honesty. Sincerity. Integrity. Authenticity.

In January 1967, after a decade of incredible results, Buffett warned his limited partners to temper their expectations: “The results of the first ten years have absolutely no chance of being duplicated or even remotely approximated during the next decade.”²

In October 1967, Buffett explained to his investors why he didn’t think he would be able to achieve the same results:

Such statistical bargains have tended to disappear over the years….

…When the game is no longer being played your way, it is only human to say the new approach is all wrong, bound to lead to trouble, etc. I have been scornful of such behavior by others in the past. I have also seen the penalties incurred by those who evaluate conditions as they were—not as they are. Essentially I am out of step with present conditions. On one point, however, I am clear. I will not abandon a previous approach whose logic I understand (although I find it difficult to apply) even though it may mean foregoing [sic] large and apparently easy profits to embrace an approach which I don’t fully understand, have not practiced successfully and which, possibly, could lead to substantial permanent loss of capital [emphasis added].³

In January 1969, even after the Buffett Partnership’s best year ever, Warren Buffett continued to stand his ground: “At the beginning of 1968, I felt prospects for BPL performance looked poorer than at any time in our history…. We established a new mark at plus 58.8 percent versus an overall plus 7.7 percent for the Dow, including dividends which would have been received through the ownership of the Average throughout the year. This result should be treated as a freak like picking up thirteen spades in a bridge game.”⁴

In May 1969, Buffett said he was running out of good investment ideas. He said he could take some chances and gamble with his investors’ money so that he could go out a hero, but he refused to do so.

Finally, in October 1969, Warren Buffett closed the Buffett Partnership.

In his final letter, Buffett wrote his partners a ten-page explanation of why he recommended tax-free municipal bonds—even offering to sit down with each of them individually to explain the rationale, as well as to make the actual purchases for them. For those who wished to continue to invest in stocks, he said, “I feel it would be totally unfair for me to assume a passive position and deliver you to the most persuasive salesman who happened to contact you early in 1970.”⁵

Buffett recommended his clients invest with his Columbia classmate Bill Ruane, not because he was the best investor Buffett knew other than himself, but because Buffett viewed him as a person with high integrity and moral character. (Remember, most of Buffett’s limited partners were his relatives and close friends.) According to Buffett, Ruane was “the money manager within my knowledge who ranks the highest when combining the factors of integrity, ability and continued availability to all partners.”

Bill Ruane turned out to be a legendary investor in his own right, and his Sequoia Fund returned 289.6 percent over the next decade, versus 105.1 percent for the S&P 500. Later on, Ruane would be included as one of the superinvestors in Buffett’s speech titled “The Superinvestors of Graham-and-Doddsville,” delivered in May 1984 at Columbia Business School.

Throughout his early partnership years, Buffett embodied what Peter Kaufmann referred to during the 2018 Daily Journal Corporation meeting as the “five aces” of money management (figure 10.1).

FIGURE 10.1 “Five Qualities of Investment Advisors” by Peter Kaufman.

Source: “Charlie Munger on Bitcoins, Banking, AI, and Life,” Safal Niveshak (blog), February 17, 2018, https://www.safalniveshak.com/charlie-munger-bitcoins-banking-life/.

Fund managers (who, in essence, are operating in a fiduciary role for their clients) should view themselves first and foremost as risk managers. As such, they should follow the key principles of prudent insurance underwriting, outlined in Buffett’s 2001 shareholder letter:

They accept only those risks that they are able to properly evaluate (staying within their circle of competence) and that, after they have evaluated all relevant factors including remote loss scenarios, carry the expectancy of profit….

They limit the business they accept in a manner that guarantees they will suffer no aggregation of losses from a single event or from related events that will threaten their solvency. They ceaselessly search for possible correlation among seemingly-unrelated risks.⁶

Charlie Munger has always admired his protégé Li Lu for his work ethic and high integrity as a trusted steward of capital. To understand why, one needs only to listen to what Lu told the students at the Guanghua School of Management in China, in October 2015:

Establish an awareness of fiduciary duty. What are fiduciary duties? You must treat every dollar of client money as though it were the fruit of your own parents’ labor, saved up piece by piece over a lifetime of diligence and thrift. Even if it’s not much, it took years of struggle and sacrifice to accumulate. If you can understand the responsibility this entails, then you can start to understand the meaning of fiduciary duty.

I think the concept of fiduciary duty is innate: people either have it or they don’t.⁷

Never forget your moral responsibility to the individuals and families who entrust you with their life’s hard-earned savings. When the perma-bull inside you urges you to engage in risky strategies or to eke out the final few points of a rampant bull market where there could be a quick 20 percent upside along with a potential 50 percent downside, think about the man or lady who worked on the checkout line at Walmart for years to put something aside for his or her retirement. How would it affect their retirement dreams and life aspirations if you lost half their money? How would they feel if they knew what you were doing? How would you feel if you were fully aware about what you were doing?

An outer scorecard, which many people have, asks, “What will people think of me? Will they judge me by the way I dress or the way I look or the car I drive?”

But the inner scorecard, which is much more important, asks, “Am I doing the right things? Am I treating people correctly? Is this working for me as an individual?”

It’s what Rose Blumkin, the Nebraska Furniture Mart founder, stood for, and she lived her life under one single motto: “Sell cheap and tell the truth.”⁸

The inner scorecard is the inner set of criteria and standards by which a person judges her- or himself. In contrast, the outer scorecard is an external, comparative picture of self-worth predicated on the judgments of others. There is a clear parallel here between the inner scorecard and the concept of intrinsic value and between the outer scorecard and the concept of market value. Benjamin Graham had talked about this very parallel in The Intelligent Investor:

Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it—even though others may hesitate or differ. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right [emphasis added].⁹

Focusing on his inner scorecard and living life in a principled manner has worked for Buffett. He has always believed in the dictum “Honesty is the best policy.” Buffett has always taken the high road, and it has paid off very well. For instance, he could have saved billions by moving his reinsurance operations’ tax domicile to a tax-advantaged jurisdiction, as many of his competitors did, but he didn’t. His independent spirit infuses every aspect of his life. This includes his diet, which mostly revolves around burgers and Cherry Coke.

In the late 1980s, when the U.S. savings and loan (S&L) companies were using accounting tricks to create capital out of thin air, they were heading toward a crisis of widespread bankruptcies that would destroy depositor savings, require a taxpayer bailout, and result in a furious public backlash. Munger, who was chairman and CEO of Berkshire’s S&L operation, Wesco Financial, foresaw that Wesco’s better behavior wouldn’t prevent it from being tainted by association. He not only cut back Wesco’s lending but also took an extreme stand to distance Wesco from the other S&Ls by resigning from the U.S. League of Savings Institutions, in a letter in which he likened the trade association to metastasizing cancer cells and called its lobbying practices “flawed, indeed disgraceful.”¹⁰ It was a step that only a person who was willing to be detested by an entire industry could take. The move paid off when the S&L crisis erupted and Wesco’s reputation was left completely unscathed. It was Munger’s action of high integrity during the 1980s’ S&L crisis that set Berkshire on its path to being held up as the moral exemplar of corporate America.

What Buffett, Munger, and a lot of other people who have been successful in life (true success, not measured by money) have in common is that they strive for a happy and fulfilling life. Not just getting rich. Not just trying to get famous. But living a truly satisfying existence with full integrity and helping others around them achieve the same.

Bernie Madoff achieved great admiration and wealth over the duration of his Ponzi scheme, but was he happy? He made it clear, after he had been caught, that he wasn’t. Here was a guy who had all the admiration in the world, an external scorecard showing an A+. But what happened when he lost it all? He heaved a sigh of relief. According to New York magazine, “For Bernie Madoff, living a lie had once been a full-time job, which carried with it a constant, nagging anxiety. ‘It was a nightmare for me,’ he told investigators, using the word over and over, as if he were the real victim. ‘I wish they caught me six years ago, eight years ago,’ he said in a little-noticed interview with them.”¹¹

Shane Parrish writes, “The little mental trick is to remember that success, money, fame, and beauty, all the things we pursue, are merely the numerator! If the denominator—shame, regret, unhappiness, loneliness—is too large, our ‘Life Satisfaction Score’ ends up being tiny, worthless. Even if we have all that good stuff!…It’s so simple. This is why you see people that ‘should be happy’ who are not. Big denominators destroy self-worth.”¹²

Adam Smith addressed this issue more than two centuries ago in his book The Theory of Moral Sentiments. He said that even though we desire to be loved by others, at the end of the day, we experience happiness only when we are successful according to our inner scorecard. We derive true joy from our achievements only when we feel we truly deserve it. We can’t just receive praise. We must be praiseworthy. We can’t just be loved. We must be loveable.

To get what you want, deserve what you want. Trust, respect, and admiration need to be earned. As Munger says:

It’s such a simple idea. It’s the golden rule so to speak. You want to deliver to the world what you would buy if you were on the other end. There is no ethos, in my opinion, that is better for any lawyer or any other person to have. By and large the people who have this ethos win in life, and they don’t win just money, not just honors. They win the respect, the deserved trust of the people they deal with, and there is huge pleasure in life to be obtained from getting deserved trust [emphasis added].¹³

The idea of living one’s life according to the inner scorecard is closely linked to the concept of the “Kantian fairness tendency,” discussed by Munger in his essay The Psychology of Human Misjudgment: “Kant was famous for his ‘categorical imperative,’ a sort of a ‘golden rule’ that required humans to follow those behavior patterns that, if followed by all others, would make the surrounding human system work best for everybody.”¹⁴

I look at this as the law of the higher good, of treading the high moral ground, of taking the road less traveled, of being the better people. Buffett and Munger have exemplified this behavior in their daily dealings for the past many decades, and their goodwill has compounded in an exponential manner over the years.

We must look at individual situations from our civilization’s point of view rather than the viewpoint of any single individual, including ourselves. If we behave in a way that encourages lies and deceit, or if we tolerate such systems, we will ruin our civilization. If we don’t punish the concerned individual, even if that person is us, the idea that it is okay to do minor unethical deeds once in a while will spread because of incentive effects and social proof (“Everyone is doing it, so it’s okay.”). It is our duty to act as moral exemplars and to inspire others to do the same.

When I was an officer in the military, we had a rule called Conduct Unbecoming an Officer. It was not specific, but it said there were certain ways to behave as an example for others…. If you rise high in a corporation or elsewhere in life, you have a duty to be an exemplar—you have a duty to take less than you deserve, to set an example [emphasis added].

—Charlie Munger

Ultimately, you want to be at peace with yourself, able to face the mirror every day. As the saying goes, “There is no pillow so soft as a clear conscience.” We should not pay mere lip service to our role models in life; we should embody them in words, action, and spirit. Over the course of our lives, we will face difficult situations in which being truthful is painful up front. Following the path of righteousness during such times delivers enormous rewards in the long run. Our goodwill compounds exponentially over time when we live life according to the inner scorecard.

Again, Munger shares some great thoughts:

I think the best single way to teach ethics is by example. And that means if you take in people who demonstrate in all their daily conduct a good ethical framework, I think that has enormous influence on the people who watch it. But if your ethics slip and people are rewarded [nevertheless, then] it cascades downward. Ethics are terribly important, but best taught indirectly by example. If you just learn a few rules by having ethics taught in school so they can pass the test, it doesn’t do much. But if you see people you respect behaving in a certain way, especially under stress, that has a real impact [emphasis added].¹⁵

The principle of reciprocity states, “Treat others the way you would like them to treat you” and “Do unto others as you would have done unto you.” Character is how you treat others when you have the upper hand and no one is watching. Over the long term, “what goes around comes around.” Karma is a like a big snowball. So, acting in an ethical manner with everyone is the most honorable way to lead one’s life. Our world’s moral fabric would be completely transformed if all of humanity imbibed, as a way of life, Seneca’s golden words: “Cherish some man of high character, and keep him ever before your eyes, living as if he were watching you, and ordering all your actions as if he beheld them.”¹⁶