Charlie Munger has spent a lifetime attempting to avoid stupid mistakes. He’s given a number of speeches on his experience over the years, that he ultimately compiled into one called: The Psychology of Human Misjudgment.
Munger noticed patterns of irrational behavior that led to repeated mistakes, so he set out to finds ways to understand psychology in order to avoid the mistakes himself:
I was greatly helped in my quest by two turns of mind. First, I had long looked for insight by inversion in the intense manner counseled by the great algebraist, Jacobi: “Invest, always invert.” I sought good judgment mostly by collecting instances of bad judgment, then pondering ways to avoid such outcomes. Second, I became so avid a collector of instances of bad judgment that I paid no attention to boundaries between professional territories. After all, why should I search for some tiny, unimportant, hard-to-find new stupidity in my own field when some large, important, easy-to-find stupidity was just over the fence in the other fellow’s professional territory? Besides, I could already see that real-world problems didn’t neatly lie within territorial boundaries. They jumped right across.
Through inversion, stupidity, and bad judgment, he came up 25 tendencies we’re all susceptible to whether we know it or not. What follows is a brief breakdown of those tendencies (though, I recommend reading the entire speech).
1. Reward and Punishment Superresponse Tendency
…almost everyone thinks he fully recognizes how important incentives and disincentives are in changing cognition and behavior. But this is not often so. For instance, I think I’ve been in the top five percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I’ve always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower…
Rewards are a great motivator. Rewards also produce bad behavior or what Munger calls “incentives caused bias.”
One of the most important consequences of incentive superpower is what I call “incentive caused bias.” A man has an acculturated nature making him a pretty decent fellow, and yet, driven both consciously by incentives, he drifts into immoral behavior in order to get what he wants, a result he facilitates by rationalizing his bad behavior, like the salesmen at Xerox who harmed customers in order to maximize their sales commissions.
If the reward involves keeping a job or higher pay, it’s likely someone will game the system, especially when the consequences seem minimal. For instance, the recent Wells Fargo scandal where employees were pushed to meet account quotas, and with no checks on the system, Wells Fargo was soon awash in fake accounts. The scandal was compounded by the bias of social proof — it must be okay if every other employee is doing it too.
Commission-based advice is another potential conflict zone. A few months of insurance sales was enough to know at least a few agents would only push the higher commission policies whether it was best for the client or not. It’s not a stretch to think the same happens with most commission-based financial products. The solution in the case of incentivized “advice” is to be skeptical and double check anything you’re told.
Never, ever, think about something else when you should be thinking about the power of incentives.
The worst incentives tend to be short-term good, long-term bad.
2. Liking/Loving Tendency
…A newly arrived human is “born to like and love” under the normal and abnormal triggering outcomes for its kind… And what will a man naturally come to like and love, apart from his parent, spouse, and child? Well, he will like and love being liked and loved. And so many a courtship competition will be won by a person displaying exceptional devotion, and man will generally strive, lifelong, for the affection and approval of many people not related to them…
One very practical consequence of Liking/Loving Tendency is that it acts as a conditioning device that makes the liker or lover tend:
- to ignore faults of, and comply with wishes of, the object of his affection,
- to favor people, products, and actions merely associated with the object of his affection (as we shall see when we get to “Influence-from Mere-Association Tendency”), and
- to distort other facts to facilitate love.
Of course, this can be taken to the point that we ignore all faults of people, things, ideas, and beliefs we admire. Anything bad is pushed aside, ignored, or distorted.
With investing, things quickly go wrong when you purposely ignore or distort the bad stuff. This confirmation bias drives you to look for confirming evidence like good news while avoiding bad news. It’s hard to make good decisions when you’re subconsciously overlooking all the facts.
Objects, like pieces of paper traded on an exchange, don’t care who owns it — don’t reciprocate emotions. And yet, investors often treat investments as if they do. The extreme consequence is that it becomes impossible to let go of investments you “love.”
3. Disliking/Hating Tendency
In a pattern obverse to Liking/Loving Tendency, the newly arrived human is also “born to dislike and hate” as triggered by normal and abnormal triggering forces in its life…
Disliking/Hating Tendency also acts as a conditioning device that makes the disliker/hater tend to:
- ignore virtues in the object of dislike,
- dislike people, products, and actions merely associated with the object of his dislike, and
- distort other facts to facilitate hatred.
Distortion of that kind is often so extreme that miscognition is shockingly large.
It’s the opposite of the liking/loving tendency but with similar outcomes. For example, rather than ignoring bad news, only the good news is overlooked. The tendency to like/dislike drive people to pick sides, create (political) divides, never change their mind, and make it impossible for anyone to agree on anything so that it’s antithetical to progress.
4. Doubt-Avoidance Tendency
The brain of man is programmed with a tendency to quickly remove doubt by reaching some decision. It is easy to see how evolution would make animals, over the eons, drift toward such quick elimination of doubt. After all, the one thing that is surely counterproductive for a prey animal that is threatened by a predator is to take a long time in deciding what to do. And so man’s Doubt-Avoidance Tendency is quite consistent with the history of his ancient, nonhuman ancestors.
Being able to jump to conclusions comes in handy when chased by a man-eater. It’s less so when the instinctual need to run kicks in during a market crash.
But then there’s doubt in general, that can lead to added stress and anxiety around decisions. That can lead to putting off a decision entirely.
5. Inconsistency-Avoidance Tendency
The brain of man conserves programming space by being reluctant to change, which is a form of inconsistency avoidance. We see this in all human habits, constructive and destructive. Few people can list a lot of bad habits that they have eliminated, and some people cannot identify even one of these. Instead, practically everyone has a great many bad habits he has long maintained despite their being known as bad. Given this situation, it is not too much in many cases to appraise early-formed habits as destiny. When Marley’s miserable ghost says, “I wear the chains I forged in life,” he is talking about chains of habit that were too light to be felt before they became too strong to be broken…
It is important not to thus put one’s brain in chains before one has come anywhere near his full potentiality as a rational person.
Simply, people are averse to change. We’re creatures of habit. Anyone who’s ever attempted to remove a bad habit or start a good habit knows how difficult that change can be, even when we know the habit is bad.
When comes to ideas, the solution is to attack confirmation bias head-on. Follow Darwin’s example. Purposely seek out counterarguments before coming to a conclusion.
6. Curiosity Tendency
Curiousity, enhanced by the best of modern education (which is by definition a minority part in many places), much helps man to prevent or reduce bad consequences arising from other psychological tendencies. The curious are also provided with much fun and wisdom long after formal education has ended.
General curiosity is the great eliminator of what Munger calls the “man with a hammer” syndrome. It loosens fixed beliefs, opens minds, and generally works against the inconsistency/avoidance tendency.
7. Kantian Fairness Tendency
Kant was famous for his “categorical imperative,” a sort of a “golden rule” that requires humans to follow those behavior patterns that, if followed by all others, would make the surrounding human system work best for everybody. And it is not too much to say that modern accultured man displays, and expects from others, a lot of fairness as thus defined by Kant.
Who knew that when you’re generally nice to people — show a mild level of decency — that people are nice back. Of course, not everyone follows along. The random jerk exists. Trolls provoke. You can take it personally, get angry, and burn a ton of time and energy on it. Or you can not sweat the small stuff.
8. Envy/Jealousy Tendency
A member of a species designed through evolutionary process to want often-scarce food is going to be driven strongly toward getting food when it first sees food. And this is going to occur often and tend to create some conflict when the food is seen in the possession of another member of the same species. This is probably the evolutionary origin of the Envy/Jealousy Tendency that lies deep in human nature…
Envy/jealousy is extreme in myth, religion, and literature wherein, in account after account, it triggers hatred and injury.
Swap food for anything — money, love, power, recognition, material possessions, investment returns — someone has that another person wants and you get the seeds of envy and jealousy that can lead to resentment and hate.
As I have shared the observation of life with Warren Buffett over decades, I have heard him wisely say on several occasions: “It is not greed that drives the world, but envy.”
9. Reciprocation Tendency
The human tendency of humans to reciprocate both favors and disfavors has long been noticed as it is in apes, monkeys, dogs, and many less cognitively gifted animals. The tendency facilitates group cooperation for the benefit of members. In this respect, it mimics much genetic programming of the social insects. We see the extreme power of the tendency to reciprocate disfavors in some wars, where it increases hatred to a level causing very brutal conduct…
Reciprocity Tendency subtly causes many extreme and dangerous consequences, not just on rare occasions but pretty much all the time.
Thanks to the Kantian fairness tendency, we tend to return favors. But that reciprocation can be manipulated so that someone performs “favors” they wouldn’t normally agree to do. Munger gives an example by Robert Cialdini who asked people to volunteer for a huge favor that no one would agree to (babysit troublemakers for two years), only to concede to a smaller, but still ridiculous request (take troublemakers to the zoo).
The fact that people can be easily manipulated to do something they never would do in the first place, should be troubling. Marketing techniques and negotiations are two areas to watch for this.
One solution is to get really good at saying, “No!” Another solution is to stop and think about what you’re agreeing to — even if it takes hours — before deciding.
10. Influence-from-Mere Association Tendency
…there is another type of conditioned reflex wherein mere association triggers a response. For instance, consider the case of many men who have been trained by their previous experience in life to believe that when several similar items are presented for purchase, the one with the highest price will have the highest quality. Knowing this, some seller of an ordinary industrial product will often change his product’s trade dress and raise its price significantly hoping that quality seeking buyers will be tricked into becoming purchasers by mere association of his product and its high price.
The correlation of quality with a higher price is abused by advertisers. Coca-cola does this. Apple does this. All luxury brands do this too. Sometimes you get what you pay for. Sometimes you pay extra for the label.
Munger gives another example of someone who gambles for the first time on a low probability bet and sees it pays off. So he repeats the bet and loses, and continues to repeat it and lose because he never bothered to consider his win was pure luck. The association of winning with a low probability bet compounds stupid decisions.
The solution is to weigh decisions independent of the result:
Carefully examine each past success, looking for accidental, noncausative factors associated with such success that will tend to mislead as one appraises odds implicit in a proposed new undertaking.
11. Simple, Pain-Avoiding Psychological Denial
This phenomenon first hit me hard in World War II when the superathlete, superstudent son of a family friend flew off over the Atlantic Ocean and never came back. His mother, who was a very sane woman, then refused to believe he was dead. That’s Simple, Pain Avoiding Psychological Denial. The reality is too painful to bear, so one distorts the facts until they become bearable. We all do that to some extent, often causing terrible problems. The tendency’s most extreme outcomes are usually mixed up with love, death, and chemical dependency.
Denial, avoiding pain or bad news, tends to compound problems. One way around this is being open to the fact that not everything works out the way we expect and it’s not the end of the world, despite feeling like it at the time.
In investing, if a loss hurts, selling is the quick short-term answer to avoiding pain. It typically leads to worse long-term returns. The lengths investors go to, to avoid pain ultimately leads to not taking any risk — loss aversion.
12. Excessive Self-Regard Tendency
We all commonly observe the excessive self-regard of man. He mostly misappraises himself on the high side, like the ninety percent of Swedish drivers that judge themselves to be above average. Such misappraisals also apply to a person’s major “possessions.” One spouse usually overappraises the other spouse. And a man’s children are likewise appraised higher by him than they are likely to be in a more objective view. Even man’s minor possessions tend to be overappraised. Once owned, they suddenly become worth more to him and he would pay if they were offered for sale to him and he didn’t already own them… And all man’s decisions are suddenly regarded by him as better than would have been the case just before he made them.
This is better known as the endowment effect. We tend to overestimate our skills, decisions, and possessions. We also prefer people similar to us. That can lead to groupthink and herd behavior which is prevalent in investing.
In investing, this leads to people who think they pick stocks when they can’t, put a higher value on the investments they own, who hang out with other people who think the same, invest in the same things, and suffer the same when they’re wrong. Then they refuse to accept their lack of skill is the problem, so they collectively blame something else for their poor results.
The solution is to be objective, open-minded, humble, and accepting of mistakes.
13. Over-optimism Tendency
Demosthenes, the most famous Greek Orator, said, “What a man wishes, that also will he believe.”
Demosthenes, parsed out, was thus saying that man displays not only Simple, Pain-Avoiding Psychological Denial but also an excess of optimism even when he is already doing well.
How many people blindly buy stocks without doing any work because they absolutely believe they’ll make money? The force that drives people to believe the stock market, casinos, or lotteries are the source for quick riches is excessive optimism. Understanding simple probabilities is a great reminder of how little control we have over the future.
14. Deprival Super Reaction Tendency
The quantity of man’s pleasure from a ten dollar gain does not exactly match the quantity of his displeasure from a ten dollar loss. That is, the loss seems to hurt much more than the gain seems to help. Moreover, if a man almost gets something he greatly wants and has it jerked away from him at the last moment, he will react much as if he had long owned the reward and had it jerked away…
In displaying Deprival Superreaction Tendency, man frequently incurs disadvantage by misframing his problems. He will often compare what is near instead of what really matters.
This can go in several directions. First is the losses hurt twice as much as gains feel good, which is prevalent in investing. Then there is the sunk cost fallacy and potential for loss aversion. And finally, there’s the drive to break even.
Casinos know this all too well, by designing games where you’re almost always thiiiis close to winning your money back. So you compound losses further.
15. Social-Proof Tendency
The otherwise complex behavior of man is much simplified when he automatically thinks and does what he observes to be thought and done around him. And such followership often works fine. For instance, what simpler way could there be to find out how to walk to a big football game in a strange city than by following the flow of the crowd. For some such reason, man’s evolution left him with Social-Proof Tendency, an automatic tendency to think and act as he sees others around him thinking and acting.
“Monkey-see, monkey-do” is more than a turn of phrase. Social proof leaves people susceptible to groupthink and herd behavior.
In investing, the crowd is a comfortable place to be. Most investors would rather be wrong with everyone else, than wrong by themselves. What doesn’t help is how the nature of cycles makes it more profitable to be independent of the crowd at the extremes of the cycle.
Learn how to ignore the examples from others when they are wrong, because few skills are more worth having.
16. Contrast-Misreaction Tendency
Because of the nervous system of man does not naturally measure in absolute scientific units, it must instead rely on something simpler. The eyes have a solution that limits their programming needs: the contrast in what is seen is registered. And as in sight, so does it go, largely, in the other senses. Moreover, as perception goes, so goes cognition. The result is man’s Contrast-Misreaction Tendency. Few psychological tendencies do more damage to correct thinking. Small-scale damages involve instances such as man’s buying an overpriced $1,000 dashboard merely because the price is so low compared to his concurrent purchase of a $65,000 car…
Small changes are almost imperceptible to see, but quickly add up. Compounding does this for the better, but also for the worse. Tiny mistake after tiny mistake, add up to huge problems:
Cognition misled by tiny changes involving low contrast, will often miss a trend that is destiny.
One of Ben Franklin’s best-remembered and most useful aphorisms is “A small leak will sink great ships.” The utility of the aphorism is large precisely because the brain so often misses the functional equivalent of a small leak in a great ship.
Price anchoring and upgrades also take advantage of this.
17. Stress-Influence Tendency
Everyone recognizes that sudden stress, for instance from a threat, will cause a rush of adrenaline in a human body, prompting faster and more extreme reaction. And everyone who has taken Psych 101 knows that stress makes Social-Proof Tendency more powerful.
In a phenomenon less well recognized, but still widely known, light stress can slightly improve performance — say, in examinations — whereas heavy stress causes dysfunction.
This should come as no surprise that excess stress can lead to faulty decisions. Being able to remove the things to lead to stress will only help improve decision.
18. Availability-Misweighing Tendency
The mental tendency echoes the words of the song: “When I’m not near the girl I love, I love the girl I’m near.” Man’s imperfect, limited-capacity brain easily drifts into working with what’s easily available to it. And the brain can’t use what it can’t remember or what it is blocked from recognizing because it is heavily influenced by one or more psychological tendencies bearing strongly on it, as the fellow is influenced by the nearby girl in the song. And so the mind overweighs what is easily available and thus displays Availability-Misweighing Tendency.
People have an innate ability to overemphasize information that’s right in front of them. Recency bias is a direct result of this. In investing, it leads to chasing returns.
A process or checklist is one solution. Following Darwin’s example given earlier is another.
19. Use-It-or-Lose-It Tendency
All skills attenuate with disuse. I was a whiz at calculus until age twenty, after which the skill was soon obliterated by total nonuse.
I can relate to Munger’s lost calculus skill (among others). Daily practice improves skills like math, sports, musical instruments, writing, and others. Likewise, practice helps maintain it. Stop practicing and your skill suffers.
20. Drug-Misinfluence Tendency
This tendency’s destructive power is so widely known to be intense, with frequent tragic consequences for cognition and the outcome of life, that it needs no discussion here to supplement that previously given under “Simple, Pain-Avoiding Psychology Denial.”
In chemical dependency, wherein morals usually break down horribly, addicted persons tend to believe that they remain in respectable condition, with respectable prospects. They thus display an extremely unrealistic denial of reality as they go deeper and deeper into deterioration… One should stay far away from any conduct at all likely to drift into chemical dependency. Even a small chance of suffering so great a damage should be avoided.
Addiction is destructive.
21. Senescence-Misinfluence Tendency
With advanced age, there comes a natural cognitive decay, differing among individuals in the earliness of its arrival and the speed of its progression. Practically no one is good at learning complex news skills when very old. But some people remain pretty good in maintaining intensely practiced old skills until late in life, as one can notice in many a bridge tournament.
This follows with use-it-or-lose-it. Curiosity, continuous learning, and practice are great ways to delay the natural side-effect of aging.
22. Authority-Misinfluence Tendency
Living in dominance hierarchies as he does, like all his ancestors before him, man was born mostly to follow leaders, with only a few people doing the leading. And so, human society is formally organized into dominance hierarchies, with their culture augmenting the natural follow-the-leader tendency of man.
But automatic as most human reactions are, with the tendency to follow leaders being no exception, man is often destined to suffer greatly when the leader is wrong or when his leader’s ideas don’t get through properly in the bustle of life and are misunderstood. And so, we find much miscognition from man’s Authority-Misinfluence Tendency.
History is filled with examples of people who put their faith in someone and things turned out well enough. And there are countless other examples where they ended up worse off.
The obvious implication: be careful whom you appoint to power because a dominant authority figure will often be hard to remove…
23. Twaddle Tendency
Man, as a social animal who has the gift of language, is born to prattle and to pour out twaddle that does much damage when serious work is being attempted. Some people produce copious amounts of twaddle and others very little.
It’s called BS. Sometimes we talk, just to talk. Other times it’s because we think we know something, we actually don’t. So we try to fake it.
The solution: Understand your circle of competence and when you’re outside it, don’t be afraid to say, “I don’t know.”
24. Reason-Respecting Tendency
This tendency has an obvious implication. It makes man especially prone to learn well when a would-be teacher gives correct reasons for what is taught, instead of simply laying out the desired belief ex-cathedra with no reasons given…
In general, learning is most easily assimilated and used when, life long, people consistently hang their experience, actual and vicarious, on a latticework of theory answering the question: Why? Indeed, the question “Why?” is a sort of Rosetta stone opening up the major potentiality of mental life.
Unfortunately, Reason-Respecting Tendency is so strong that even a person’s giving a meaningless or incorrect reason will increase compliance with his orders and requests.
Explaining “Why?” can open the door to learning, better work results, or manipulation.
The power of Why becomes obvious in Munger’s example of another of Robert Cialdini’s social experiments. People were more willing to allow someone else to cut in front of them to use the copy machine when the person cutting gave a reason why. It worked even when the reason was: “I have to make some copies.”
25. Lollapalooza Tendency
The tendency to get extreme consequences from confluences of psychological tendencies acting in favor of a particular outcome.
You may have noticed that few 0f Munger’s biases work in a vacuum. Most work in concert to produce bad decisions. Going through Munger’s tendencies like a checklist is one way to unravel the biases potentially leading you to irrational mistakes.