The Psychology of Human Misjudgement by Charlie Munger – Expanded
This is from Charlie Munger’s famous speech, “The psychology of human misjudgement”. In it he talks about 23 Standard Causes of Human Misjudgment. This is a quick summary.
1. First: Under-recognition of the power of what psychologists call ‘reinforcement’ and economists call ‘incentives.’
2. My second factor is simple psychological denial.
3. Third: incentive-cause bias, both in one’s own mind and that of ones trusted advisor, where it creates what economists call ‘agency costs.’ (brokers of real estate and stocks).
4. Bias from consistency and commitment tendency, including the tendency to avoid or promptly resolve cognitive dissonance. Includes the self-confirmation tendency of all conclusions, particularly expressed conclusions, and with a special persistence for conclusions that are hard-won. (public commitment leading to confirmation bias).
5. Fifth: bias from Pavlovian association (the dog, coke), misconstruing past correlation as a reliable basis for decision-making.
6. Sixth: bias from reciprocation tendency, including the tendency of one on a roll to act as other persons expect.
7. Seventh, now this is a lollapalooza, and Henry Kaufman wisely talked about this: bias from over-influence by social proof — that is, the conclusions of others, particularly under conditions of natural uncertainty and stress.
Nine [he means 8]: what made these economists love the efficient market theory is the math was so elegant. And after all, math was what they’d learned to do. To the man with a hammer, every problem tends to look pretty much like a nail.
9. Nine: bias from contrast-caused distortions of sensation, perception and cognition (real estate broker, frog).
10. Bias from over-influence by authority.
11. Bias from deprival super-reaction syndrome, including bias caused by present or threatened scarcity, including threatened removal of something almost possessed, but never possessed.
12. Bias from envy/jealousy.
13. Bias from chemical dependency.
14. Bias from mis-gambling compulsion (commitment & consistency from choosing a number).
- Slot machines: deprival super-reaction syndrome (near-misses).
15. Bias from liking distortion, including the tendency to especially like oneself, one’s own kind and one’s own idea structures, and the tendency to be especially susceptible to being misled by someone liked. Disliking distortion, bias from that, the reciprocal of liking distortion and the tendency not to learn appropriately from someone disliked.
16. Seventeen [he means 16]: bias from the non-mathematical nature of the human brain in its natural state as it deal with probabilities employing crude heuristics, and is often misled by mere contrast, a tendency to overweigh conveniently available information and other psychologically misrouted thinking tendencies on this list.
17. Now we come to bias from over-influence by extra-vivid evidence.
18. Twenty-two [he means 18]: Mental confusion caused by information not arrayed in the mind and theory structures, creating sound generalizations developed in response to the question “Why?” Also, mis-influence from information that apparently but not really answers the question “Why?” Also, failure to obtain deserved influence caused by not properly explaining why.
19. Other normal limitations of sensation, memory, cognition and knowledge.
20. Stress-induced mental changes, small and large, temporary and permanent.
21. Then we’ve got other common mental illnesses and declines, temporary and permanent, including the tendency to lose ability through disuse.
22. And then I’ve got development and organizational confusion from say-something syndrome (honey bee).
The combination of one or more psychological tendencies greatly increases power to change behavior, compared to the power of merely one tendency acting alone – aka the Lollapalooza effect.
Multiple biases, tendencies or mental models acting in compound with each other at the same time in the same direction.
- Tupperware parties.
- Alcoholics anonymous
- The milgrim shock experiment – authority
The open-outcry auction. Well the open-outcry auction is just made to turn the brain into mush: you’ve got social proof, the other guy is bidding, you get reciprocation tendency, you get deprival super-reaction syndrome, the thing is going away… I mean it just absolutely is designed to manipulate people into idiotic behaviour.
The institution of the board of directors of the major American company. Well, the top guy is sitting there, he’s an authority figure. He’s doing asinine things, you look around the board, nobody else is objecting, social proof, it’s okay? Reciprocation tendency, he’s raising the directors fees every year, he’s flying you around in the corporate airplane to look at interesting plants, or whatever in hell they do, and you go and you really get extreme dysfunction as a corrective decision-making body in the typical American board of directors. They only act, again the power of incentives, they only act when it gets so bad it starts making them look foolish, or threatening legal liability to them. That’s Munger’s rule.
Optimal Practical applications
Karl Braun’s communication practices. He designed oil refineries with spectacular skill and integrity. He had a very simple rule. Remember I said, “Why is it important?” You got fired in the Braun company. You had to have five Ws. You had to tell Who, What you wanted to do, Where and When, and you had to tell him Why.
- Pilot Simulations.
- Alcoholics Anonymous.
- Clinical training.
- Granny rule: do the important unpleasant first, then reward.
- The use of post-mortems.
- Charles Darwin avoiding confirmation bias.
- Warren Buffett rule of the open-outcry auction: don’t go.
Further Research in Psychology and Decision Making
The Cognitive Bias Codex. To summarise, we have a lot of psychological biases that influence decision making.
The Human Brain and its functions
It’s estimated that 95% of brain activity is subconscious according to Neuroscience. The 5% at the front acts as the CEO.
Thinking fast and slow, by Daniel Kahnenman
System 1: Fast, automatic, frequent, emotional, stereotypic, unconscious.
System 2: Slow, effortful, infrequent, logical, calculating, conscious.
Anchoring: depending too heavily on initial information.
Availability: basing judgments on information and examples that quickly come to mind.
Optimisation: you are more likely to experience good over bad events.
Loss aversion: tendency to prefer avoiding losses rather than gains.
Overconfidence: believing we are better than we are.
He highlights the use of cognitive biases in decision making.