Charlie Munger – The Psychology of Human Misjudgment

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Charlie Munger - The Psychology of Human Misjudgement

Standard thinking errors

We can make better decisions if we understand why people make poor choices and look for ways to avoid the same mistakes. It’s why Charlie Munger has held a lifelong interest in human cognition. Dissatisfied with academic psychology, he developed his own model for standard thinking errors, which he kindly shared in his 1995 speech: The Psychology of Human Misjudgement. This post summarises the key lessons I took from Munger’s speech.

The psychology of persuasion

Before diving in, it’s worth noting Robert Cialdini’s Influence: The Psychology of Persuasion and its impact on Munger’s thinking. Cialdini’s described six tendencies that cause people to act in predictable, automatic and sometimes exploitable ways: (1) reciprocation, (2) commitment and consistency), (3) social proof, (4) authority, (5) liking and (6) scarcity.

One can see the traces of Cialdini in Munger’s speech. In fact, Munger enjoyed Cialdini’s book so much that he sent copies of it to all his children. He even gave Cialdini one share of Class A Berkshire stock as a thank you. (I don’t think I’ve seen a bigger book endorsement than that.)

Tendencies in human misjudgement

Munger identified twenty five tendencies that lead to common thinking errors. It’s a pretty long list, filled with somewhat unusual names like the deprival super reaction tendency. This makes Munger’s tendencies difficult to remember. So, I’ve taken some liberties and reordered them into seven themes. While these sub-classes aren’t perfect by any means, it’s helped me to grasp his ideas. You might find some use in them as well.

Jump ahead

(1) Incentives

The first class of tendencies refer to incentives that individuals, groups and systems face. Munger refers to them as the reward and punishment super-responses. He spends a great deal of his speech talking about incentives, one indicator of its relative importance.

Reward and punishment super-response tendency

“If you would persuade, appeal to interest and not to reason”.

Benjamin Franklin, Poor Richard’s Almanack.

People repeat the behaviours that work. And systems that reward good (bad) behaviour, will produce good (bad) habits. Incentives play an important role in our decision making process.

One by-product of this is an incentive-caused bias, where we rationalise our behaviours and choices due to the incentives we face. It’s hard to imagine management consultants, for example, recommend their clients to spend less on consulting services.

The choice and design of incentives have important consequences. Here, Munger contrasts commissions-driven sales teams with fixed-wage sales teams. While the former is typically more productive and motivated, they’re also more susceptible to misconduct. Where strong incentives exist, Munger expects to find individuals that try to ‘game’ the system.

It goes without saying that organisations should maintain strong audit systems, implement policies to discourage misconduct, and punish wrongdoing when it takes place. For individuals, Munger recommends we scrutinise the behaviours of ourselves and others in the context of the incentives we face. We should also endeavour to understand the basics of our advisors’ trades to avoid those that sell snake oil.

(2) Anchors

The second group of tendencies are based on the way we evaluate our estimates, preferences and desires. Some thinking errors emerge from an improper reference point or framing of the problem. Others come from emotions that we attach to what we have, what don’t have and what we desire.

Contrast mis-reaction tendency

We tend to evaluate results in relative terms, not in absolutes. While this simplifies our evaluation process, the contrast is sometimes misleading. Here, Munger describes the approach of some real estate agents. To increase the perceived value of real estate, some agents will show the overpriced and undesirable homes first, and the intended property for sale after. Other experts, like Robert Cialdini and Annie Duke, have referred to such tactics as the contrast effect.

Contrast mis-reaction also operates in reverse. We often neglect small changes that can accumulate over time. Munger cites a great aphorism from Benjamin Franklin: “A small leak will sink [the] great ship”, much like the frog in boiling water.

Availability mis-weighing tendency

We also tend to focus on evidence that are most accessible and available to us. We often place too much weight on some evidence and too little on others.

Envy and jealousy tendency

Warren Buffett once remarked that “it is not greed that drives the world, but envy”. Munger agrees with this sentiment and is stupefied that envy and jealousy have received so little attention in psychology textbooks. Envy and jealousy are powerful drivers in business, political, religious and domestic affairs.

Deprival super reaction tendency

This tendency describes the irrational intensity that we sometimes attribute to threatened losses. This sense of loss towards objects almost but not yet possessed results from an incorrect framing of our problems. This explains for example why some CEOs overpay for acquisitions during open-outcry auctions. Munger’s antidote here is to learn the skill of good poker players: to distinguish between your hand and portfolio, and to know when to quit.

(3) Narratives

This group describes the tendencies in how we make sense of our complex, uncertain and sometimes painful world.  

Doubt avoidance tendency

Uncertainty is sometimes an uncomfortable feeling. So, we find ways to eliminate it, often through the use of narratives. But this isn’t always conducive to good decision making, especially when the future is very uncertain.

Inconsistency avoidance tendency

Similarly, we try to avoid inconsistency and change due to its cognitive toll and/or emotional discomfort. One consequence of this tendency is the first conclusion bias, in which we reject new ideas and facts that don’t conform to prior conclusions we’ve made. Another related consequence is the status quo bias, where we find it easier and simpler to stick with the default.

Munger described how Charles Darwin trained himself, early in his career, to seek disconfirming evidence – the very opposite of ‘confirmation bias’. It’s a quality that more of us should try to emulate when seeking evidence and reaching conclusions.

Simple, pain avoiding psychological denial

This tendency is straightforward. When something is economically or emotionally painful, we’ve a tendency to distort reality to preserve our psychological state.

Overoptimism tendency

Like our tendency to avoid psychological pain, we are sometimes overoptimistic. Munger’s antidote here is to apply simple probability to problems and forecasts where we can. But most of us are also poor judges of probability. So, this is easier said than done.

Twaddle tendency

As social creatures with the “gift of language”, some of us find it an irresistible urge to “twaddle”. Some do it more so than others. Munger says it helps to distinguish between those that do and don’t. Put another way, it’s useful to separate useful information from noise.

Reason respecting tendency

We reason with one another to coordinate and cooperate as social groups. Sometimes, we’ll act because of reason, not the quality of said reason. This can lead to nonsensical or exploitable behaviours. In Influence, Robert Cialdini describes how people are more likely to accept your request to skip in line if you give a reason, even if the reason is somewhat vacuous or nonsensical. Munger recommends we ask “why?” with another “why?” to test the merit of reasoning.

(4) Associations

This group focuses on our tendencies to make decisions based on how we ‘feel’ about the subject or object. While such associations can simplify our decision-making framework, they can also lead to erroneous choices and conclusions.

Liking and disliking tendency

With regards to the people we like or love, we are more likely to ignore their faults; comply with their desires; favour associations about them (e.g. people, products, behaviours, etc.); and distort our reality to preserve their affection and association. The reverse is also true with the people, products or attributes we dislike. Here, we are more likely to ignore their virtues, dislike their associations, and distort our reality to preserve our disdain for them.

Influence from mere association tendency

Similarly, we tend to extrapolate attributes from one area into another. So, we must check whether such associations are sensible. Historical attributes are not always a reliable indicator. In Thinking, Fast and Slow, Daniel Kahneman warns readers about the dangers of inferring the general from a particular. In the Psychology of Human Misjudgement, Munger warns us about inferring the particular from the general. So, I guess the message is just to be careful with inference in general.

Excessive self-regard tendency

Munger also talks about our tendency to over-appraise ourselves and our possessions. One psychosocial consequence of this is to surround ourselves with people similar to ourselves. This often leads to disastrous hiring practices and decision-making, particularly in fields like finance and politics. Another consequence is what economists call the ‘endowment effect’, where we value objects more once we own it. For example, we might hold onto a bad investment for too long as the result of the endowment effect and our bias for the status quo.

(5) Herding

This group focuses on the social tendencies we construct as groups.  

Social proof tendency

Munger observes how we conserve cognition by thinking and doing as others around us are thinking and doing. It’s a simple, cost-effective social rule. It exists not only in action, but in inaction as well. Like antelope in the savannas, social proof has supported much of humanity’s survival and progress. But such mindless behaviours can be dangerous. As Munger puts it, “it is not all uncommon to find leaders who display followership akin to that of teenagers”.

Authority mis-influence tendency

To manage the size and complexities of human society, we organise ourselves into hierarchies. Whether in business, politics or religion – we tend to ‘follow-the-leader’. Obviously, this tendency is costly when our leaders are incompetent or exploitative. So, it’s important to consider the reasonableness of those we appoint, listen to and follow.

Kantian fairness and reciprocation tendency

Here, Munger is referring to Immanuel Kant’s observation of the ‘categorical imperative’. It describes the social patterns that enable human groups to function. In societal norms, this is often reflected in our tendencies to cooperate and reciprocate.

While Kantian fairness or reciprocation isn’t bad (human societies would collapse without it), it is a predictable tendency. Munger’s point is to recognise its potential for error, particularly when combined with other psychological tendencies. Cults, for example, tend to emerge from a complex web of reciprocation, authority mis-influence, social proof, liking and association, pain-avoidance and inconsistency avoidance.

(6) State of mind

This group captures the remaining tendencies that I thought were related to the personality, state and/or health of cognition. They’re self-explanatory, so I’ll summarise them briefly.

Curiosity tendency

Despite our tendency for doubt and inconsistency avoidance, many of us are also curious by nature. Curiosity is an important safeguard against the adverse consequences of the tendencies discussed.

Stress influence tendency

Stress and adrenaline can lead to rushed and extreme decision making. The antidote is obvious: find ways to minimise debilitating stress; and develop policies to guide decision making under stressful conditions.

Use it or lose it tendency

The mind is like a muscle, so daily use is important. Practice and revision are good ways to preserve our fluency, skills and knowledge.

Drug mis-influence tendency

This is another straightforward one. We should avoid harmful drugs and mind-altering substances. I’m reminded of Richard Feynman, who gave up alcohol after early signs of alcoholism, fearful of what it might do to his brain.

Senescence mis-influence tendency

Our cognitive functions might deteriorate with advanced age. Here, Munger reminds us that “continuous thinking and learning, done with joy, can somewhat help delay what is inevitable”.

(7) Lollapalooza tendency

The most important idea in Munger’s speech I think is the lollapalooza effect, a reminder that tendencies that act in the same direction can lead to extreme behaviours. For example, a combination of social proof, deprival and envy can create a fear-of-missing-out, ingredients that help to to feed stock market booms and busts.

Antidotes

“Fixable but unfixed bad performance is bad character and tends to create more of itself”.

Charlie Munger

Munger offers several antidotes to combat standard thinking errors and tendencies. Firstly, we should use checklists, inversions and decision trees to test our thinking. Secondly, we should engage in simulations, training and autopsies to learn and evaluate. Thirdly, we should design incentives to nudge our behaviours in the right direction.

These antidotes also reminded me of Philip Fernbach and Steven Sloman’s work on The Knowledge Illusion. They too proposed four ideas for improved decision making: (1) reduce complexity in our environment; (2) develop and apply simple decision rules; (3) engage in ‘just-in-time’ education; and (4) make it a habit to check our understanding. Atul Gawande has also shared similar views in Complications: A Surgeon’s Notes on an Imperfect Science.

Persian Messenger Syndrome

To challenge our understanding and conclusions, Munger recommends we surround ourselves with sceptical people with “far-reaching minds”. He reminds readers of the Persian Messenger Syndrome, describing the ancient Persian empire’s practice of executing the messengers that returned to them with bad news. The messengers soon learned that it was better to flee than to return with valuable information. We should build a habit to welcome bad news, and avoid creating an environment in which our friends, families and colleagues are afraid to tell us bad news.

Paradoxical understanding

“It’s important not to put one’s brain in chains”.

Charlie Munger

Finally, Munger points out the paradox in disciplines like behavioural psychology and finance: theories that describe reflexive systems become less true the more we study and apply it. This idea is made most obvious in the stock market. If everybody is using the same ‘winning strategy’, then it is unlikely to be a winner after all. There’s no easy remedy to these problems. We have to keep learning and relearning, and avoid putting our “brains in chains”.

Further reading

References

  • Munger, C., & Kaufman, P. (2005). Poor Charlie’s Almanack, The Wit and Wisdom of Charles T. Munger. More info at < https://www.poorcharliesalmanack.com/pca.php >
  • Munger, C., & Clark, D. (2017). The Tao of Charlie Munger: A Compilation of Quotes from Berkshire Hathaway’s Vice Chairman on Life, Business, and the Pursuit of Wealth With Commentary by David Clark.