One of the greatest investors in history, Charles Munger, passed away on the 28th of November 2023, 33 days short of his 100th birthday. His celebrated talk at Harvard University in 1995 on the subject of ‘Human Misjudgment’ is undoubtedly a masterclass about the patterns of human irrationality. This and the next posts are about those 24 tendencies of the human brain that Mr Munger has immortalised in his celebrated lecture.
1. Underrecognition of the power of incentives: Munger illustrates his point using the cases of FedEx and Xerox, demonstrating that it was not logic but incentives that drove their employees. The incentives were intended to speed up work and improve sales. However, the workers maximised the commissions and overtime by selling inferior products and working longer.
2. Psychological denial: It is a type of mechanism by the brain to avoid reality, as it can cause deep pain and anxiety. Examples are parents refusing to believe the loss of their children or youths getting into crimes.
3. Incentive-caused bias: It’s also known as the Principal-Agent problem in companies. The people entrusted to lead companies (on behalf of the owners/shareholders) erode the long-term value of companies (principals’ interest) by going after short-term fixes or management’s vested interests (agent’s gain).
4. Self-confirmation bias: People tend to persist on already-made conclusions even when (newly) available evidence disproves them.
5. Bias from cognitive dissonance: It is similar to the earlier one. Cognitive dissonance bias is the mental discomfort that a person goes through if they have to hold two conflicting views about something. Most often, the receiver of the new information revolts with it, leading to selective perception and decision-making.
6. Bias from Pavlovian association: This refers to the famous experiments on dogs carried out by Pavlov. The experiments prove a great deal about the mental shortcuts of humans in making decisions. In other words, people choose a ‘go’ for an incentive stimulus, whereas they select a ‘no go’ on punishment stimuli. A wonderful example is how advertisements work in our minds.
7. Bias from reciprocation tendency: Humans return favour when they receive something from others. While this may seem a virtue, the behaviour can be manipulated, compelling individuals to substantially lower the cost of services.
8. Bias from over-influence of social proof: This is the absolute compliance to the ‘wisdom of the crowd’ or inability to act against social norms. Social proof works in unclear social situations where people follow what the surrounding people do. Munger gives an example of how all major oil companies started buying fertiliser companies when one of them initiated the trend. Another term closely related to this topic is the ‘power of reinforcement‘. Typical causes of bull or bear runs of stock markets.
9. Bias from distortions caused by distortion, sensation, and perceptions: In Cialdini’s famous experiment, students who first dipped their hands in hot water felt cold and cold water felt hot on a subsequent dip in the water at room temperature. He cites the familiar trick of a real estate broker who manages to sell her client a moderately over-priced house by first showing an outrageously overpriced house.
10. Bias from over-influence by authority: It is a tendency of the brain to be influenced by the opinion of an authority figure, even when the content is inaccurate. Like all cognitive biases, the authority bias is a shortcut our brains use to save energy in decision-making.
Reference
The Psychology of Human Misjudgement – Charlie Munger Full Speech: Warren Buffett
