Charlie Munger's 24 Causes Of Misjudgement

Hello investors, welcome to my blog, where I study the best Investors and businesses from around the world. This week, we’ll learn from Charlie Munger’s view on human misjudgment.

This speech on the Psychology of Human Misjudgment was given to an audience at Harvard University in 1995 where Charlie speaks about the framework of decision making and the factors contributing to misjudgments. Economic psychology is the interdisciplinary investigation of the interface between psychology and economics. It is concerned with the psychological basis of the economic behaviors of individuals, and the impacts of economic processes on individuals’ psychology. This video is dedicated to the study of Psychology of Human Misjudgement as understood by Charlie Munger.

So without further ado, let’s get into the 24 causes of misjudgment according to Charlie Munger.

1) BIAS FROM REINFORCEMENT AND INCENTIVE

The power that incentives and disincentives have on the actions of others cannot be overstated. Munger says this should be obvious but so many people don’t understand how important incentives are for shaping people’s motivation to complete a task.

Incentives and disincentives are extremely important in changing behavior.

He suggests that the first cause of misjudgement is to  “Never think about something else when you should be thinking about the power of incentives.” and that “Incentives will almost always trump any moral duty” And as a manager in a business, he says that “The most important rule in management is to “Get the incentives right” especially since “bad behavior is intensely habit forming when it is rewarded.” One of Munger’s idols, Benjamin Franklin’s quote sums it up well, when he says - “If you would persuade, appeal to interest and not to reason”

2) MAN WITH A HAMMER SYNDROME.

To the man with a hammer, every problem tends to look pretty much like a nail. The “Man with a Hammer” syndrome is the idea that if you only have one or two mental models in your head, you’ll approach all your problems with the same solution. Hammer syndrome is a subconscious process. And we do it every-single-day without any hesitation. This is why Charlie Munger encourages others to add more models in the toolkit, to expand the territory of knowledge, organize them, and use them for the problem-solving process. 

3) SIMPLE PSYCHOLOGICAL DENIAL 

This is the third cause of misjudgement according to Charlie Munger - he says that humans perceive reality as too painful to bear, so they just distort it until it’s bearable. Humans have a habit of distorting facts, until they become bearable for our own views. Facing the truth can be too hard to bare. In the most extreme cases such as death, love and drug dependency, it is easy to distort the facts when the pain of reality is too hard to face.

So simple psychological denial of reality. If the reality is too painful to bear humans just distort it until it's bearable. We all do this to some extent, and it's a common psychological misjudgment that causes terrible problems.

4) INCENTIVE CAUSED BIAS

This is when we’re too trusting of advisors who don't know more than you. The risk that the agent will shirk a responsibility, make a poor decision, or otherwise act in a way that is contrary to the principal’s best interest can be defined as agency costs.

5) BIAS FROM CONSISTENCY AND COMMITMENT TENDENCY or SELF-CONFIRMATION TENDENCY 

In other works, it’s hard to change your mind once you’re emotionally committed to an idea.

This is a superpower in error causing psychological tendency, these include the tendency to avoid or promptly resolve cognitive dissonance - which is the state of having inconsistent thoughts, beliefs, or attitudes.

That’s the power of commitment and consistency bias. We are creatures of habit, for better or for worse. It’s the reason why you like a decision more the moment after you make it. It’s why you have trouble updating your point of view when presented with new information. It’s why a sales rep will do just about anything to get their foot in the door. Because once you commit to something, you are likely to commit to much more.

6) BIAS FROM PAVLOVIAN ASSOCIATION, MISCONSTRUING PAST CORRELATION AS A RELIABLE BASIS FOR DECISION MAKING.

Pavlovian association is an enormously powerful psychological force in the daily life of all of us, and also in economics. Charlie Munger says about three quarters of advertising works on pure Pavlov, especially when you consider how Pure Association works. He gives an example of Coca-Cola and how they want to be associated with every wonderful image: heroics in the Olympics, wonderful music, you name it.

Our life and memory revolve around associations. The smell of good food makes our stomach growl, the songs we hear remind us about the special times that we’ve had and horror movies leave us with goosebumps.

These natural, uncontrolled responses upon a specific signal are examples of classical conditioning or learning by association. But Pavlov made an accidental observation that dogs started salivating even before their food was presented to them. These emotional and physical triggers are also present in humans.

7) BIAS FROM RECIPROCATION TENDENCY 

Reciprocity bias is our tendency to reciprocate the actions of others creating a wave of indebtedness. If somebody does something for us, or gives us something, we are more likely to return the favour or pass the favour on to others. We have the tendency to behave toward others as they behave toward us. Has a car salesman ever offered you a cup of coffee or a glass of water upon entering the dealership? Have you been handed a free sample of a product as a gift? These small acts are meant to initiate reciprocation tendency: your tendency to reciprocate the favors, disfavor, and concessions of others. 

This also applies to what’s called “the foot in the door technique” and can be used as a compliance tactic which assumes that agreeing to a small request increases the likelihood of agreeing to a second, larger request. So, initially you make a small request and once the person agrees to this they find it more difficult to refuse a bigger one. This is where we ask for a lot and then back off to a lower offer.

8) BIAS FROM OVER-INFLUENCE OF SOCIAL PROOF

Humans are programmed to conform. Social Proof is embedded deep into our evolutionary code. We look to others to determine the correct way in which to behave. We compare constantly. Are influenced by the majority. In business, Charlie Munger gives the example of oil companies. He said - “The wave of oil companies buying fertilizer companies was driven in part by social proof. One oil company buys a fertilizer company, and all other oil companies follow, with no one having any good reason for doing so.” Even at the company level, we are willing to place an enormous amount of trust in the collective knowledge of the crowd. Social Proof is most powerful for those who feel unfamiliar or unsure in a specific situation and who, consequently, must look outside themselves for evidence of how best to behave.

9) BIAS FROM CONTRAST 

This is when you are lowering or distorting your standards by comparing two options that are equally bad - or having a "grass greener on the other side" mentality by comparing to an unrealistically high standard. 

Contrast Bias is the tendency to mentally upgrade or downgrade an object when comparing it to a contrasting object. In a work environment, contrast bias occurs when a manager compares an employee’s performance to other employees rather than to an established company standard.

10) BIAS FROM OVER-INFLUENCED BY AUTHORITY

Authority Bias is the tendency to blindly follow or believe the instructions and views of a person in authority. As human beings, we have evolved over the millions of years as a herd, led by a leader. The leader alone, or a set of trusted advisors, made the big decisions and the rest followed suit.

As a result, human beings have a deeply rooted sense of duty to follow authority. In the age-old days, kings, queens and ministers played the role of an authority. Today, politicians or CEO’s play the same role. Even experts in a profession such as doctors, economists, celebrities fit into the role of authorities.

11) BIAS FROM DEPRIVAL SUPER REACTION SYNDROME 

The sunk cost effect is manifested in a greater tendency to continue an endeavor once an investment in money, effort, or time has been made. This occurs when someone chooses to do or continue something just because they have invested, unrecoverable, resources in it in the past. Have you continued with a project long after you should have abandoned it? Persevered with a relationship even after the point of no return? Dragged yourself to an event in miserable weather just because you already bought the ticket with your hard-earned cash? These are all examples of the “sunk cost fallacy”. 

12) BIAS CAUSED BY ENVY, JEALOUSY

Envy or jealousy comes from the desire to have a quality, possession or attribute belonging to someone else. Envy or jealousy occurs often when the object of your desire is seen in possession of another person. Warren Buffet has been quoted as saying “it is not greed that drives the world, but envy”. Wanting something that someone else has, or fearing that what you have will be taken away is a primal cause of misjudgement. If you look at it from an evolutionary standpoint, humans need food to survive. Seeing someone else have food, if you don't have any yourself, it makes you want to take the food for yourself.

13) BIAS FROM CHEMICAL DEPENDENCY 

These are addictions. Humans have a tendency to be strongly influenced by drugs which can lead to moral breakdown and massive denial. People are influenced by drugs and the effects of drug abuse can be extreme. A person may sacrifice a lot as a result of his or her addiction. It can be from legal drugs like alcohol or illegal drugs like cocaine. Usually these chemical addictions always cause a moral breakdown and almost always involve massive denial. This also has the undesired effect for someone to have the tendency to distort reality so that it's bearable.

14) BIAS FROM MIS-GAMBLING COMPULSION 

Compulsive gamblers suffer from an optimism bias that modifies their subjective representation of probability and affects their decisions in situations involving high-risk monetary wagers.A growing number of gamblers suffer from pathological gambling, a disease that is usually characterized as either a loss of impulse control or a behavioral addiction. It results in an inability to limit the frequency of gambling and the amount of money wagered. This increasingly common psychiatric disorder creates financial, professional and personal hardships that can have severe consequences for the patients and the people around them.

15) BIAS FROM LIKING DISTORTION 

People ignore the faults of other people, products or companies that they love, like or admire. Humans ignore the faults of, comply with the wishes of and favor people or products associated with the object of their affection. 

16) BIAS FROM DISLIKING DISTORTION

This is where we are under the influence by someone we dislike - especially if they are right and we are wrong. Humans ignore the virtues and views put forth by those things or persons they dislike. People will often distort facts to justify the hatred towards people, products or companies while putting on blinder to other options or opinions. We even dislike products or views associated with what we hate.

17) BIAS FROM THE NON-MATHEMATICAL NATURE OF THE HUMAN BRAIN.  

The human brain tends to ignore rational and the correct decision by favoring the emotional side. Bias arises from the non-mathematical nature of the human brain in its natural state as it deals with probabilities employing crude heuristics and is often misled by mere contrast. We are too stupid to understand maths and too lazy to learn.

18) BIAS FROM FEAR OF SCARCITY

A scarcity mindset is the belief that there will never be enough, resulting in feelings of fear, stress, and anxiety. A lot of hate comes from scarcity and competition. Whenever we compete for resources, our own mistakes can mean good fortune for others. In these cases, we affirm our own standing and preserve our self-esteem by blaming others. At first we are merely annoyed. But then as the situation fails to improve and our frustration grows, we are slowly drawn into false attributions and hate. We keep blaming and associating “the others” who are doing better with the loss and scarcity we are experiencing (or perceive we are experiencing). That is one way our emotional frustration boils into hate. 

19) BIAS FROM SYMPATHY

Munger cautions of human sympathy - if they immediately say I will never do it again, then the regret or remorse is not genuine. Sympathy acts in a way that provides a means of understanding another person's experience or situation, good or bad, with a focus on their individual well-being. It is often easier to make decisions based on emotional information, because all humans have a general understanding of emotions. This ability to see things from another person's perspective and sympathize with another's emotions plays an important role in our social lives, but it’s important to remove bias from sympathy. This is wh Munger says to not trust someone who immediately says “I’ve never done it before, and I’ll never do it again”.

20) BIAS FROM OVER-INFLUENCE AND VIVID EVIDENCE

It's very easy to miss the vivid evidence. Munger cites the example of Belridge Oil where they turned down a large block of shares because he “just mis-weighed it” based on his assessment of an extraordinarily peculiar CEO. That decision cost him a short-run profit of more than $5 million that mushroomed into the hundreds of millions of dollars on an opportunity-cost basis over the ensuing decades. By reliving or remembering vivid experiences, it makes you believe that the same thing will happen in the given scenario. With countless possibilities, the expectation and belief that history repeats, instead of rhyming, over-influences the decision making process.

21) BIAS CAUSED BY MENTAL CONFUSION CAUSED BY INFORMATION NOT ARRAYED IN THE MIND TO CREATE SOUND GENERALIZATIONS 

This is where you memorized new information, but you haven't learned it or know how to make it useful. You can test your new information by answering "why". This is where we develop a response to the question why? Charlie Munger says that you've got to array facts, theory structures, and information by answering the question of why, if you don't do that you just cannot understand the complicated world we live in. 

22) STRESSED INDUCED MENTAL CHANGES 

This is similar to the pavlov conditioning, where stress causes us to change our behavior. Whether it’s small or large, or temporary or permanent.  It’s an easy way to make mistakes and cause unnecessary mistakes in judgement.

23) COMMON MENTAL ILLNESSES AND DECLINES TEMPORARY AND PERMANENT AND QUITTING THE TENDENCY TO LOSE ABILITY THROUGH DISUSE 

Although Charlie skipped this explanation since he said in his lecture that he doesn't have time for it, this cause of misjudgement talks about the common mental illnesses that can decline one’s thought process either permanently or temporarily. It will be tough to have good judgment if you’re clouded by temporary or permanent mental illness.

24) THE DO OR SAY-SOMETHING SYNDROME 

It’s important to note that Munger considers the Say-Something Syndrome a major source of development and organizational confusion. The Say Something Syndrome is essentially describing our innate bias towards action or expression – our confusion of activity with results. Most of us, whether consciously or unconsciously, believe that more action will equal better results.

Although not a particular cause of misjudgement, Charlie Munger talks about the combination of effects which he dubs The Lollapalooza Effect, which I would describe as the twenty fifth cause of misjudgement.

25) The Lollapalooza Effect - The combination of one or several causes of misjudgement

All the previous tendencies interact with each other and when combined have an exponential effect. All 24 tendencies interact with each other and people will merge multiple tendencies in favor of a particular outcome. The Lollapalooza tendency can be used for positive or negative purposes. We humans have many inherent biases and tendencies that can sway our behavior one way or another. When several of them act in concert to drive us toward a particular action, you have a Lollapalooza effect. The Lollapalooza effect can create large-scale drivers of human behavior.

This was a long article and congratulations on sticking it through to the very end. Let me know in the comments below if you think Charlie Munger missed any causes of human misjudgment. Thank you so much for reading, and if you like this article please share it with your friends and family, it’ll help the blog a lot! Leave in the comments section, your thoughts about this article and what company I should cover next.