The Psychology of Human Misjudgment
A checklist of questions to ask oneself when making important decisions. Inspired by the wisdom of Charlie Munger, Vice-Chairman of Berkshire Hathaway.
“When I saw this patterned irrationality, which was so extreme, and I had no theory or anything to deal with it, but I could see that it was extreme, and I could see that it was patterned, I just started to create my own system of psychology, partly by casual reading, but largely from personal experience, and I used that pattern to help me get through life. “ —
Charlie Munger, Harvard University, 1995
Charles Thomas Munger is an American business magnate, lawyer, investor, and philanthropist. Largely considered to be one of the greatest investors of all time.
In an attempt to prevent as much human misjudgment as I could in my life, following the wisdom and teachings of Charlie, I began to compile a checklist of questions to ask myself before making important decisions.
This article is my attempt to document that decision-making process into a checklist for future reference. Inspired by the wonderful wit and wisdom of Charlie Munger.
1. The Power of ‘Incentives’
Under-recognition of the power of what psychologists call ‘reinforcement’ and economists call ‘incentives.’
“If you want to persuade, appeal to interest not to reason.” — Benjamin Franklin
- What is the underlying incentive for a person involved in a particular type of job to do it?
Is there an incentive for him to cheat as it is easy for him/her to get away with it while making quick money? Or would they be subject to reputational damage that would make him/her avoid such a situation?
- Would a person’s incentives change if there was an underlying change in his situation? Would a change in his position reveal some hidden incentives?
Eg. A salesman making a higher commission on a particular type of product would make him want to sell that type of product over anything else.
2. Simple Psychological Denial
Reality is too painful to bear, so you just distort it until it’s bearable.
- Am I turning reality to suit a comfortable narrative because I can not bear a harsh truth?
This is a common psychological misjudgment that causes terrible problems. The question above must be answered honestly.
3. Incentive-cause Bias
A stockbroker or real estate salesman has very little incentive to do what is right for his/her client. Given his incentive structure does not align with the interests of his client.
- What is the underlying incentive of someone selling you something? Or advising you on a particular matter?
4. Consistency and Commitment Tendency Bias
“When the facts change, I change my mind — what do you do, sir?”― John Maynard Keynes
In spite of disconfirming evidence, making the error of sticking to or committing to a conclusion, because you made a public disclosure, etc.
- Are you afraid of saying you were wrong simply because you feel like others may judge you? Stick to learning and accepting the truth.
5. Pavlovian Association Bias
Think of how association, pure association, works in companies like Coca Cola or McDonald’s. They want to be associated with every wonderful image: heroics in the Olympics, wonderful music, etc.
- Who do you associate with in your daily life and how do they influence you? Do their goals, ambitions, and interests align with your own?
- Are you surrounding yourself with people who only tell you what you want to hear? Commonly called the ‘Persian Messenger Syndrome’.
6. Reciprocation Tendency Bias
In other words, what you think may change what you do, but perhaps even more important, what you do will change how you think.
- Does the repetition of one’s work cause you to think a certain way even when it seems illogical?
7. Bias from Over-Influence by Social Proof
Making a decision based on the conclusions of others, particularly under conditions of natural uncertainty and stress.
- Are you making a decision because someone else is doing it?
- Does your underlying reason for the decision purely depend on how someone else is acting and have you no logical independent reasoning that holds ground by itself?
In capital markets you do something and if the market goes up, you get paid, rewarded and applauded. The market reflects the ultimate form of social proof in the price, this is the ultimate form of reinforcement.
This is a simple denial of reality.
8. Elegant Math
“It is better to be roughly right than precisely wrong.”- John Maynard Keynes
Can mathematical formulas and elegant theories solve all problems?
- How often have the most brilliant academic minds relied disastrously upon elegant theories (Long Term Capital Management fiasco, the complexities of financial instruments created resulting in the 2008 Sub-prime mortgage crisis, etc)
- In the spring of 1720, Sir Isaac Newton owned shares in the South Sea Company, the hottest stock in England. Sensing that the market was getting out of hand, the great physicist muttered that he ‘ could calculate the motions of the heavenly bodies, but not the madness of the people.’ Newton dumped his South Sea shares, pocketing a profit but just months later, swept up in the wild enthusiasm of the market, Newton jumped back in at a much higher price — and lost £20,000 (or more than $3 million in [2002–2003’s] money.
9. Sensation, Perception and Cognition Distortion Bias
Have you had a magician remove your watch? — without your noticing it. He’s taking advantage of contrast-type troubles in your sensory apparatus.
- Are you going ahead with a certain decision because one was going through the little ‘ask-for-a-lot-and-back-off’? Does the fact that asking for a little after asking for a lot change the underlying decision?
A real estate broker or salesman use these type of tactics to make a sell. The first thing they’d do is take you to two or three over-priced houses, before taking you to a moderately overpriced house and by contrast, you are likely to think it is more reasonable because you compare it to the first and second.
10. Over-Influence by Authority Bias
One is more likely to pay attention and heed the words of a figure of authority.
- Just because one wears a uniform or has a title in his/her name does not mean the logic and reasoning of their views and ideas must not be questioned.
11. Deprival Super-reaction Syndrome Bias
Irrational behavior can come from just subconsciously over-weighing the importance of what you’re losing or almost getting and not getting.
People have a tendency to overweight minor decrements. Look at the big picture to get a bird’s eye view of a problem and get a better perspective.
12. Envy/jealousy Bias
Envy drives much of the world. It operates, to a considerable extent, on the subconscious level.
- Anybody who doesn’t understand how powerful envy can become is underestimating its effect on rational big picture thinking.
- Is envy or jealousy driving your decision?
13. Mis-gambling Compulsion Bias
Gambling is a powerfully addictive force. Modern slot machines, internet trading platforms, and betting platforms do well to exploit human psychology.
Further, when you pick the point at which you decide to place your bet on an internet platform or when you draw the ticket to a lottery — you think you are in control and you have committed to it.
The minute people think they’ve picked it themselves it gets an extra validity. After all, they thought it and they acted on it.
These are powerful psychological tendencies that destroy wealth and one’s life.
14. Liking/disliking Distortion Bias
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.
15. Man with a Hammer Syndrome
To a man with a hammer, why does everything look like a nail? Why do people think that their profession or what they do in life will solve all problems?
You’ve got four or five of these elementary psychological tendencies discussed above combining to create this man-with-a-hammer syndrome.
- It’s incentive caused bias. His professional reputation is all tied up with what he knows. He likes himself and he likes his own ideas, and he’s expressed them to other people — consistency and commitment tendency.
If you rely on an advisor, you can learn the basic elements of your advisor’s trade and then make him explain why he’s right.
You can’t buy your thinking in this world — you’ve got to constantly challenge it and test it against better ideas and evidence.
16. Non-mathematical human brain state bias
The nature of the human brain in its natural state as it deals with probabilities employing crude heuristics is often misled by mere contrast, a tendency to overweigh conveniently available information and other psychologically misrouted thinking tendencies.
Availability does change behavior and cognition, think of the Coca-Cola Company, which has raised availability all around the world over the years.
Train yourself to mentally run down this list instead of just jumping on availability.
Use the simple probability mathematics of Fermat and Pascal applied to all reasonably obtainable and correctly weighted items of information that are of value in predicting outcomes.
- If you’re going to catch 10 embezzlements a year, what are the chances that any one of them — applying what Tversky and Kahneman called baseline information — will be somebody who only did it this once?
- And the people who have done it before and are going to do it again, what are they all going to say? “I never did it before, I’ll never do it again.”
Here you have a lot of psychological factors that will cause the evil behavior to spread, and pretty soon the entire place is rotten.
17. Over-influence by extra-vivid evidence bias
When the truth of a situation is foolproof but you miss-weigh the vivid evidence, just because it is right in front of you.
18. Mis-influence and failure to obtain information caused by not properly explaining “why”?
Mental confusion caused by information not arrayed in the mind and theory structures. 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.
You’ve got to array facts on the theory structures by answering the question “Why?”.
19. Stress-induced mental changes, small and large, temporary and permanent
Experiencing a total reversal of conditioned personality and behavior in an unexpected event or experience that brings out high levels of stress and anxiety.
20. Development and Organizational Confusion from “say-something” syndrome
An important part of human organization is the noise created in the public domain and the reciprocation of its attention received.
People who have the “say-something” syndrome should not influence your decision-making process in any way.
Conclusion
Here are 2 important questions raised from the above.
A). What happens when these standard psychological tendencies combine?
What happens when the situation, or the artful manipulation of man, cause several of these tendencies to operate on a person toward the same end at the same time?
The combination greatly increases the power to change behavior, compared to the power of merely one tendency acting alone.
Here are a few examples of when this can happen
- Picking investments in capital markets
- Participating in an open-outcry auction
- Operating in a bureaucracy
- Participating in a board meeting
B). Can we overcome tendencies permanently programmed into the human mind by evolution?
Isn’t the practical benefit of running through this list prevented because these psychological tendencies are programmed into the human mind by broad evolution so we can’t get rid of them?
They were programmed in by broad evolution and serve some good purposes, otherwise, they wouldn’t be there. However, forcing oneself to consider the psychological thought system described above is very useful in spreading wisdom and good conduct when one understands it and uses it constructively.
Here are some real-life examples of this productive psychological thought system brought into play.
- Carl Braun’s communication practices: The great industrialist had a very simple rule. The five Ws. You had to tell Who, What you wanted to do, Where and When, and you had to tell him Why.
- The use of simulators in pilot training or the use of real-life product prototypes in testing customer feedback.
- The rules of the U.S. Constitutional Convention: It was totally secret, no vote until the whole vote, then just one vote on the whole Constitution.
- The use of granny’s rule: You don’t get the ice cream unless you eat your carrots. The corporate interpretation of this would be — organize your day so you force yourself to do what’s unpleasant and important by doing that first, and then rewarding yourself with something you really like doing.
- The use of post-mortems at Johnson & Johnson: At most corporations, if you make an acquisition and it turns out to be a disaster, all the paperwork and presentations that caused the dumb acquisition to be made are quickly forgotten. At Johnson & Johnson, they make everybody revisit their old acquisitions and wade through those presentations routinely.
- The Charles Darwin method of avoiding confirmation bias: Charles Darwin always paid extra attention to the disconfirming evidence and all these little psychological tricks by maintaining notes of disconfirming evidence. He made a habit of persistently searching for disconfirming evidence while performing his research.
- The Warren Buffett rule for open-outcry auctions: Don’t go
References
This article was derived in large part by the influence and inspiration listed below.
- Charlie Munger, Harvard University, June 1995 — Original video link
- Influence: The Psychology of Persuasion by Robert B. Cialdini — Amazon
- Sir Issac Newton and the South Sea Bubble — link
- The Milgram Experiment — link
- How Darwin Thought — link
- Learning from Charles Darwin — link
- Carl Braun — link
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If you enjoyed what you read here, be sure to check out my article on Ben Graham’s ‘The Intelligent Investor’ here or my review of Adam Smith’s ‘Wealth of Nations’ here.
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