Suhtoshi's Blog

Psychology of Human Misjudgment

A look at Charlie Munger's speech at Harvard June 1995.

About six months ago, I came across a pdf online that was titled: Charlie Munger 1995: Psychology of Human misjudgment. This pdf was roughly typed by who I believe to be an audience member that was present at the speech at Harvard University in 1995. It was shared by Michael Burry. Now, The Big Short is a great movie, but Michael Burry has some other great insights about things, not just the stock and bond markets. I love reading about psychology, and when I find overlaps in my interests I become very attentive. The idea of human psychology intertwined into both economics and individual businesses is often hidden from the public or the customer respectively. Facebook is one great example of both.

This pdf begins with an introduction to Charlie Munger and how his business and investing career have been affected by the misjudgments he has made based on certain assumptions or biases that get overlooked. This is a rather long document, so I wanted to talk about the “24 Standard Causes of Human Misjudgment.” As I said before, this looks to be a typed document by an audience member and there are a few mistakes the original scribe pointed out. After reading and collecting each misjudgment, I came to 22.

Just for some clarification, I would like to point out what I understood to be a cause of human misjudgment. I took this as how I can make a mistake. I took it as “How I can make a decision and be completely wrong? What assumptions did I have about the scenario? How did my past experiences affect my decision-making?” All of these questions take some self-reflection on both our own life and our own bad habits. Charlie mentions significant financial loss during his career due to failing to recognize these in his own life. I’ll list each one and give a few examples for each.

22 Standard Causes of Human Misjudgment

  1. Under-recognition of reinforcement/incentives

The example Charlie used for this was the Federal Express night shift. Federal Expressed realized that by changing from pay by the hour to pay by the shift, the workers were inclined to get more done, in a faster time. Keeping the night shift on pay by the hour was costing the company money on a productivity basis. Having the incentive to complete all of one’s tasks and potentially getting to leave early was huge for productivity. Understanding this human psychology of incentives can help with decision making in many different areas of business both for the employees working and the customers purchasing. Under-recognizing can cost you money.

  1. Psychological denial

We have all seen on the news where the anchor is interviewing the mother or neighbor of a murderer and having a complete denial of their crimes. There is some connection between mothers and children that defaults to “they would never.” We do this ourselves on certain topics that are very close to our identity. We have to look at certain scenarios and detach ourselves from the situation and look at it from all angles.

  1. Incentive-cause bias

Most of the time, people with a vested interest in something will tend to steer you toward their own way of thinking. The example he uses in this part talks about a doctor in Nebraska, who was later removed from his post. He thought “the gall bladder was the source of all medical evil, and if you really love your patients, you couldn’t get that organ out rapidly enough.” You can imagine the number of people who went in with something, getting an ear full from this doctor suggesting their gall bladder be removed. His financial incentives were out in the open when he began suggesting everyone have it removed. I’m sure some were justified, but when this incentive bias becomes the default answer to every problem, you run into issues.

  1. Bias from self-confirmation

Charlie calls this one a “superpower in error-causing psychological tendency.” This is often a tendency to avoid, or promptly resolve cognitive dissonance. He compares the human mind to the human egg. When one sperm gets in, it shuts down so the next one can’t get in. The human mind is very similar. We have a strong force that is attached to the first idea, or first notion about a subject when presented. This coupled with the immediate public announcement via social media of your conclusion only pounds it into your own head even further.

  1. Pavlovian Association

Ahhh. Coca-Cola. The king of association. Nothing but good times, Christmas polar bears, and gold medalist Olympians included in their advertisements. Pavlov’s dog’s mouth would water when he rang the bell. All of these associations to products work on a subconscious level. It’s not trying to get you to directly go out and buy a coke every time you see a commercial. It’s using these powerful, happy hooks to get you to associate the Coca Cola brand with something like Christmas. Then, when given the choice between all of the products at the gas station, there is a small, subconscious connection that is tied to the Coke and you are more likely to select it. Understanding this tendency and being aware of it, can help you make decisions and recognize certain advertising commercials/ads from your favorite products.

  1. Bias from reciprocation tendency

One example of this is people acting in a way they “should” act based on what you have already done for them. If someone knows you will act a certain way based on what they have done for you, it can be exploited. I don’t think Charlie is talking about being nice and returning favors. This example is when people are using you because they know you will act a certain way. Saying no often times comes off as rude and some people know you feel that way and will take advantage of it. Misjudging situations as being helpful when you are being used is the point he is trying to make.

  1. Bias from over-influence by social proof

Doing things your friends or coworkers are doing because they are doing them is a classic example of this one. Really sitting yourself down and asking yourself if you are doing something based on social proof is a hard pill to swallow. Charlie mentioned when all of the oil companies began buying fertilizer companies when one company did. All of the other oil companies had practically no idea why they were doing it, “but if Exxon was doing it, it was good for Mobil.” This is also tied to fear of missing out.

  1. Better to be roughly right than precisely wrong

This one is pretty easy. Sometimes we are so scared of being completely wrong on something we will settle with being only roughly right. When making both financial and everyday decisions, often times the risks are so great we are scared of being wrong. I think these risks are sometimes overestimated.

  1. Bias from contrast-caused distortions of sensations

Suppose I present you with two buckets of water: One ice-water cold and the other from my 100 degree hot-tub water. I then ask you to place one hand in the ice-water and the other in the hot tub bucket. After several seconds, I present you with a third, luke-warm water bucket and ask you to put both hands in the bucket. You will immediately feel two different temperatures in the same bucket. When we look at a problem or an issue, we often do not realize we are coming from an ice water bucket of experiences and make decisions based on those. If your two hands were two different people discussing political issues, you can now understand how someone could argue over the temperature of a bucket.

  1. Bias from over-influence by authority

Telling your boss or an upper-level executive when you think they are wrong requires some courage. We often default to: “well, they are my boss, they probably do know better than me.” Charlie uses the co-pilot/pilot simulations where the junior co-pilot doesn’t stop the plane from crashing because he assumes the pilot knows what he’s doing because he has more hours and he is an authority figure.

  1. Bias from deprival super-reaction syndrome

Charlie talks about how minor increments down, with regards to a product, can make people crazy. He mentions New Coke. They introduced a new flavor and experienced this huge deprival super-reaction syndrome. He claims Pepsi was within weeks of releasing Old Coke in a bottle, but Coke released the original flavor again based on the outrage. From a decision-making standpoint, he also mentions this is similar to near-misses in slot machines. They found that if you give people a lot of near misses that are more inclined to keep pulling the lever. This razor-thin margin of taste or super close 777 spins on a slot machine can affect our actions.

These last ones are pretty simple and do not require much explaination.

  1. Bias from envy/jealousy

  2. Bias from chemical dependency (caffeine, alcohol, drugs)

  3. Bias from mis-gambling compulsion

People that feel in control of picking their lottery numbers play way more than those who are given random numbers. He mentions the connection between people and commitment. If people are committed to something, they feel it has to be right. “The minute they picked it themselves, it gets an extra validity.”

  1. Bias from liking distortion (liking oneself, one’s own kind, and ones own idea structures

  2. Bias from human brains dealing with probabilities

The example of when someone says “I’ve never done it before, and I’ll never do it again.” We have a tendency to believe that person without looking at the probabilities of it being true. We are often tied to the person in some way that muddies the water. We have feelings that override our ability to realize that it will probably happen again.

  1. Bias from over-influence by vivid evidence

This is usually over-reacting to first impressions, the “wow factor” of a person in leadership, or anything that would distract you from solving the core problem, or understanding an individual.

  1. Mental confusion in the human mind when asking why

When I first read this one I wasn’t quite sure what he was trying to explain. As I understand it now, it’s sometimes accepting answers that really don’t answer the question. Accepting “this” as the answer when in reality it doesn’t answer the question. The complexity of “why” requires an array of facts to explain and give an adequate answer. Sometimes people don’t do that and we accept their answer to why.

  1. Normal limitations of sensation, memory, cognition, and knowledge

  2. Stress-induced mental changes

  3. Mental illness/tendency to lose ability through disuse

If you don’t use it, you lose it!

  1. Say-something syndrome

Charlie’s final example of human misjudgment is with regards to the honey bee. Typically a honey bee finds nectar and returns to the hive, where he communicates the location of the nectar with a dance for the other bees. A scientist decided to do an experiment where he placed nectar straight up above the hive. The honey bee doesn’t have a genetic dance to describe straight up, so he returns to the hive and just does a completely random dance in front of the other bees. Charlies says, “All my life, I’ve been dealing with the human equivalent of that honeybee.”

At the conclusion of this talk he proposes a few questions that I think are worth sharing:

  1. What happens when these standard psychology tendencies combine?

  2. Aren’t there overlaps?

“I would say one thing that causes the most trouble is when you combine a bunch of these together, you get this lollapalooza effect. And again, if you read the psychology textbooks, they don’t discuss how these combine, at least not very much. Do they multiply? Do they add? How does it work?”

After reading this 6 months ago I can catch myself a couple of times having one of these tendencies. It’s really hard to change your brain wiring, but being aware of how our brains work and help change them to be more well rounded and aware of our own biases. As of now, I believe the scribed location is still active if you wish to download the full 22-page pdf of the talk. A quick google search might work for you.

-Suhtoshi