Charlie Munger: A List of Human Misjudgments

To make it through our days, we fall back on some simple rules of thumb—heuristics—that allow us to make many decisions without thought or much thought. Without them, we would get nothing done, as in “analysis paralysis.” The same holds in our investing lives.

But these same heuristics can result in tendencies to do things that are dysfunctional, especially if several of them are intertwined (remember, from the last chapter, the lattice of mental models?).

Chapter four of “Charlie Munger: The Complete Investor” lists 25 major psychological tendencies that may affect our judgment. Author Tren Griffin outlines Munger’s thinking about them:

1. Reward and punishment, a “superresponse tendency”: While almost all of us would agree with this tendency, not all of us recognize its power. Munger said, “Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower.” Griffin added, “It is surprising how many people fail to recognize how performance suffers if you pay someone in advance… It’s precisely because of the dangers of misaligned incentives that Munger and Buffett chose to make compensation decisions themselves, whereas they delegate almost all management responsibilities.”
2. The liking and loving tendency: Munger thinks people often ignore or deny the faults of people they love—and investors make investing mistakes when they fall in love with a company. Similarly, we should not delegate our investing decisions to people we like or love.
3. The disliking and hating tendency: Obviously the flip side of the tendency above. So Munger refuses to invest in companies that sell something he does not like for ethical reasons. Neither he nor Buffett invest in casinos, for example.
4. The doubt-avoidance tendency: Decisions can be made more quickly when our brains reject doubt. For example, many investors did not investigate Bernie Madoff (later found to be a major swindler) before giving their funds to him. Why? Because he managed the money of many important people and it was assumed those important people would have done the due diligence.
5. The inconsistency-avoidance tendency: “The brain of man conserves programming spaces by being reluctant to change,” according to Munger. Think of all the investors who experienced losses, sometimes severe losses, because they could not see how personal computers and mobile phones would threaten the companies they owned.
6. The curiosity tendency: This a trade-off tendency, since curiosity can be good or bad. While curious businesses can find breakthroughs, they are just as likely to find failure because they got involved in too many products or services.
7. The Kantian fairness tendency: Investors sometimes respond irrationally when they get into a situation which they consider unfair. Similarly, some investors prefer to lose money rather than see someone else benefit from unfairness (the “Kantian” label apparently comes from the ethical framework of Immanuel Kant’s philosophy).
8. The envy/jealousy tendency: Munger said, “The idea of caring that someone is making money faster [than you] is one of the deadly sins. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun. Why would you want to get on that trolley?” More broadly, investors may take increased risks when they envy someone else’s success.
9. The reciprocation tendency: Anyone want a free weekend at a timeshare condominium? There may be a catch since those sales models work this tendency. You feel obligated toward buying because this “nice” company has given you a free weekend holiday. This tendency can work in two ways; first, when we reward another person who has done something for us, and second, when we withhold rewards for someone who did not help us.
10. The influence-from-mere-association tendency: Munger has used the example of Coca-Cola (KO, Financial), of which Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) is the major shareholder. The company wants to be associated with “wonderful” images such as heroics at the Olympic games and heartwarming music. This tendency works because humans are pattern seekers.
11. The simple, pain-avoiding psychological denial: Since we humans do not like bad news or anything inconsistent with our existing beliefs, we may blind ourselves. For example, Griffin wrote that smart investors should have known it was not possible for the Madoff fund to generate such outstanding returns month after month.
12. The excessive self-regard tendency: People tend to have an overly positive view of their own capabilities, which is why Munger likes to invest only within his circle of competence. A 2012 survey found that 91% of active investors believed they would beat or equal the market returns in the coming year, a mathematical impossibility.
13. The overoptimism tendency: As Griffin explained, investor overoptimism and overpessimism are what make Mr. Market bipolar. For Graham value investors, remaining optimistic at rational levels should lead to buying and selling opportunities.
14. The deprival super-reaction tendency: Also known as loss-aversion, this causes investors to sell their winning stocks too soon and to hold their losers too long. Recently, some investors traumatized by the 2007 financial crisis completely missed the bull market that followed.
15. The social-proof tendency: Given that people do not have unlimited time and complete information, they tend to follow the herd. Even professional managers can make this mistake; Munger noted that Exxon (XOM, Financial) once bought a fertilizer company and every other major oil company did the same, for no other reason than Exxon had done it.
16. The contrast-misreaction tendency: This occurs when we value something in terms of something else. Munger used the example of a realtor who first shows clients an unattractive property at an inflated price, so the clients will buy a subsequently viewed property. Investors should not buy an asset simply because it is better than the one just seen or owned.
17. The stress-influence tendency: This refers to the well-known tendency of making bad decisions when we are under stress (although minor stress may make us better performers). Again, the author points to the practices of timeshare salespeople, as they use stress-inducing tactics to pressure visitors into buying.
18. The availability-misweighing tendency: In other words, making decisions based on facts we can easily recall. For example, there were many bargain stocks in 2002, but the memory of the dot-com collapse kept many investors from buying at an opportune time.
19. The use-it-or-lose-it tendency: A skill degrades unless we practice it. For example, if you don’t fly as a pilot very often, you should not fly as a pilot at all. To be a successful investor, you must commit your time and energy to real or paper investing on a regular basis.
20. The drug-misinfluence tendency: Munger said, “Three things ruin people: drugs, liquor, and leverage.”
21. The senescence-misinfluence tendency: As we age, it is essential that we stay active, both mentally and physically. Munger argued, “Some people remain pretty good in maintaining intensely practiced old skills until late in life, as one can notice in many a bridge tournament.… Continuous thinking and learning, done with joy, can somewhat help delay what is inevitable.”
22. The authority-misinfluence tendency: When faced with uncertainty, we don’t always look inside ourselves for guidance; instead, we look to authorities to lead us. For example, beware of stock promoters in expensive suits who look like authority figures.
23. The twaddle tendency: Twaddle is any kind of communication considered silly or untrue. Munger worries about people who pay fees to consultants and advisors for twaddle. Griffin added the hardest thing to recognize is when you are speaking twaddle to yourself.
24. The reason-respecting tendency: Our undue deference to rules, whether those rules make sense or not, often confounds our decision-making. That includes acting on stock market patterns such as the “death cross”.
25. The lollapalooza tendency: Griffin defines this as “the tendency to get extreme confluences of psychological tendencies acting in favor of a particular outcome.” Sometimes it can be bad, as in the development of investment bubbles, but it can also be good. As Munger wrote, “The system of Alcoholics Anonymous: a 50 percent no-drinking rate outcome when everything else fails? It’s a very clever system that uses four or five psychological systems at once toward, I might say, a very good end.”

(This article is one in a series of chapter-by-chapter digests. To read more, and digests of other important investing books, go to this page.)

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.

Read more here:

• Charlie Munger: A Lattice of Mental Models and Worldly Wisdom
• Charlie Munger: Looking Into Graham's 4 Investment Principles
• Charlie Munger: Trying to Be a Better Investor by Not Being Stupid