Charlie Munger: The Psychology of Human Misjudgment - Part I š§
Discover key psychological biases from Charlie Munger's 'The Psychology of Human Misjudgment' and learn how they affect investing decisions in Part I of this series.
Hi, everyone! š
I'm happy to kick off a new series diving into the timeless wisdom of Charlie Munger with Part I of The Psychology of Human Misjudgment. š§
āØ If you've ever wondered how psychological biases can impact your investing decisions, this series is going to be a game-changer for you!
I hope you enjoy the Part I!
And remember:
š¦ Follow me on Twitter
š¼ Follow me on LinkedIn
š BREAKING! Iāve just released a series of brand-new, free ebooks designed to help you master the strategies of some of the greatest investors of all time.
š„ Download them below!
Charlie Munger, the legendary investor and former vice chairman of Berkshire Hathaway, has provided invaluable insights into human psychology, particularly how it influences decision-making. One of his most famous contributions is his speech, "The Psychology of Human Misjudgment," where he explores various psychological biases that can lead to poor judgment and costly mistakes.
In this post, which is the first of a five-part series, we will delve into five key biases from Charlie Mungerās The Psychology of Human Misjudgment and how understanding them can help you make better decisions, especially in investing.
TL; DR
Incentives have a powerful influence on behavior. Understanding how rewards and punishments shape decisions can help you avoid being misled by others' motivations.
Emotional attachments can cloud judgment. Recognize this bias to ensure that your investment decisions are based on objective facts, not personal feelings.
Strong dislikes can lead to irrational decisions. Stay objective and donāt let personal feelings negatively impact your investment choices.
The desire to eliminate doubt can result in hasty decisions. Embrace uncertainty and take the time to thoroughly analyze all available information before acting.
People often resist changing their minds, even when presented with new evidence. Stay mentally flexible and be willing to revise your beliefs as new information emerges.
1. Reward and Punishment Superresponse Tendency
In Charlie Mungerās The Psychology of Human Misjudgment, the superinvestor emphasizes the overwhelming power of incentives. The "Reward and Punishment Superresponse Tendency" is the idea that humans respond strongly to rewards and punishments, which can significantly influence their behavior. Munger notes that even those who think they understand the power of incentives often underestimate its effects.
For example, in the financial world, advisors may push certain financial products not because they are in the best interest of their clients, but because those products offer higher commissions. This misalignment of incentives can lead to ethical compromises and poor outcomes for clients. Mungerās insight serves as a reminder to critically assess the motivations behind othersā actions, especially when financial incentives are involved.
Everyone wants to be an investment manager, raise the maximum amount of money, trade like mad with one another, and then just scrape the fees off the top. I know one guy; heās extremely smart and a very capable investor. I asked him, āWhat returns do you tell your institutional clients you will earn for them?ā He said, ā20 percent.ā I couldnāt believe it, because he knows thatās impossible. But he said, āCharlie, if I gave them a lower number, they wouldnāt give me any money to invest!ā The investment-management business is insane.
āCHARLIE MUNGER
2. Liking/Loving Tendency
Another critical bias discussed in Charlie Mungerās The Psychology of Human Misjudgment is the Liking/Loving Tendency. This bias refers to the human tendency to ignore or downplay the faults of people or things we like or love. Munger argued that while this bias can be beneficial in personal relationships, it can be detrimental in business and investing.
For instance, investors might become too attached to a particular company or product because they like the brand or the people involved. This emotional attachment can lead them to overlook significant risks and make poor investment decisions. To counteract this bias, Charlie advised seeking out opinions from those who may disagree with you to ensure a more balanced perspective.
Admiration also causes or intensifies liking or love. With this āfeedback modeā in place, the consequences are often extreme, sometimes even causing deliberate self-destruction to help what is loved.
āCHARLIE MUNGER
3. Disliking/Hating Tendency
The Disliking/Hating Tendency is the flip side of the Liking/Loving Tendency, and it's also a crucial concept in Charlie Mungerās The Psychology of Human Misjudgment. Munger explained that strong dislike or hatred can lead to irrational decisions, such as avoiding potentially lucrative investments simply because of personal feelings towards the people involved.
Charlie himself avoided doing business with people he dislikes but warns against allowing this tendency to interfere with rational decision-making. For example, disliking a companyās CEO should not automatically disqualify the company as a viable investment option if the fundamentals are strong.
Avoid evil, particularly if theyāre attractive members of the opposite sex.
āCHARLIE MUNGER
4. Doubt-Avoidance Tendency
In Charlie Mungerās The Psychology of Human Misjudgment, the Doubt-Avoidance Tendency refers to the human inclination to eliminate doubt as quickly as possible, often leading to rushed decisions. This bias can be particularly harmful in investing, where taking the time to thoroughly analyze all available information is crucial.
Charlie points out that this tendency can cause investors to make snap judgments based on incomplete information, potentially leading to significant losses. Instead of rushing to a decision, headvises embracing uncertainty and allowing time for careful consideration of all factors involved.
[Itās] counterproductive for a prey animal that is threatened by a predator to take a long time in deciding what to do.
āCHARLIE MUNGER
5. Inconsistency-Avoidance Tendency
Finally, Charlie Mungerās The Psychology of Human Misjudgment highlights the Inconsistency-Avoidance Tendency, where individuals resist changing their minds even when presented with new evidence. This bias is particularly dangerous in investing, where adaptability and the willingness to revise opinions in light of new data are essential.
Munger warned that this bias can lead to stubbornness, causing investors to hold onto losing investments or ignore new opportunities. To overcome this tendency, Charlie suggested maintaining mental flexibility and being open to changing your views as new information becomes available.
The brain of man conserves programming spaces by being reluctant to change.
āCHARLIE MUNGER
Summary
Understanding the psychological biases outlined in Charlie Mungerās The Psychology of Human Misjudgment is essential for anyone looking to improve their decision-making, particularly in investing. These biasesāReward and Punishment Superresponse, Liking/Loving, Disliking/Hating, Doubt-Avoidance, and Inconsistency-Avoidanceācan profoundly impact investment decisions and overall behavior.
Download this post š
Got a burning question or a topic you're curious about? I'd love to hear from you! Please drop a comment š¬ below or shoot me an email š§ at grahamqualityinvestor@gmail.com
hi i really liked your post, do you have some suggestions to dive a bit deeper into this topic?