If you invest, you have one goal in mind.
For your investments to be profitable.
What you and I can also agree on is that we don’t like being fooled by ourselves or others. We certainly don’t want to make bad decisions.
But we do it all the time.
Over and over again.
And many people refuse to do anything about it.
In theory, we agree that we are in the markets to make money.
Yet our behavior doesn’t reflect it. It’s just lip service.
Warren Buffett isn’t where he is by forgetting about losses and the causes of those losses.
He hated, no… Buffett abhorred losing money and failing to let it compound.
He knew he needed every bit of traction and momentum to compound his wealth.
Biases Causing Foolish Mistakes and Bad Decisions
Munger then comes along and puts it out there plain and simple.
Biases that cause you to make the same mistakes, or biases that you don’t even know about.
In any case, the best way to combat it, is to first recognize which ones you are weak against, and then take measures to prevent it.
In 1995, Charlie Munger gave a speech to Harvard students known as the psychology of human misjudgment.
As you go through these examples, try to recall examples to see how these biases played out in your life or investments.
1. Under-recognition of ‘reinforcement’ or ‘incentives’
Early in the history of Xerox, Joe Wilson, who was then in the government, had to go back to Xerox because he could not understand how their better, new machine was selling so poorly in relation to their older and inferior machine.
Of course when he got there he found out that the commission arrangement with the salesmen gave a tremendous incentive to the inferior machine.
2. Simple psychological denial
“If you turn on the television you find the mothers of the most obvious criminals that man could ever diagnose and they all think their sons are innocent. The reality is too painful to bear so you just distort it until it’s bearable. We all do it to some extent. It’s a common psychological misjudgment that causes terrible problems.”
3. Incentive cause bias creating ‘agency cost’
“the cash register was a great moral instrument when it was created. And Patterson knew that, by the way. He had a little store, and the people were stealing him blind and never made any money, and people sold him a couple of cash registers and it went to profit immediately. And, of course, he closed the store and went into the cash register business…”
4. Bias from consistency and commitment tendency
“if you make a public disclosure of your conclusion, you’re pounding it into your own head. Many of these students that are screaming at us, you know, they aren’t convincing us, but they’re forming mental change for themselves, because what they’re shouting out [is] what they’re pounding in.”
5. Misconstruing past correlation as a reliable basis for decision-making
“You’ve got two products; suppose they’re complex, technical products. Now you’d think, under the laws of economics, that if product A costs X, if product Y costs X minus something, it will sell better than if it sells at X plus something, but that’s not so. In many cases when you raise the price of the alternative products, it’ll get a larger market share than it would when you make it lower than your competitor’s product.”
6. Bias from reciprocation tendency
When somebody does something for you, you feel obligated to do something in return.
Robert Cialdini shows in his book “influence” how he went around campus asking people to take juvenile delinquents to the zoo.
And it was a campus, and so one in six actually agreed to do it. And after he’d accumulated a statistical output he went around on the same campus and he asked other people, he said, “Gee, would you devote two afternoons a week to taking juvenile delinquents somewhere and suffering greatly yourself to help them,” and there he got 100% of the people to say no. But after he’d made the first request, he backed up a little, and he said, “Would you at least take them to the zoo one afternoon?” He raised the compliance rate from a third to a half. He got three times the success by just going through the little ask-for-a-lot-and-back-off.
How many items do you buy on Amazon by ignoring the reviews?
Do you buy stocks because a famous investor has bought it?
8. Bias from contrast-caused distortions of sensation, perception and cognition
“Cialdini cites the case of the real estate broker. And you’ve got the rube that’s been transferred into your town, and the first thing you do is you take the rube out to two of the most awful, overpriced houses you’ve ever seen, and then you take the rube to some moderately overpriced house, and then you stick him. And it works pretty well, which is why the real estate salesmen do it. And it’s always going to work.”
“You get a pilot and a co-pilot. The pilot is the authority figure. They don’t do this in airplanes, but they’ve done it in simulators. They have the pilot do something where the co-pilot, who’s been trained in simulators a long time — he knows he’s not to allow the plane to crash — they have the pilot to do something where an idiot co-pilot would know the plane was going to crash, but the pilot’s doing it, and the co-pilot is sitting there, and the pilot is the authority figure. 25% of the time the plane crashes.”
10. Bias from deprival super-reaction syndrome
“I have a neighbor, a predecessor who had a little island around the house, and his next door neighbor put a little pine tree on it that was about three feet high, and it turned his 180 degree view of the harbor into 179 3/4. Well they had a blood feud like the Hatfields and McCoys, and it went on and on and on…because you don’t just reciprocate affection, you reciprocate animosity, and the whole thing can escalate.”
11. Bias from envy/jealousy
Those of you who have raised siblings you know about envy, or tried to run a law firm or investment bank or even a faculty? I’ve heard Warren say a half a dozen times, “It’s not greed that drives the world, but envy.”
12. Bias from chemical dependency
“It will always cause this moral breakdown if there’s any need, and it always involves massive denial… the tendency to distort reality so that it’s endurable.”
13. Bias from mis-gambling compulsion
“You have a lottery where you get your number by lot, and then somebody draws a number by lot, it gets lousy play. You have a lottery where people get to pick their number, you get big play. Again, it’s this consistency and commitment thing. People think if they have committed to it, it has to be good. The minute they’ve picked it themselves it gets an extra validity. After all, they thought it and they acted on it.”
14. Bias from liking distortion
“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.”
15. 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.
“You find an isolated example of a little old lady in the See’s Candy Company, one of our subsidiaries, getting into the till. And what does she say? “I never did it before, I’ll never do it again. This is going to ruin my life. Please help me.”
And you know her children and her friends, and she’d been around 30 years and standing behind the candy counter with swollen ankles. When you’re an old lady it isn’t that glorious a life. And you’re rich and powerful and there she is: “I never did it before, I’ll never do it again.” Well how likely is it that she never did it before? If you’re going to catch 10 embezzlements a year, what are the chances that any one of them, 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? Well in the history of the See’s Candy Company they always say, “I never did it before, and I’m never going to
do it again.” And we cashier them. It would be evil not to, because terrible behavior spreads. “
16. Bias from over-influence by extra-vivid evidence
By reliving or remembering vivid experiences, it makes you believe that the same thing will happen in the given scenario. With countless number of possibilities, the expectation and belief that history repeats, instead of rhyming, over-influences the decision making process.
17. Bias and mental confusion created by generalizations and fully understanding the “Why”
Well we all know people who’ve flunked, and they try and memorize and they try and spout back and they just…it doesn’t work. The brain doesn’t work that way. You’ve got to array facts on the theory structures answering the question “Why?” If you don’t do that, you just cannot handle the world.
18. Bias from stress-induced mental changes
“[Pavlov] had all these dogs in cages, which had all been conditioned into changed behaviors, and the great Leningrad flood came and it just went right up and the dog’s in a cage. And the dog had as much stress as you can imagine a dog ever having. The water receded in time to save some of the dogs, and Pavlov noted that they’d had a total reversal of their conditioned personality. And being the great scientist he was, he spent the rest of his life giving nervous breakdowns to dogs, and he learned a helluva lot that I regard as very interesting.”
19. Development and organizational confusion from say-something syndrome
Greatest example is the media coverage of the 2016 election. You have talking heads from every angle “saying-something” which was all incorrect. This type of syndrome simply creates noise, doesn’t add to the discussion or ultimate decision.
“a honeybee goes out and finds the nectar and he comes back, he does a dance that communicates to the other bees where the nectar is, and they go out and get it. Well some scientist who is clever, like B.F. Skinner, decided to do an experiment. He put the nectar straight up. Way up. Well, in a natural setting, there is no nectar where they’re all straight up, and the poor honeybee doesn’t have a genetic program that is adequate to handle what he now has to communicate. And you’d think the honeybee would come back to the hive and slink into a corner, but he doesn’t. He comes into the hive and does this incoherent dance… And it’s a very important part of human organization so the noise and the reciprocation and so forth of all these people who have what I call say-something syndrome don’t really affect the decisions.”