Reviewing Munger's The Psychology of Human Misjudgment - Part II

Charlie Munger is Warren Buffett's right hand man at Berkshire Hathaway (BRK.A) We're summarizing the text he authored titled "The Psychology Of Human Misjudgement", where he describes some of man's tendencies. By understanding and learning from these tendencies, we better equip ourselves to avoid psychological biases when investing.

The first installment of the series is here.

Part X- Excessive Self-Regard

Ninety-percent of Swedish drivers believe themselves to be above average drivers. This is an example of the tendency of man to overrate his own abilities. This tendency can also be extended to man's possessions: once a man owns something, he places a higher value on its worth than he otherwise would.

The repercussions of this tendency are visible in various forms. Lotteries where gamblers can pick their own numbers (as opposed to being offered a random set) are bigger draws. Man will also strongly prefer people like himself. In a "lost-wallet" experiment, subjects were found to be more likely to return a wallet to a stranger when that stranger resembled the subject.

In business, excesses of self-regard can often cause poor hiring decisions. (The hirer believes in his superior ability to select a candidate in a face-to-face, and therefore ignores more objective measures of a candidate's value.) Munger actually points to the hiring of the well-spoken Carly Fiorina as CEO of Hewlett-Packard (HPQ) as an example of a mistake due to this tendency.

Munger argues that the best antidote to falling victim to this tendency is to try to think objectively about oneself, one's family and one's possessions. While this is not easy, it is far preferable than allowing one's psychological biases to control one's thoughts.

Part XI- Over-Optimism

Munger starts his description of man's tendency to be over-optimistic by quoting the Greek orator Demosthenes, who said "What a man wishes, that also will he believe." In addition to psychologically denying when things are going badly, man will tend to be overly optimistic when things go well.

For evidence of this tendency, Munger points to people happily buying lottery tickets despite having the odds stacked against them. People also believe in new business ideas that are often poor substitutes for efficient, existing companies.

Munger believes that while this tendency has likely been helpful for evolutionary reasons, it is best to approach issues more objectively. To do so, individuals are encouraged to make more use of the simple, high-school level, probability math of Fermat and Pascal. Munger likens avoiding the antidote to this tendency (the antidote being habitual use of probabilities) to letting natural evolution determine one's golf grip rather than taking golf lessons.

Part XII- Deprival

The tendency that Munger describes as "deprival" is the human tendency to hate losing more than liking winning. For example, the loss of a ten dollar bill seems to hurt much more than a gain of ten dollars seems to help.

The problem with this tendency is that man mis-prioritizes his problems. For example, a man with a brokerage account containing $10 million will agonize over missing $100 from his wallet. This irrational tendency to be intensely focused on small losses, whether to property, friendship, territory, status or other valued items is quite normal.

Munger notes that this tendency has ghastly effects in labor relations. When a corporation is in trouble, workers find it very difficult to give up benefits they currently enjoy, even if it is in everyone's best interest to do so (to make the company more competitive). As a result, many companies go bust when, had rational thinking prevailed, the situation could have been corrected.

This tendency also causes the form of business failure that encourages otherwise wise men to use up good assets in fruitless attempts to rescue a venture gone bad. Munger also believes this tendency is what drives gamblers towards ruin: once he has suffered a loss, the gambler becomes obsessed with breaking even in order to recover that loss. Being cognizant of this tendency can help one focus on making rational decisions rather than throwing good money after bad.

Comments

[TonyCinTX:]

As a statistician, let me point out that it is entirely possible that 90% of Swedish drivers are better than average; if the other 10% are particularly bad.

Similarly; in the USA we have 42 murders per 100,000 people every year. So our average murders per capita is non-zero, but about 99.9% of us are "better than average," having committed exactly zero murders.

As far as Swedish drivers are concerned; it is entirely possible that 90% have never been in an accident that was legally their fault. No matter how you define "good driver," I imagine "not causing accidents" is a necessary characteristic.

Yet, we know of accidents and hear of them frequently; so we all know the average number of accidents caused per capita is non-zero; and if I have exactly zero to my credit (and I do), I am justifiably better than the average driver.

To be even more critical of this idiotic study, when one asks whether somebody is a "better than average driver" they implicitly claim two things; that driving ability can quantified and thus averaged, and that it can be sorted in a spectrum from bad to good.

If the metric is not defined by the question, it is left up to the subject to define their own metric. Given this freedom, every subject is free to choose any measurement they want, guess at the average based on experience, and conclude CORRECTLY their own measure is better than the average! It is surprising that 100% of the respondents did not claim they were better than the average. This doesn't measure objectivity, this measures creativity or depression or humility. It tells us that 10% of Swedish drivers could not imagine a metric in which they were above average, or were prevented by personal ideology from claiming it.

Jul 07 08:54 AM

[Burton A. J...:]

"Other people's triumphs and excellences belong to them.
Likewise, your possesions may have excellence, but
you yourself don't derive excellence from them."

Epictetus

Epictetus, as usual, got it right. He was a slave-turned-philosopher and tutor to the upper classes - Marcus Auralius was one of his star pupils. Epictetus limited himself to the pursuit of reality. He left probability and possibility in the lap of the gods, where they belong.
Mr. Munger and his pal WB have been in the reality business for decades.

Burton A. Johnson, M.D., J.D.

Jul 07 03:38 PM