The Psychology of Human Misjudgment
In June, 1995 at Harvard University Charlie Munger gave to this date what is one of the best speeches I’ve ever heard.
I’m not talking about a Tony Robbins or Chael Sonnen style motivational speech that leaves you energized for a few hours without any specific information to help you move forward in life.
Charlie Munger’s speech titled The Psychology of Human Misjudgment will equip you with the knowledge of the 25 cognitive biases that are constantly skewing and altering our decision-making and actions whether we realize it or not.
As the old saying goes ‘knowledge is power’
The #1 method I’ve found to not fall victim to the cognitive biases (or at least to take them into account when making your decisions) is to be aware of them.
Knowledge that changes your instincts is key, not just text book knowledge… this is instinctual knowledge.
Munger’s speech itself runs for well over an hour and although packed with information can be tedious to listen to, below you’ll find my notes on the key points I’ve picked up from listening to the The Psychology of Human Misjudgment 5+ times.
“But SJ, what actually is a cognitive bias?”
A cognitive bias is a mistake in reasoning, evaluating, remembering, or other cognitive process, often occurring as a result of holding onto one’s preferences and beliefs regardless of contrary information. Psychologists study cognitive biases as they relate to memory, reasoning, and decision-making.
Cognitive biases cause us to overpay at auctions, to place higher value on things than we should, to trust people that shouldn’t necessarily be trusted and to make decisions which, if looked at through the means of a mental model or framework we would see is irrational.
In short, a cognitive bias is a hard-wired way we think that causes us to misjudge.
If you’ve heard or watched any of Tai Lopez’s videos or speeches over the last few years you’d likely know he’s a big advocate of understanding and the power of the 25 cognitive biases – Tai did not come up with these, he’s merely carrying the message of Charlie Munger.
“Why should I listen to Charlie Munger? I’ve never heard of him before…”
In the investment world Charlie Munger is a legend.
Munger, now in his 90s is Vice Chairman of Berkshire Hathaway.
When it comes to managing and creating wealth there’s no room for error, and unlike many fly-by-night operators that use dodgy, unethical and extremely risky strategies (much like the approach some people take in the fitness industry) to get ahead Munger is quite the opposite.
He believes in having a set of frameworks, rules and guidelines for decision making not only in his investments but in every day life because he knows the way our brains are wired.
The success Munger has obtained and the decades upon decades of experience Charlie Munger has is more than enough of a reason as to why anyone and everyone should take advice from this man.
Munger avoids the limelight more-so than his business partner, Warren Buffet but it goes without saying when he speaks publicly we should listen…
The rest of the time he allows the results he amasses to do the talking.
My Notes From Charlie Munger’s 25 Cognitive Biases Speech
1. Reward and Punishment Tendency
Under-recognition of the power of what psychologists call ‘reinforcement’ and economists call ‘incentives.’
Getting things done fast comes down to incentives to the employee.
The Federal Express shifted from an hourly rate to a shift based rate as their job was time sensitive.
Needless to say, the quicker they could get the shift done the quicker they could go home and the more money they’d make in a shorter amount of time (provided they worked harder).
This is the #1 reason why typically all sales job are commission based – there’s literally no motivation for the salesmen to put in the hard yard to acquire clients and make sales unless they’re getting something extra out of it too – cold hard cash in the form of commission.
You could not disagree that this system works, look at the relentless pressure car salesmen and real estate agents use to try and seal deals that will benefit them.
2. Simple, Pain-Avoiding Psychological Denial
The pain of admitting and accepting certain truths (like the death of a loved one or the criminal activity of someone you know) is too much to handle so we continue to deny it and deny it.
We distort our judgement for years until we’re able to bear it.
Take for example the people that were lost on Malaysian Airlines flight MH370 – searches continued for months upon months with the thought that they’re still all alive and intact somewhere.
We know well and good that a human can only survive X amount of time without food and water, let alone if left in the ocean or other unfavourable terrain.
3. Disliking/Hating Tendency
The power of incentives and the power of rationalized, terrible behavior.
The example Charlie Munger offers here is a surgeon that went out of his way to tell his clients that their gall bladder was the cause of all of their issues (and promptly exercised his talents to remove it when in cases it was often not necessary).
The surgeon remained employed, got to use his skills and earned big money doing so which was his justification until he was removed from his position.
In a less dramatic case you’ll see this same rationalized behavior when it comes to real estate agents and financial advisors who receive benefits from you purchasing X property or signing up for X mutual fund (so they’ll tell and do what they have to do in order to get you to sign on the dotted line, ensuring they get their incentives!)
Munger goes on to say “If you read the psychology texts, you will find that if they’re 1,000 pages long, there’s one sentence. Somehow incentive-caused bias has escaped the standard survey course in psychology.”
4. Doubt Avoidance Tendency
Once we’ve got some information on a subject we don’t like to hear new (even correct!) information.
For example, if you were firm in the believe that counting calories didn’t work and you believed this for a decade even when new information comes out proving that it 100% does, and that previous studies and information were incorrect and ill-informed your brain would attempt to block out this information.
Munger uses a specific example from a Dean of Physics in his speech:
“According to Max Planck, the really innovative, important new physics was never really accepted by the old guard. Instead a new guard came along that was less brain-blocked by its previous conclusions”
Do not put your brain in chains too young, be open and adaptable to new information – don’t allow your brain to keep you stubborn and stuck with the information you already know and are bias towards.
5. Influence-from-Mere Association Tendency
Also known as ‘Pavlovian association’.
Big brands understand the association or pavlovian bias and use this to their advantage ALL of the time.
For example, Coca Cola sponsors athletes, celebrities and likes to get there name out at any major event they can.
Why are Coca Cola spending so much time and money investing in these people and events that aren’t really linked to their product?
So your brain subconsciously associates the Coca Cola brand with these great people and fun times.
The end result? You spend more money on their product as your brain has perceived the experience of having their product as fun and ties in the association of the greats you’ve seen associated with the brand.
6. Reciprocation Tendency
Being a compliance practitioner.
When requesting something of someone the success rate is easily increased by asking for more first then backing off and asking for what you truly want.
Aka. the ask-for-a-lot-and-back-off technique.
For example, you may ask a bunch of friends if they’ll drive you to the doctors surgery 50 miles away and a number of them will say yes, and I’m sure a number will say no.
The follow up to those that declined your request is the real request – for example “will you take me to a doctors surgery 20 miles away instead then?” This will likely get more ‘yes!’ responses than if you originally asked them to drive you 20 miles.
What you think may change what you do, but what is more important is that what you do will change what you think.
7. Social-Proof Tendency
We look at what everyone else is doing in order to determine what we’ll do.
Say there’s a shooter running around madly, if everyone else was sitting on the floor calmly you would do the same – social proof is telling you that’s the right thing to do.
On the other hand if everyone was running around in a flurry screaming you’d be doing the exact same thing! You wouldn’t even think of sitting still on the floor.
I used the shooter example as Charlie Munger states that this is over-influence from social proof is at its strongest under conditions of stress.
This social proof tendency is apparent in business too, if one business starts doing certain processes differently or starts adding assorted products to their lineup often you’ll find their competition doing the exact same thing without knowing why! It sets off a chain reaction as it seems to be ‘the right thing to do’ every though it may very well not be.
8. Inconsistency Avoidance Tendency
To the man with a hammer, every problem looks like a nail.
As the great economist Keynes said “better to be roughly right than precisely wrong.”
9. Contrast-Misreaction Tendency
We’re constantly over-influenced by contrast.
For example, put one hand in a bucket of hot water and the other hand in a bucket of cold water for a minute.
Immediately remove both hands and place them in a bucket of room temperature water and one hand will still feel hot while the other feels cold – the water is the same temperature however we’re basing the feelings on the contrast of our previous experience (bucket).
We do not have an absolute scale, we only have a contrast scale.
“If you throw a frog into very hot water, the frog will jump out, but if you put the frog in room temperature water and just slowly heat the water up, the frog will die there.”
This ties into contrast, as small change bit by bit can go un-noticed to those (most of us!) that’re not very observant.
10. Authority-Misinfluence Tendency
When it comes to authority figures, whether they be a CEO, police officer or pilot we tend to trust their actions irrespective of our own knowledge.
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.
11. Deprival Superreaction Tendency
We react irrationally when there’s a chance we’ll love something we had or almost had… regardless of how small or petty it is.
The #1 example of this is attempting to take a toy out of a dogs mouth once it has been carrying it around, the dog will take you to war before it gives up its toy!
The toys it has not yet played with or placed in its mouth it could not care less about.
Another example of this I’ve seen time and time again is when you’ve got a perfect view at an event or concert and a car, person or object of any kind ever so slightly obstructs your view…
The arguments and disdain this can cause are highly irrational.
12. Envy/Jealousy Tendency
As Warren says “It’s not greed that drives the world, but envy.”
Envy of those in better shape than us, envy of those that earn more per year than us.
Do not fall victim to the envy of your siblings, peers or strangers.
13. Drug-Misinfluence Tendency
The tendency to distort reality so it’s bearable.
If you’re spending every evening or weekend when you’re not at work drinking alcohol or taking recreational drugs it’s time to take a step back and change the path you’re on.
Examine your career, your relationships and create a life of choice that you do not need to escape from.
14. Mis-gambling Compulsion
When it comes to gambling (or any form of wager for that matter) when we’re inputting our own numbers or our own opinion of any kind we’re far more invested.
We’ll likely gamble more and continue to do so as we’ve expended effort, we’re committed.
As Munger says:
“For instance, a lottery. 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.”
15. Liking/Loving Tendency and Disliking/Hating Tendency
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.
Disliking distortion, bias from that, the reciprocal of liking distortion and the tendency not to learn appropriately from someone disliked.
This is almost pathological behavior!
16. Availability-Misweighing Tendency
Bias from the non-mathematical nature of the human brain in its natural state as it deal with probabilities employing crude heuristics, and is often misled by mere contrast, a tendency to overweigh conveniently available information and other psychologically misrouted thinking tendencies.
In a sense these psychological tendencies make things unavailable, because if you quickly jump to one thing, and then because you jumped to it the consistency and commitment tendency makes you lock in, boom, that’s error number one.
Or if something is very vivid, that will really pound in. And the reason that the thing that really matters is now unavailable and what’s extra-vivid wins is, I mean, the extravividness creates the unavailability.
17. Stress-Influence Tendency
Here’s one that…I’m at least $30 million poorer as I sit here giving this little talk because I once bought 300 shares of a stock and the guy called me back and said, “I’ve got 1,500 more,” and I said, “Will you hold it for 15 minutes while I think about it?” And the CEO of this company — I have seen a lot of vivid peculiarities in a long life, but this guy set a world record; I’m talking about the CEO — and I just mis-weighed it. The truth of the matter was the situation was foolproof. He was soon going to be dead, and I turned down the extra 1,500 shares, and it’s now cost me $30 million. And that’s life in the big city. And it wasn’t something where stock was generally available. So it’s very easy to misweigh the vivid evidence, and Gutfreund did that when he looked into the man’s eyes and forgave a colleague.
18. Reason-Respecting Tendency
Mental confusion caused by information not arrayed in the mind and theory structures, creating sound generalizations developed in response to the question “Why?” Also, mis-influence from information that apparently but not really answers the question “Why?” Also, failure to obtain deserved influence caused by not properly explaining why.
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.
You want to persuade somebody, you really tell them why.
Remember, incentives matter. Vivid evidence matters and WHY really, really matters. Answer it correctly.
19. Use-It-or-Lose-It Tendency
Other normal limitations of sensation, memory, cognition and knowledge.
Skills attenuate with disuse.
When a skill is raised to fluency then the skill (1) will be lost more slowly and (2) will come back faster when refreshed with new learning.
20. Stress-Influence Tendency
Stress can cause both small and large changes which can be both temporary and permanent in nature.
Stress is also responsible for quick & extreme reactions to any and all situations – this can be good and bad.
Stress beyond a certain point (constant stress) can hinder performance and cause health issues, although small amounts of stress can be harnessed as motivation.
21. Senescence-Misinfluence Tendency
As we age there is a natural loss of certain skills and abilities.
Life long learning in the form of reading books, attempting new skills and being curious in general will slow down this entropy (decay over time).
This ties in with the use-it-or-lose-it tendency however senescence-misinfluence is also a time based ordeal.
22. Twaddle Tendency
Also known as development and organizational confusion from ‘say -something’ syndrome.
Munger gives the example of a honey bee, once it finds nectar it communicates to the other bees the location of the nectar – when it can’t find nectar instead of retreating to the hive it returns to perform an incoherent dance to the other bees as it has no means of communicating what it has (or rather hasn’t found).
The twaddle tendency is essentially the performance of time wasting activities as a result of confusion.
Don’t twaddle – instead opt to retreat, save your energy and plot instead of burn your finite energy achieiving nothing (Tai Lopez refers to this as ‘flurries of activity’)
23. Lollapalooza Tendency
The lollapaloozza tendency is the result of multiple cognitive biases combining together to form an almost irresistible offer or scenario.
Examples of lollapalooza situations include:
- Tupperware parties
An auction is the perfect example of the lolapolooza effect, as it incorporates the following biases:
- Scarcity bias (there’s only one item and a limited amount of time to bid/buy it)
- Social proof bias (there’s other people there interested in purchasing and bidding on the same items as you)
- Authority bias (the auctioneer is physically positioned higher than you and is seen as an authority)
- Reward bias (the ‘feel good’ moment and dopamine release upon ‘winning’ regardless of whether this comes as a result of paying above market value)
24. Benefits of this Psychological Thought System
You are the only person that truly has your best interest in mind. You must remember this as now you’re aware of cognitive bias and can use them to your advantage you must remember that at the same time others are trying to make your fall victim to cognitive biases, whether this be to help them or for their financial gain.
By understanding this thought system you’ll be able to prevent yourself from making poor decisions due to the influence and tactics of others, while at the same time using these to your own advantage (ethically).
25. Special Knowledge Problems Lie Buried in the Thought System
These psychological tendencies are programmed into the human mind by broad evolution, we can’t get rid of them as they do serve a purpose.
These psychological tendencies are partly good and, indeed, probably much more good than bad, otherwise they wouldn’t be there. By and large these rules of thumb, they work pretty well for man given his limited mental capacity. And that’s why they were
programmed in by broad evolution. At any rate, they can’t be simply washed out automatically and they shouldn’t be.
Want To Listen To The Full Audio? Here It Is!
Want To Know More About Cognitive Biases & How To Dominate Life?
I recently purchased Charlie Munger’s flagship book, Poor Charlie’s Almanack – a book filled with hundreds of pages of wisdom from a billionaire and master of mindset and mental frameworks to improve your life..
This book cost me $65 USD. To most this will seem absurd…
“$65 for a book?! What a waste of money”
…these are the same people that spend hundreds of dollars on junk food and alcoholic beverages on Friday and Saturday night.
Delay The Instant Gratification
Don’t adopt the epicurean mentality of “eat, drink and be merry for tomorrow we die.”
You must think long term, you must delay the instant gratification we’re so used to experiencing in this life and invest for tomorrow (stoicism).
“Don’t invest in things that’ll rust, rot or depreciate, invest in things that’ll be worth more later or make you be worth more later”.
The information in this book is worth well over $65 if read and implemented, the information on investing and cognitive biases is worth its weight in gold.
But remember, It’s the application of knowledge that counts, not just the acquisition (read it and take action!)