This series on human misjudgment is authored by Philip Ordway. Phil originally shared his insights in a talk at The Zurich Project.

Preface: Phil Ordway on “Human Misjudgment Revisited”

“I’ve been wrong for many years in saying that the single greatest challenge for investors is to develop self-control. In fact, the single greatest challenge investors face is to see ourselves as we actually are.” –Jason Zweig

Introduction to the Psychology of Misjudgment

“Man is a rational animal. So at least we have been told. Throughout a long life I have searched diligently for evidence in favor of this statement. So far, I have not had the good fortune to come across it.” –Bertrand Russell

Under-Recognition of the Power of Reinforcement and Incentives

“I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.” –Charlie Munger

Incentive-Caused Bias and Agency Costs

“Human nature causes this terrible abuse. Many of the people doing it you would be glad to have marry into your family compared to what you’re otherwise going to get.” –Charlie Munger

Consistency and Commitment Tendency

“The human mind is a lot like the human egg, and the human egg has a shut-off device. When one sperm gets in, it shuts down so the next one can’t get in. The human mind has a big tendency of the same sort.” –Charlie Munger

Simple Psychological Denial

“The reality is too painful to bear, so you just distort it until it’s bearable. We all do that to some extent, and it’s a common psychological misjudgment that causes terrible problems.” –Charlie Munger

Bias from Pavlovian Association

“So the dog salivated when the bell rang – so what? The truth is that it is an enormously powerful force in the life of all of us. We wouldn’t have money without secondary reinforcement…Three-quarters of advertising works on pure Pavlov.” –Charlie Munger

Reciprocation Tendency

“It is so easy to be a patsy for what [Cialdini] calls the compliance practitioners of this life…a very, very powerful phenomenon.” “Wherever you turn, this consistency and commitment tendency is affecting you. In other words, what you think may change what you do, but perhaps even more important, what you do will change what you think.”–Charlie Munger

Bias from Over-Influence by Social Proof

“Big-shot businessmen get into these waves of social proof…I think time and time again, in reality, psychological notions and economic notions interplay, and the man who doesn’t understand both is a damned fool.” –Charlie Munger

Man-with-a-Hammer Syndrome

“What made these economists love the efficient market theory is the math was so elegant. And after all, math was what they’d learned to do. To the man with a hammer, every problem tends to look pretty much like a nail. The alternative truth was a little messy, and they’d forgotten the great economist Keynes, whom I think said, ‘Better to be roughly right than precisely wrong.” –Charlie Munger

Contrast-Caused Distortions of Sensation, Perception and Cognition

“The sensation apparatus of man is over-influenced by contrast – it has no absolute scale but it has a contrast scale. And it’s a scale with quantum effects too – it takes a certain percentage chance before it’s noticed. Here the great truth is that cognition mimics sensation. People are manipulating you all day with contrast. If it comes to you in small pieces you’re likely to miss it.” –Charlie Munger

Bias from Over-Influence by Authority

“This is a very powerful psychological tendency. It’s not quite as powerful as some people think, and I’ll get to that later.” –Charlie Munger

Deprival Super-Reaction Syndrome

“People are really crazy about minor decrements down…People do not react symmetrically to loss and gain. Well maybe a great bridge player like Zeckhauser does, but that’s a trained response. Ordinary people, subconsciously affected by their inborn tendencies…” –Charlie Munger

Prospect Theory and Loss Aversion

Prospect theory and loss aversion have a lot to say here. And beyond the idea of losing something owned or almost owned, there is a related deprival factor. Scarcity – real or perceived – is a huge driver of human behavior.

Bias from Envy/Jealousy

Envy and jealousy made two of the Ten Commandments, and for good reason. Buffett: “It’s not greed that drives the world, but envy.” Anyone who has raised siblings, or run a law firm or an investment bank or even a faculty is familiar with this issue. –Charlie Munger

Chemical Dependency

“It always causes moral breakdown if there’s any need, and it always involves massive denial. It aggravates [denial] as in the aviator case, the tendency to distort reality so that it’s endurable.” –Charlie Munger

Mis-Gambling Compulsion

Skinner showed that variable reinforcement rates in his lab animals was able to pound in a behavior better than any other method. But it not the only explanation for gambling. A lottery, for example, gets better play when it uses commitment and consistency tendency to have players pick their numbers as opposed to numbers generated by random. Slot machines do better by employing deprival super-reaction syndrome: BAR-BAR-LEMON (“near miss” after “near miss.”) –Charlie Munger

Bias from Liking/Dis-Liking Distortion

This article is part of a multi-part series on human misjudgment by Phil Ordway, managing principal of Anabatic Investment Partners. Bias from…

Bias from the Non-Mathematical Nature of the Human Brain

“The right way to think is the way Zeckhauser plays bridge. And your brain doesn’t naturally know how to think the way Zeckhauser knows how to play bridge.” –Charlie Munger

Bias from Over-Influence by Extra-Vivid Evidence

“It’s very easy to misweigh the vivid evidence, and Gutfreund did that when he looked into the man’s eyes and forgave the colleague.” –Charlie Munger

Excessive Self-Regard Tendency

Man commonly misappraises his own abilities and his own possessions. –Charlie Munger

Overoptimism Tendency

Demosthenes said, “What a man wishes, that also will he believe.” He was referring to denial and excessive optimism. There are other factors at play too, and they lead to happy people buying lottery tickets. –Charlie Munger

Stress-Induced Mental Changes

“Here, my favorite example is the great Pavlov. He 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. And 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.” –Charlie Munger

Common Mental Illnesses and Declines

This article is part of a multi-part series on human misjudgment by Phil Ordway, managing principal of Anabatic Investment Partners. Common mental…

Say-Something Syndrome

“[It] is a very important part of human organization to set things up 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.” –Charlie Munger

Reason-Respecting Tendency

“There is in man, particularly one in an advanced culture, a natural love of accurate cognition and a joy in its exercise. This accounts for the widespread popularity of crossword puzzles, other puzzles, and bridge and chess columns, as well as all games requiring mental skill. This tendency has an obvious implication. It makes man especially prone to learn well when a would-be teacher gives correct reasons for what is being taught, instead of simply laying out the desired belief ex cathedra with no reasons given. Few practices, therefore, are wiser than not only thinking through reasons before giving orders but also communicating these reasons to the recipient of the order.” –Charlie Munger

What Happens When These Standard Psychological Tendencies Combine?

“The clear answer is the combination greatly increases power to change behavior, compared to the power of merely one tendency acting alone.” When you get these lollapalooza effects you will almost always find four or five of these things working together. When I was young there was a whodunit hero who always said, “Cherchez la femme.” What you should search for in life is the combination, because the combination is likely to do you in.” –Charlie Munger

What Good, in the Practical World, is the Thought System Indicated by the List?

“The answer is the 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. Nonetheless, the psychological thought system described is very useful in spreading wisdom and good conduct when one understands it and uses it constructively. –Charlie Munger

Commentary by Jason Zweig

“A frequently asked question is, how do you learn to be a great investor? First of all, you have to understand your own nature, said Munger. Each person has to play the game given his own marginal utility considerations and in a way that takes into account his own psychology. If losses are going to make you miserable-and some losses are inevitable-you might be wise to utilize a very conservative pattern of investment and saving all your life. So you have to adapt your strategy to your own nature and your own talents. I don’t think there’s a one-size-fits-all investment strategy I can give you.” – Charlie Munger

Appendix

This article is part of a multi-part series on human misjudgment by Phil Ordway, managing principal of Anabatic Investment Partners. Recommended Reading…