Friday, July 3, 2009

The Psychology Of Human Misjudgment: Excessive Self-Regard

Charlie Munger is Warren Buffett's right hand man at Berkshire Hathaway. Over the next few weekends, we'll be 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 (without having to grab an online psychology degree), we better equip ourselves to avoid psychological biases when investing.

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 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.

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