The Psychology Of Human Misjudgement: Lollapalooza Tendency

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, we better equip ourselves to avoid psychological biases when investing.

Lollapalooza tendency is Munger's name to describe the many tendencies already described when they act in concert. When tendencies work together and reinforce each other, extreme outcomes can occur. As examples, Munger cites the Milgram experiments and the formation of cults as extreme outcomes due to the fact that many tendencies are at play.

But according to Munger, most psychology textbooks look at tendencies in oversimplified forms, where other tendencies are not present. In the fields of chemistry and physics, students learn the effects of several forces acting in combination. In the field of psychology, however, Munger believes there is much to be learned by studying the effects of these tendencies when seen in combination.

Munger describes a real world example of how several tendencies acted together to cause an unfortunate event that could have been prevented if antidotes had been applied. At McDonnell Douglas, an evacuation accident causing paralysis was caused by tendencies towards rewards, doubt-avoidance, authority-misinfluence, inconsistency-avoidance, social proof, and deprival.

Munger finishes the talk by making it clear that these tendencies have likely been more helpful than not to mankind over time, or they wouldn't exist. However, that doesn't mean rational individuals can't improve their situations by using antidotes where appropriate.

The Psychology Of Human Misjudgement: Reason Respecting

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, we better equip ourselves to avoid psychological biases when investing.

Humans enjoy mental exercises, puzzles and games. Munger attributes this to the fact that humans have a natural love for accurate cognition. As such, one of the best ways to convince a man to do something is to explain the reasons for why it must be done.

As an example of this tendency put to great use, Munger describes the philosophy of Carl Braun, the skilled designer of oil refineries. Whenever an order was given within his company, the order must always be accompanied by the reason why. Braun would fire those who didn't give the 'why', because he understood the positive influence it would carry down the line.

Because of this human preference for reason, even meaningless or incorrect reasons will increase compliance. Munger references a psychology experiment where people budge to the front of the line with meaningless excuses that are better received than they should be!

Marketers and various corporate departments will of course use this loophole within this reason-respecting tendency by offering up various claptrap reasons to help them get what they otherwise would not. As such, the student would be wise to investigate/analyze reasons before accepting them as valid.

The Psychology Of Human Misjudgement: Twaddling

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, we better equip ourselves to avoid psychological biases when investing.

To twaddle: to talk in a trivial, feeble, silly, or tedious manner; prate.

To prattle: to talk in a foolish or simple-minded way; chatter; babble.

Munger clearly does not have much time for twaddlers and prattlers. As a social animal, however, man is prone to twaddle even when serious work is being attempted. But some humans are more prone than others to twaddle, and those are the ones Munger believes should be kept far away.

To make himself appear more tactful, Munger quotes a very blunt Caltech professor who said "The principal job of an academic adminstration is to keep the people who don't matter from interfering with the work of the people that do."

Munger says he has suffered backlash due to the fact that he has expressed his view on this subject. Munger tells the story of a honeybee in an experiment who tried to convey the location of nectar to the other bees. Typically, the honeybee's dance serves as a map for the other bees to find the nectar. In the case of the experiment, however, the nectar had been placed straight up in the air, so that there was no existing communicative gesture in the honeybee language. The honeybee in the experiment proceeded to perform a completely incoherent dance. Munger says he has been dealing with the human equivalent of that honeybee all his life.

The Psychology Of Human Misjudgement: Authority Misinfluence

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, we better equip ourselves to avoid psychological biases when investing.

Man has a follow-the-leader tendency. While this can often lead to effective group operation, particularly when the leader is proficient, it can lead to disaster if the leader is wrong or if the leader's communication is misunderstood. This is due to the fact that followers will often ignore logic in the belief that the action as suggested by the leader must be correct.

Munger describes several situations, from the humourous to the disastrous, where the instructions of leaders were clearly wrong or misunderstood, yet the followers would perform seemingly illogical acts in the belief that the leader must know what he's doing. Hitler's ability to convince a group of people to commit genocide is a particularly grave example.

Because people will follow leaders whether they are wrong or right, it is extremely important to choose good leaders. Many CEOs are able to remain in power because of the respect they are afforded due to their positions! Munger notes a specific example where a CEO was blind to reality but remained at the helm of his company simply because of the respect afforded to his position.

The Psychology Of Human Misjudgement: Use It Or Lose It

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, we better equip ourselves to avoid psychological biases when investing.

Skills degrade when not practiced. The antidote to this unfortunate reality is to frequently practice useful but rarely used skills. This is akin to how pilots use flight simulators to practice rarely-used skills that they can't afford to lose.

Munger argues that if man does not practice his existing skills, his learning capacity will also shrink. This is due to the fact that he creates gaps in the framework he needs for understanding new experiences. A wise man creates a checklist of his skills, to ensure they are kept sharp.

But this tendency does not treat all skill bearers equally. If a skill is practiced diligently until fluency is reached, it degrades much more slowly and is refreshed much more quickly than if a skill is quickly crammed to, say, pass an exam.

With advanced age also comes more severe deterioration of skill. But an individual can maintain well-practiced skills to even a very old age. Munger also argues that continuous thinking and learning can help delay the deterioration that is inevitable.

The Psychology Of Human Misjudgement: Availability-Misweighing

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, we better equip ourselves to avoid psychological biases when investing.

When information is readily available, humans tend to put more emphasis on the value of that information. It is not only unavailable information that is underweighed as a result, but information that the brain can't remember or is blocked from using as a result of being influenced by another tendency.

Munger describes the main anitode to this tendency is the use of standard procedures (or checklists). Another antidote involves emphasizing factors for which numerical data is not available. Finally, one can hire intelligent, skeptical and articulate minds to argue against incumbent opinions.

While vivid and memorable evidence should be consciously underweighed (since it is subconsciously overweighed), such evidence can still be very useful. For one, it can be used constructively to persuade others of a correct conclusion. For another, it can be used to improve one's memory by attaching vivid images to items one does not want to forget, a technique of Greek and Roman classical orators who gave long, organized speeches without notes.

The lesson of this tendency is to understand that an idea or fact is not worth more simply because it is available.

The Psychology Of Human Misjudgement: Stress-Influence

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, we better equip ourselves to avoid psychological biases when investing.

It is known to many that stress causes an adrenaline rush that results in faster, more extreme reactions. Furthermore, light stress can improve performance, but heavy stress can cause dysfunction. But Munger argues that few people understand the mental breakdowns that stress can help cause, apart from depression.

Munger discusses various stress-related experiments run by Pavlov on dogs that demonstrate the awesome power of stress. In these experiments, Munger discusses the fact that Pavlov was able to identify how easily a particular dog would succumb to a nervous breakdown, that any dog could be broken down, and that a breakdown could only be reversed by imposing more heavy stress.

Munger asserts that stress can be so powerful that it is the key ingredient in the success of cults. Some of Pavlov's work could conceivably be applied to help parents 'deprogram' children that have been broken down by cults.

While the business or investing implications of this human tendency are not immediately obvious in this discussion, Munger wished to bring up the subject of stress lest his examination of human tendencies be glaringly incomplete.

The Psychology Of Human Misjudgement: Contrast Misreaction

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, we better equip ourselves to avoid psychological biases when investing.

"Contract-Misreaction" causes people to take actions which are potentially detrimental, because they appear insignificant or appear positive when compared to other actions. Munger uses an analogy of the human eyes to illustrate how this tendency works: humans only see items which contrast with their environment. In the same way, humans find it difficult to differentiate perceptions where there is little in the way of contrast. For example, a man may buy a $1,000 leather dashboard, even if overpriced, when considered in combination with the fact that the vehicle cost is a much larger $65,000.

While the above example is a relatively minor one, Munger points to some examples where this tendency can have detrimental and long-lasting effects. In business, Munger has seen marketers use this practice to their advantage. Real-estate brokers may show clients awful properties at inflated prices for the purpose of closing a sale on merely a bad property at a merely partially inflated price. This practice is also seen frequently in mainstream advertising, with service/product providers asserting a phony price for a product and then promptly offering a 'discount' to a lower price. Munger argues that even though consumers recognize this practice, it still works! Therefore, being aware of psychological ploys does not prove to be a perfect defense!

While a minor mistep caused by this tendency is on its own not disastrous, Munger argues that a series of seemingly minor misteps can lead to disaster. This can occur because each step represents only a minor deviation (i.e. low contrast) from the current situation. Munger uses the example of the live frog that boils to death because it never jumps out of a pot of slowly heated water, not realizing that the temperature is changing because the changes are minute.

Ben Franklin said that a small leak will sink a great ship. Munger argues that this is due to the fact that the brain often misses the small leak in the large ship.

The Psychology Of Human Misjudgement: Social Proof

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, we better equip ourselves to avoid psychological biases when investing.

Humans do as other humans do. This tendency has likely been beneficial throughout Man's history (e.g. in running away from an unseen predator because everyone else is doing it), but it causes some intriguing actions. For example, psychology professors have observed men turning around and facing backwards in elevators after the others (in collusion as part of the experiment) in the elevator have done so. Social-proof tendency has also been frequently used to cause subjects of experiments to make wild measurement errors simply because they trust the group's conclusions more than their own.

Munger sees this tendency often in the business world. When one management purchases a mining company, the competitor's management will seek to follow suit. When several competitors are involved, this often leads to a bidding war and the overvaluation of target companies beyond logic.

Not only negative actions are contagious, however; both good and bad behaviours are copied as a result of social proof. Therefore, Munger stresses the importance for human societies to stop bad behaviour as well as stress/display good behaviour. Furthermore, it is not only actions that serve to perpetuate social proof, but also inaction. Munger sees many companies' boards of directors as excellent examples of copied inaction leading to detriment: many directors fail to object to the group's line of thought until some form of public embarassment has been felt.

Munger finishes his thoughts of this tendency by offering the following advice to readers: "Learn how to ignore the examples from others when they are wrong, because few skills are more worth having."

The Psychology Of Human Misjudgement: Deprival

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, we better equip ourselves to avoid psychological biases when investing.

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 misprioritizes 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 labour 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.

The Psychology Of Human Misjudgement: Over-optimism

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, we better equip ourselves to avoid psychological biases when investing.

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.

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.

The Psychology Of Human Misjudgement: Pain-Avoiding Denial

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, we better equip ourselves to avoid psychological biases when investing.

The perfectly sane mother of a soldier who had not been heard from since World War II refused to believe her son was not alive and well. In order to avoid the pain she would feel from acknowledging his death, she distorted the facts in her own mind. This is what Munger refers to as simple, pain-avoiding, psychological denial.

It is difficult to criticize an individual who has used this denial to shield themselves from pain, but Munger finds it an admirable trait that others prefer to live by a different creed: "It is not necessary to hope in order to persevere."

While Munger believes we all use this form of denial at various points in our lives, it is particularly visible when used by those who suffer from some form of chemical dependency. Those under the influence of addiction often believe themselves to be in respectable condition with good prospects, when this is clearly not the case.

The Psychology of Human Misjudgement: Influence From Association

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, we better equip ourselves to avoid psychological biases when investing.

Humans tend to form judgements based on factors that may be irrelevant. This tendency of humans to be influenced by association is well understood by advertisers. In this way, people can be tricked into believing things that are not true. For example, producers will sometimes charge a higher price for a product only because customers perceive its quality to be higher due to the higher price. The association can even be trivial: if a pretty girl is pictured on the product's packaging, this too can drive buyers to be influenced to purchase.

However, Munger argues that the ramifications of this tendency that are caused by advertising are relatively trivial. The most important miscalculations due to this tendency come from improper associations with past successes, and liking/disliking to the point of ignoring relevant factors.

For example, if a man has success at a casino, he will associate that success with particular behaviours, and believe that his success can be repeated. All too often, he will wager - and lose - far more than his initial gains. Traders who are blessed with early success will often believe they are superior speculators, only to fall victim to their overconfidence. Munger argues two antidotes to combat this improper association: 1) look for accidental, non-causative factors that led to the initial success, and 2) look for dangerous aspects in the new venture that were not present in the old.

When it comes to liking/disliking to the point of ignoring relevant factors, Munger uses the example of man's (un)willingness to listen to bad news. People who "blame the messenger" often find themselves living in realities void of bad news and also void of fact. Munger uses examples from Ancient Persia, two major oil companies, and CBS to illustrate the detriment of ignoring bad news. To counteract this tendency, Munger claims Berkshire has a policy of "Tell us the bad news promptly; the good news can wait."

The Psychology Of Human Misjudgement: Reciprocation

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, we better equip ourselves to avoid psychological biases when investing.

Humans, apes, monkeys, dogs, and other animals all share the tendency to reciprocate. When someone does something nice (mean) to you, you tend to do something nice (mean) to them as well. The tendency fosters cooperation within groups, and also protects groups from the ill-intentioned.

The power of this tendency is strong, and can drive individuals to perform brutal acts. For example, in wars sometimes prisoners are not taken (but rather killed) when one side believes the other side is treating its prisoners unfairly. Non-war examples of disfavourable actions as a result of this tendency are road rage and injury-causing temper tantrums on athletic fields.

Munger notes that, whether good or bad, humans are not programmed to turn-the-other-cheek. The best antitode to falling victim to disfavourable actions resulting from this tendency is to defer reaction. Munger quotes Tom Murphy, whom Buffett has often called one of the best managers alive, who frequently says, "You can always tell the man off tomorrow, if it's such a good idea."

Positive reciprocation is just as strong as well. Marriage and commercial trade are listed as examples where this reciprocation fosters strong relationships. Because it is often a subconscious behaviour, one's tendency to reciprocate can also be taken advantage of. For example, when an automobile salesman offers small favours, you are more likely to accept a final sale price that is $500 higher than otherwise. A man who is spending someone else's money (e.g. the manager of a company, a government employee) are more likely to fall into this trap, since he is not the one who has to foot the bill. Sam Walton (the man who started Walmart) recognized this tendency early, causing him to implement a policy disallowing purchase managers from receiving gifts of any kind from vendors.

The Psychology Of Human Misjudgement: Curiosity and Fairness Tendencies

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, we better equip ourselves to avoid psychological biases when investing.

While all mammals are curious, apes are abnormally more curious than other mammals, and humans are by far the most curious of them all. Munger argues that this curiosity can drive the advancement of knowledge, using examples from Ancient Greece, where much math and science was developed out of pure curiosity. Individuals who are more curious than others also benefit from added wisdom long after their formal education is complete.

Munger also argues that man displays and expects fairness to and from others. Man's tendency towards reciprocity is part of this fairness tendency: when someone does something nice for you, you feel like doing something nice for them.

Sometimes, an individual will do something nice for another even when he knows that person will not have occasion to repay them. Man will allow drivers in front of them on the highway and even allow others to advance when they don't have right-of-way. This behaviour pattern may have evolved due to the fact that it makes everybody better off when these acts of indirect reciprocity are performed.

Because fairness has come to be expected, much conflict arises when fairness is expected and not provided!

The Psychology Of Human Misjudgement: Like and Dislike

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, we better equip ourselves to avoid psychological biases when investing.

The 2nd and 3rd tendencies Munger discusses are human tendencies to like and dislike. Certain triggers cause man (and other animals) to like and dislike others. For example, a baby goose will love and follow the first creature that is nice to it, whether it's its mother or a human being.

A consequence of these tendencies is that man will ignore faults of the object of their affection, favour people/products associated with that object, and distort facts to facilitate that love. Conversely, man will ignore virtues in the object of his dislike, dislike people/products associated with that object, and distort facts to facilitate hatred! Munger uses as an example the fact that mediations between Israelis and Palestinians are difficult because the facts on each side overlap very little.

Man also likes being liked, causing man to strive for the devotion and admiration of those around him. Munger also argues that an individual that loves admirable persons with a strong intensity has a great advantage in life. He says that both he and Warren Buffett are so inclined, and they both admired Warren's uncle Fred in this manner.

The Psychology of Human Misjudgement: Reward and Punishment Tendencies

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, we better equip ourselves to avoid psychological biases when investing.

In this chapter, Munger discusses the super powers of incentives. While he believes everyone understands how important incentives are, he also believes that everyone (including himself) constantly underestimates its powers. Munger takes the reader through examples at several companies (including Fedex, Xerox, GE, and Westinghouse) where aligned (misaligned) incentives powered (impeded) the firm's effectiveness. According to Munger, the most important rule in management is "Get The Incentives Right!"

An important consequence of the power of incentives is human bias caused by the very same incentives. This causes even generous and caring individuals to be able to rationalize to themselves even the most immoral and callous of behaviours. Munger's examples of this "cognitive drift" in action include a doctor murdering his patients, salesmen/brokers selling products their clients don't need, and management consultant reports that conclude with the advice "This problem needs more management consultant services."

Munger suggests some antidotes against falling prey to such bias: fear advice that, if implemented, is good for the advisor, learn the basic elements of your advisors trade, and doublecheck/disbelieve much of what you're told.

As powerful as incentives are, it is a puzzle to Munger that the topic is not discussed in academic textbooks devoted to psychology. Economists have long studied its powers, as incentives form the basis of many economic theories. Economists have also long used the term "agency costs" to describe a firm's costs due to the disconnect between manager and owner incentives. For example, a sales force paid only in commissions may be more efficient than a salaried sales force, but will also be more difficult to keep moral. As such, incentive systems make tradeoffs between costs and efficiency gains.

Read the other misjudgments here!