Sunday, July 5, 2009

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.


Par1234 said...

This is interesting - especially when read in conjunction with your last post. On one hand, people are overly optimistic when it comes to their odds. On the other hand, they take "deprival" very hard. I wonder if they hate losing more than winning because it comes as more of a surprise, given their tendency to be overly optimistic about their odds!

I guess this means that workers may, for example, fight tooth-and-nail over the loss of benefits, confident in the belief that their jobs are safe when, in fact, the company that they work for is sinking fast (which can place them in a far worse situation than the loss of their benefits). Scary!

Saj Karsan said...

Interesting association! You may be right