1/18/2007

Miscellaneous Munger

A while back I posted about a speech regarding the shortcomings of Economics given by Charlie Munger, Warren Buffet's partner. While doing research for Moonshots and Tsunamis, my co-author Fouro acquired an audio recording of a speech given at Harvard in 1995 entitled The Psychology of Human Misjudgment. Clearly, the economics speech was a derivative work of this masterpiece. In the Harvard speech, Mr. Munger outlines about 20 causes of human misjudgment, and provides wonderful real world examples of these principles in action. I think we could raise GDP significantly if everyone would read this work at least once a year.

Here is the list of causes of human misjudgment, as he stated them in the speech:
  • Under-recognition of the power of what psychologists call 'reinforcement' and economists call 'incentives.'
  • Simple psychological denial.
  • Incentive-cause bias, both in one's own mind and that of ones trusted advisor, where it creates what economists call 'agency costs.'
  • This is a superpower in error-causing psychological tendency: bias from consistency and commitment tendency, including the tendency to avoid or promptly resolve cognitive dissonance. Includes the self-confirmation tendency of all conclusions, particularly expressed conclusions, and with a special persistence for conclusions that are hard-won.
  • Bias from Pavlovian association, misconstruing past correlation as a reliable basis for decision-making.
  • Bias from reciprocation tendency, including the tendency of one on a roll to act as other persons expect.
  • Now this is a lollapalooza, and Henry Kaufman wisely talked about this: bias from over-influence by social proof -- that is, the conclusions of others, particularly under conditions of natural uncertainty and stress.
  • Bias from contrast-caused distortions of sensation, perception and cognition.
  • Bias from over-influence by authority.
  • Bias from deprival super-reaction syndrome, including bias caused by present or threatened scarcity, including threatened removal of something almost possessed, but never possessed.
  • Bias from envy/jealousy.
  • Bias from chemical dependency.
  • Bias from mis-gambling compulsion.
  • Bias from liking distortion, including 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.
  • 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 on this list.
  • Bias from over-influence by extra-vivid evidence.
  • 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.
  • Other normal limitations of sensation, memory, cognition and knowledge.
  • Stress-induced mental changes, small and large, temporary and permanent.
  • Then we've got other common mental illnesses and declines, temporary and permanent, including the tendency to lose ability through disuse.
  • Development and organizational confusion from say-something syndrome.

He then goes on to say that exploiting these biases in combination is extremely powerful (or dangerous, depending upon one's motivations). He cites Tupperware parties as a particularly profitable example of this phenomenon.

Later, I found this written compilation of his thoughts. The material is completely reorganized, and some biases are renamed, such as the "Twaddle Tendency". Perhaps this version should be the standard reading, but 90 pages might put some people off.

Continuing to look for definition of Munger's Lattice of Models, I found a speech he gave at USC in 1994 entitled “A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business” (also known as Art of Stockpicking). This one describes in more detail his notion of the Lattice of Mental Models necessary for investing success. He also talks about how he thinks people make money at the horse track and in equities. They're the same. Where the Harvard speech focuses on psychology, this one mentions a knowledge of psychology as one of the models, but focuses more on others, such as some key areas of mathematics, basic accounting, simple statistics, and microeconomics to name a few. FocusInvestor.com has a nice analysis of these principles.

Between these items and the speech in the previous post, you can get a pretty good idea of the importance of psychology to nearly every field of endeavor, and a model for how to array your decision-making processes to avoid misjudgments.



posted by Mike at 5:40 PM


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