Charlie Munger's lasting wisdom: 12 mental errors that can impact decision making of investors and managers

"Even man’s minor possessions tend to be overappraised. Once owned, they suddenly become worth more to him than he would pay if they were offered for sale to him and he didn’t already own them," said Charlie Munger. (Photo by George Becker: Pexels)

"Of what use is a philosopher who never offends anybody," asked the late Charlie Munger, quoting Diogenes, a Greek philosopher and founder of Cynicism.

This was in a preface to a speech titled 'Psychology of Human Misjudgement', a revised and expanded version published in 2005, more than 10 years after the original.

Munger, a legendary investor and long-time associate of Warren Buffett, died on November 28, a little over a month before his 100th birthday on January 1.

Also read: Invert, always invert: Charlie Munger's mental models that helped build his ‘30-second mind’

Quickly, using his 30-second mind as Warren Buffett called it, Munger saw the four disadvantages of publishing this speech — one, a longer version would be boring also because of its esoteric references to psychological terms; two, lack of formal knowledge that would invite criticism from experts in the field; three, disapproval of people who used to like him also seeing his speech as an act of arrogance; and four, that he would make a fool of himself.

Yet, Munger published this, for various reasons including Munger's love of his way of "laying out psychology" because it has been useful to him.

He went on to discuss 25 errors that the human mind makes. Here are 12 of them, which investors and managers can avoid, including the poor use of incentives and their "super power".

1. Reward and punishment super-response tendency
He said that since incentives have superpowers, they can lead to incentive-caused bias, such as Xerox inadvertently encouraging salespeople to sell inferior, older models instead of the newer ones with a badly thought out commission arrangement, or the Soviet Union's reward system ending in the administration pretending to pay the workers for the work they pretend to do. Since professionals are incentivised in the exercise of their skills, they may tend to overuse them to the detriment of the client; Munger cited the example of a surgeon who removed "bushel baskets full of normal gall bladders" believing the organ to be the root of all evil. He said, "Widespread incentive-caused bias requires that one should often distrust, or take with a grain of salt, the advice of one’s professional advisor, even if he is an engineer. The general antidotes here are: (1) especially fear professional advice when it is especially good for the advisor; (2) learn and use the basic elements of your advisor’s trade as you deal with your advisor; and (3) double check, disbelieve, or replace much of what you’re told, to the degree that seems appropriate after objective thought." There are well-designed reward systems and one of them, according to Munger, is what he calls the "Granny's Rule".

He said, "Granny’s Rule, to be specific, is the requirement that children eat their carrots before they get dessert."

2. Liking/loving tendency
A person has a natural tendency to "like and love being liked and loved". But this tendency can cause a person to act unwisely, according to Munger — by ignoring faults of, and complying with wishes of, the object of his affection; favouring people, products, and actions merely associated with the object of their affection; and distorting other facts to facilitate love. When when this liking/loving causes admiration, it feeds the liking/loving and this feedback loop can even cause "deliberate self-destruction to help what is loved".

3. Disliking/hating tendency
Just as liking/loving is a natural tendency, disliking/hating also is one, according to Munger. This causes a person to ignore virtues in the object of dislike; dislike people, products, and actions merely associated with the object of his dislike; and distort other facts to facilitate hatred.
4. Doubt avoidance tendency
Munger observed that the brain of man is driven to "quickly remove doubt by reaching some decision". This tendency is what gave rise to the need for judges and juries, he noted and added this tendency helps religions greatly. What triggers this tendency? According to Munger, puzzlement and stress.

5. Inconsistency avoidance tendency
Just as they don't like doubt, people's minds are resistant to change, noted Munger. He said, "People tend to accumulate large mental holdings of fixed conclusions and attitudes that are not often re-examined or changed, even though there is plenty of good evidence that they are wrong." In fact, people may even hold on to an identity or an idea they have pretended to like, only to avoid inconsistency. Munger said, "Many a hypocrite is improved by his pretensions of virtue. And many a judge and juror, while pretending objectivity, is gaining objectivity. And many a trial lawyer or other advocate comes to believe what he formerly only pretended to believe."

6. Reciprocation tendency
There is an extreme tendency among humans to reciprocate both favours and disfavours. While this tendency "enormously facilitated" commercial trade, which is a "fundamental cause of modern prosperity, this tendency can also be used to mislead people,” said Munger. He gave the example, of a person going shopping for a car. If the salesperson talks well and offers him/her a cup of coffee, the buyer could be persuaded to spend a little extra. In this case, since the money is going from the buyer himself/herself, there may be a certain amount of protection from manipulation, noted Munger. But if the buyer is there for someone else—like a company or a rich employer—the buyer could be persuaded more easily to part with that extra money. He said, "Wise employers, therefore, try to oppose reciprocate-favour tendencies of employees engaged in purchasing."

7. Influence from mere association tendency
People miscalculate based on past associations, for example, associate a brand with happiness by going by an advertisement or associate military with glory by going by the triumphant band music. But Munger said that the biggest miscalculations are made by associations that come from past successes, such as gamblers who score an accidental win in a casino and keep going there to repeat that feat. He said, "The proper antidotes to being made such a patsy by past success are (1) to carefully examine each past success, looking for accidental, non-causative factors associated with such success that will tend to mislead as one appraises odds implicit in a proposed new undertaking and (2) to look for dangerous aspects of the new undertaking that were not present when past success occurred." This causes organisations and people to punish people who bring bad news, and this can harm organisations in the long run. Therefore, at Berkshire, the common injunction is to "always tell us the bad news promptly. It is only the good news that can wait".

8. Excessive self-regard tendency
A person usually misappraises himself/herself on the high side, observed Munger, and also misappraises all that is associated with them. He said, "Even man’s minor possessions tend to be overappraised. Once owned, they suddenly become worth more to him than he would pay if they were offered for sale to him and he didn’t already own them." This leads to managers and team heads hiring people who are like them and the formation of cliques, and this ultimately stops change for the better. He noted, "Some of the worst consequences in modern life come when dysfunctional groups of cliquish persons, dominated by Excessive Self-Regard Tendency, select as new members of their organisations persons who are very much like themselves."

9. Overoptimism tendency
He quoted the Greek philosopher Demosthenes to make his point: "What a man wishes, that also will he believe". He said that an effective antidote to the blinding optimism is "trained, habitual use of the simple probability math of Fermat and Pascal".

10. Deprival-superreaction theory
"The quantity of man’s pleasure from a ten-dollar gain does not exactly match the quantity of his displeasure from a ten-dollar loss. That is, the loss seems to hurt much more than the gain seems to help," said Munger. This tendency hurts labour relations greatly, he noted. Workers seem to be more okay with companies shutting down than companies reducing their wages, though the former situation is more harmful, they see the second situation as more unacceptable because it is seen as a deprival.

Also read: Charlie Munger's common sense approach to investing

11. Twaddle tendencyMunger quoted an experiment done by a scientist BF Skinner, who studied honeybees that have to communicate the location of nectar to its hive. When they were faced with a structure they didn't comprehend, they didn't stay silent, instead, they did an incoherent dance (their form of communication). Munger said, "It’s a very important part of wise administration to keep prattling people, pouring out twaddle, far away from the serious work".

12. Reason-respecting tendency
Man has a "natural love of accurate cognition and a joy in its exercise", noted Munger. While this will serve in education well, with teachers having to give reasons to back what they are asserting, this tendency can work adversely too. Munger said that this tendency is so strong that "even a person’s giving of meaningless or incorrect reasons will increase compliance with his orders and requests".