Almost 20 years ago, Berkshire Hathaway Inc. (NYSE:BRK.B) vice-chairman Charlie Munger gave a talk called “The psychology of human misjudgment” at Harvard. He’s given dozens of talks since, but I don’t think any match its wisdom and usefulness.
I recently came found the talk on video. You can listen to the whole thing here, and I highly encourage you to if you have an hour to spare.
For the impatient, the talk discusses about 18 separate biases that cause people to fool themselves make bad decisions. I’ve summarized them here, along with a few comments from Munger.
1. Under-recognition of the power incentives. “I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. Never a year passes that I don’t get some surprise that pushes my limit a little farther.”
2. Simple denial. “If you turn on the television you find the mothers of the most obvious criminals that man could ever diagnose and they all think their sons are innocent. The reality is too painful to bear so you just distort it until it’s bearable. We all do it to some extent. It’s a common psychological misjudgment that causes terrible problems.”
3. Incentive-caused bias. “Both in one’s own mind and that in one’s trusted advisor … It causes perfectly terrible behavior. Take sales presentations of brokers of commercial real estate businesses. I’m 70 years old and I’ve never seen one that I thought was even within hailing distance of objective truth.”
4. Bias from consistency and commitment tendency. “The human mind is a lot like the human egg, in that the human egg has a shut-off device. One sperm gets in, and it shuts down so that the next one can’t get in. The human mind has a big tendency of the same sort … According to Max Plank, the really innovative and important new physics was never really accepted by the old guard. Instead, a new guard came along that was less brain-blocked by its previous conclusions. And if Max Plank’s crowd had this consistency and commitment tendency that kept their old conclusions intact despite disconfirming evidence, you can imagine what the crowd that you and I are a part of behaves like … What people are shouting out they are pounding in.”
5. Bias from Pavlovian association. “Practically three-quarters of advertising works on pure Pavlov. Just think how pure association works. Take The Coca-Cola Company (NYSE:KO), where we’re the largest shareholder. They want to be associated with ever-wonderful images — heroics, the Olympics, music, you name it. They don’t want to be associated with presidents’ funerals. The association really works … at a subconscious level, which makes it very insidious. The Persians really did kill the messenger that brought the bad news. Do you think that is dead?”
6. Bias from reciprocation tendency. “The human mind, on a subconscious level, can be manipulated and you don’t know it. I always use the phrase, ‘You’re like a one-legged man in an ass-kicking contest.’ … A guy named Zimbardo had people at Stanford divide into two pieces: one were the guards and the other were the prisoners. And they started acting out roles as people expected. He had to stop the experiment after about five days. He was getting into human misery and breakdown and pathological behavior … What you think may change what you do, but perhaps even more important, what you do will change what you think.”