Use Munger’s Psychology of Human Misjudgement to Boost Returns

This guest post documenting Munger’s Psychology of Human Misjudgement was written by Henry Jackson. Henry is a private investor based out of New York. Article image (creative commons) by Geralt.

My father had common sense in abundance. Pop taught me the benefit of patience and thrift and he had a flair for turning a phrase. Every year, I’d hear,

“You just got that money for your birthday, and it’s all gone? Put some aside. Don’t let it burn a hole in your pocket.”

My all-time favorite dad wisdom was,

“Christ! You’re always in a rush! Slow down! Take your time and do it right.”

My father’s sharp-tongued (but loving) admonishments remind me of Charlie Munger. Charlie is a lawyer, investor and business partner of Warren Buffett. Charlie is well known for his quick wit, sharp tongue and ability to simplify complex concepts.

What drives me nuts, though, is that Charlie has never provided a methodical process for picking stocks such as the methods I have found on Net Net Hunter and Broken Leg Investing. Charlie has said himself that, unlike Evan, he has no interest in providing information on how to make people rich. Charlie focuses on human biases that are destructive to investors.

In 1995 Charlie gave a lecture entitled The Psychology of Human Misjudgement. In the lecture, Charlie lays out 24 human biases that skew our thinking in many situations. Let’s review a few of these tendencies and consider how they often impact our thought process as deep value investors.

Psychology of Human Misjudgement: Doubt-Avoidance Tendency

This bias is rooted in the propensity that people have for making firm decisions in order to remove doubt. Charlie has this to say in Psychology of Human Misjudgement,

“It is easy to see how evolution would make animals drift toward the elimination of doubt. One thing that is counterproductive for a prey animal, threatened by a predator, is to take a long time in deciding what to do. The trigger for this tendency is some combination of puzzlement and stress.”

Early in my investing career when I was less knowledgeable (read: grossly ignorant), I allowed a stockbroker to convince me to purchase a “golden, can’t’-miss opportunity”. Of course, there was a limited time window that I had to act within. My lack of knowledge in researching companies caused stress and doubt in my nascent stock picking abilities. In order to feel better, I called the broker and in my most authoritative voice gave him an order to buy this stock.

We all know how this ends. The stock fell, and I lost money. The price of removing doubt: $400.00 -- money I could not afford to lose. Deep value investors should take this as a cautionary tale. If we are all subject to the doubt-avoidance tendency, recognizing it can help us avoid making decisions in order to avoid doubt. If we are puzzled and in doubt, perhaps the best thing to do is either get more information or put it in the “too hard pile” and move on. That is what Charlie and Warren Buffett would do.

Psychology of Human Misjudgement: Social-Proof Tendency

This bias dovetails nicely with the doubt-avoidance tendency. Charlie stated,

When will social-proof tendency be most easily triggered? In the presence of puzzlement or stress, and particularly when both exist.”

Charlie went further in describing social-proof tendency:

“Man’s evolution left him with social-proof tendency, an automatic tendency to think and act as he sees others around him thinking and acting.”

Applied to investing, this bias can be catastrophic to a deep value investor’s portfolio. Think about past economic bubbles such as the dot-com and the housing bubbles. Asset and stock prices became disconnected with reality as everyone around us was talking about the great investments they were making. These great investments were given credence by the talking heads on investment news programs and in the mainstream media. In both bubbles, the end results were a protracted economic contraction and the collapse of many hard-working peoples’ portfolios.

The current Bitcoin/cryptocurrency bubble is being fueled by the same bias that instigated and perpetuated past economic bubbles. Charlie commented on the Bitcoin frenzy in a CNBC interview:

“I think it is perfectly asinine to even pause to think about them. Its bad people, crazy bubble, bad idea, luring people into the concept of easy wealth without much insight or work. That’s the last thing on Earth you should think about. There’s just a whole lot of things that aren’t going to work for you. Figure out what they are and avoid them like the plague. One of them is Bitcoin. It is total insanity”.

There is a tendency to get caught up in the frenzy of bubbles. It is very difficult to fade the crowd. My father used to say,

“Peer pressure is a son of gun, but in the long run Henry, follow your own movement. You will be better off and sleep well.”

As deep value investors, the lesson here is about the importance of independent, critical thinking. Avoiding the herd mentality behind the latest investment fad keeps us focused on long-term growth in our deep value portfolios.

Psychology of Human Misjudgement: Twaddle Tendency

Twaddle. It’s a ridiculous sounding word, like a mixture of twit and waddle. But don’t let the silliness of the word fool you -- it refers to a huge bias that investors can fall prey to. Charlie stated in The Psychology of Human Misjudgement,

“Man, as a social animal who has the gift of language, is born to prattle and to pour out twaddle that does much damage when serious work is being attempted. Some people produce copious amounts of twaddle and others very little.”   

I think of twaddle as simply noise. There is so much noise out there, from CNBC, the Wall Street Journal, friends, family, stock market hucksters pushing the latest hot stock, fad, or investment that will make you rich beyond your wildest dreams. The logical part of our brain tells us these things are just a load of bunk, but this bias can draw us in if we get caught up in the twaddle tendency maelstrom.    

Charlie comment further on twaddle,

I had a gift for recognizing twaddle and there’s nothing remarkable about it. I don’t have any wonderful insights that other people don’t have. I just slightly more consistently than others have avoided idiocy. Other people are trying to be smarter. All I’m trying to be is non-idiotic. I find that’s all you have to do to get ahead in life is to be non-idiotic and live a long time. It’s harder to be non-idiotic than most people think.”

This is an example of the use of inverted thinking which has contributed to Charlie’s investing success. Avoiding non-idiotic behavior is difficult, but being aware of these universal human biases or tendencies can be of great worth to deep value investors.

Psychology of Human Misjudgement Charlie is right

When disagreeing on an issue, Charlie once said to Warren Buffett,

“Warren, think it over and you’ll agree with me because you’re smart and I’m right.”

We can chuckle at the tongue-in-cheek arrogance of Charlie’s statement but when you think of his long life, storied investment career, speeches, and understanding of  human behavior, you can see the rightness of his thinking.

I also think of the continuous work I have to do to continue to improve my skill as a deep value investor. Charlie’s insights in The Psychology of Human Misjudgement can teach all of us how to recognize cognitive biases and tendencies and do the necessary work to achieve success. I’m sure my father would agree.

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