Why we behave the way we do

The Psychology of Human Misjudgment by Charlie Munger

I’ve had this post in drafts for a while, but given the sad news today that Charlie Munger passed away at age 99, I figured it was time to get it out¹.

⚠️ Fair warning: this is a long read! If you’re tired, just watch the video below and come back when your mind is fresh :)

Here’s a 5 minute video looking back at the life and legacy of the investing legend:

“Berkshire Hathaway could not have been built to its present status without Charlie’s inspiration, wisdom and participation”

Warren Buffett .

ScrewDownCrown is a reader-supported guide to the world of watch collecting, behavioural psychology, & other first world problems. Both free and paid subscriptions are available.

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While he was one of the world’s best investors, Munger was best known for his armchair psychology and wisdom over the years. Here’s a compilation of some of his wisest quotes.

Moving beyond just his quotes… When he addressed Harvard University in 1995², he succinctly identified some key biases and genres of misguided thinking which cause people to make avoidable yet sometimes catastrophic mistakes. He shared lessons learned over his lifetime; Lessons which, in his own words, “didn’t learn well enough early enough.”

Charlie Munger spent his life attempting to avoid stupid mistakes. He gave a number of speeches on his experience over the years, and he ultimately compiled it all into one called: The Psychology of Human Misjudgment.

Munger noticed patterns of irrational behavior that led to repeated mistakes, so he set out to finds ways to understand psychology in order to avoid the mistakes himself:

I was greatly helped in my quest by two turns of mind.

First, I had long looked for insight by inversion in the intense manner counseled by the great algebraist, Jacobi: “Invert, always invert.” I sought good judgment mostly by collecting instances of bad judgment, then pondering ways to avoid such outcomes.

Second, I became so avid a collector of instances of bad judgment that I paid no attention to boundaries between professional territories. After all, why should I search for some tiny, unimportant, hard-to-find new stupidity in my own field when some large, important, easy-to-find stupidity was just over the fence in the other fellow’s professional territory? Besides, I could already see that real-world problems didn’t neatly lie within territorial boundaries. They jumped right across.

Luckily for us mere mortals, he came up with a list of 25 tendencies we’re all susceptible to… whether we know it or not. Here’s brief breakdown of these tendencies:

1. Reward and Punishment Superresponse Tendency

…almost everyone thinks he fully recognizes how important incentives and disincentives are in changing cognition and behavior. But this is not often so. For instance, I think I’ve been in the top five percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I’ve always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower…

While rewards are a great motivator, they can just as easily lead to bad behaviour or what Munger defines as “incentive caused bias.”

“One of the most important consequences of incentive superpower is what I call “incentive caused bias.” A man has an acculturated nature making him a pretty decent fellow, and yet, driven both consciously and subconsciously by incentives, he drifts into immoral behavior in order to get what he wants, a result he facilitates by rationalizing his bad behavior, like the salesmen at Xerox who harmed customers in order to maximize their sales commissions.”

This Xerox story he’s referring to, is where they couldn’t understand why a new machine was selling less well than an older and inferior machine. It turned out the commission arrangement with the salespeople gave a large incentive to push the inferior machine on customers.

It will not come as a surprise to anyone that when the reward involves keeping a job or receiving more money, it is more likely someone will game the system, especially when the consequences seem minimal. We see this all the time in the watch media world, as well as with ‘influential’ personalities or ‘collectors’ with a large following. Don’t hate the player… just understand the game.

Never, ever, think about something else when you should be thinking about the power of incentives.

The worst incentives tend to be beneficial in the short-term good but value destructive in the long-term. In the Xerox example, customers were getting an inferior product when they need not have been, and this would end up annoying them when they discovered much later on, they were being sold an outdated product. In future, they may choose to buy from a competitor instead. That is value destructive.

The same principle can be applied to multi-brand watch dealers who have been known to bundle desirable watches with bad-sellers; or mono-brand boutiques who also bundle the hype pieces with the commonplace ones… this is value destructive.

2. Liking/Loving Tendency

“And what will a man naturally come to like and love, apart from his parent, spouse, and child? Well, he will like and love being liked and loved. And so many a courtship competition will be won by a person displaying exceptional devotion, and man will generally strive, lifelong, for the affection and approval of many people not related to him.

One very practical consequence of Liking/Loving Tendency is that it acts as a conditioning device that makes the liker or lover tend:

1. to ignore faults of, and comply with wishes of, the object of his affection,

2. to favor people, products, and actions merely associated with the object of his affection (as we shall see when we get to “Influence-from Mere-Association Tendency”), and

3. to distort other facts to facilitate love.

Where to begin with this one!? In the extreme, one might ignore all faults of people, things, ideas, and beliefs … when we admire them. Even if we can’t completely ignore the faults, we are likely to discount the faults, or distort their significance.

In the real world, whether you’re buying watches you covet, investing in stocks of companies you admire, or buying a property you love; when you purposely ignore or distort the bad stuff, thigs tend to end up badly.

The inherent confirmation bias drives us to seek evidence which supports our views and pushes us to avoid digesting or even acknowledging bad news. We become incapable of making sensible decisions when we are subconsciously overlooking all the relevant facts.

Further, people tend to treat objects or assets as if they can reciprocate emotions. You might buy a watch and “fall in love” with it, because aside from the beauty or the technical brilliance, the market value also appreciated significantly, and so the watch reminds you of your shrewdness and impeccable ability to ‘pick winners’. Such thinking will have the extreme consequence of being unable to let go of these objects even when it is clearly the right thing to do. Stuff is just, stuff; don’t lose sight of that.

3. Disliking/Hating Tendency

In a pattern obverse to Liking/Loving Tendency, the newly arrived human is also “born to dislike and hate” as triggered by normal and abnormal triggering forces in its life…

Disliking/Hating Tendency also acts as a conditioning device that makes the disliker/hater tend to:

1. ignore virtues in the object of dislike,

2. dislike people, products, and actions merely associated with the object of his dislike, and

3. distort other facts to facilitate hatred.

Distortion of that kind is often so extreme that miscognition is shockingly large.

This is basically the opposite of the liking/loving tendency, the outcomes aren’t dissimilar at all. This is the equivalent of hating all Rolex-wearers because “they are all obnoxious show-offs,” or something equally daft. Dislike or hate can drive people to become closed-minded, and this might lead to selection bias or even twisting of facts, to fit the narrative of their hate. 

4. Doubt-Avoidance Tendency

The brain of man is programmed with a tendency to quickly remove doubt by reaching some decision. It is easy to see how evolution would make animals, over the eons, drift toward such quick elimination of doubt. After all, the one thing that is surely counterproductive for a prey animal that is threatened by a predator is to take a long time in deciding what to do. And so man’s Doubt-Avoidance Tendency is quite consistent with the history of his ancient, nonhuman ancestors.

We all have the pre-programming required to reach decisions quickly. If you’re being chased by a lion in Namibia, you won’t take long to decide it is time to run away. If, however, the watch market is tanking, this instinctual urge to run becomes less beneficial. Then of course, comes doubt; this usually leads to stress and anxiety, and can cause people to avoid decisions altogether. Doubt is why people might avoid good deals on watches, in a bear market, after a crash… despite these values being objectively low in the context of their collecting journey.

5. Inconsistency-Avoidance Tendency

The brain of man conserves programming space by being reluctant to change, which is a form of inconsistency avoidance. We see this in all human habits, constructive and destructive. Few people can list a lot of bad habits that they have eliminated, and some people cannot identify even one of these. Instead, practically everyone has a great many bad habits he has long maintained despite their being known as bad. Given this situation, it is not too much in many cases to appraise early-formed habits as destiny. When Marley’s miserable ghost says, “I wear the chains I forged in life,” he is talking about chains of habit that were too light to be felt before they became too strong to be broken…

It is important not to thus put one’s brain in chains before one has come anywhere near his full potentiality as a rational person.

We are creatures of habit, and averse to change by default. Try going on a new eating plan, starting a new hobby, or quitting a bad habit; you’ll know from experience, this is tough!

Specifically for collectors, the solution is to avoid confirmation bias at every opportunity. Before reaching any conclusions, seek counterarguments to disprove your beliefs, and if you find them compelling… be brave enough to change your mind.

6. Curiosity Tendency

Curiosity, enhanced by the best of modern education (which is by definition a minority part in many places), much helps man to prevent or reduce bad consequences arising from other psychological tendencies. The curious are also provided with much fun and wisdom long after formal education has ended.

What Munger described as the “man with a hammer syndrome” is easily solved by having a general sense of curiosity in life. Too often, we take things at face value, and fundamentally get fooled into group think without even realising it. In this old post, I wrote about how fake news works, worth a look if you missed it.

7. Kantian Fairness Tendency

Kant was famous for his “categorical imperative,” a sort of a “golden rule” that requires humans to follow those behavior patterns that, if followed by all others, would make the surrounding human system work best for everybody. And it is not too much to say that modern accultured man displays, and expects from others, a lot of fairness as thus defined by Kant.

This is generally true but there are always exceptions. The world is not fair. No sh*t. The key takeaway is you will never be able to control for the small percentage of a**holes you encounter in life. You can choose to take it personally, get upset, and waste your time and energy on them... Or simply accept they are not worth any of your time and move on. It is always a choice.

8. Envy/Jealousy Tendency

A member of a species designed through evolutionary process to want often-scarce food is going to be driven strongly toward getting food when it first sees food. And this is going to occur often and tend to create some conflict when the food is seen in the possession of another member of the same species. This is probably the evolutionary origin of the Envy/Jealousy Tendency that lies deep in human nature…

Envy/jealousy is extreme in myth, religion, and literature wherein, in account after account, it triggers hatred and injury.

The magic here, is of course food can be anything you want: money, power, recognition, investment returns or watches. One person may have what another person desires… and this can lead to envy and jealousy that which, in turn lead to resentment and hate. Here’s a link to a bunch of my old posts on this topic.

As I have shared the observation of life with Warren Buffett over decades, I have heard him wisely say on several occasions: “It is not greed that drives the world, but envy.”

9. Reciprocation Tendency

The human tendency of humans to reciprocate both favors and disfavors has long been noticed as it is in apes, monkeys, dogs, and many less cognitively gifted animals. The tendency facilitates group cooperation for the benefit of members. In this respect, it mimics much genetic programming of the social insects. We see the extreme power of the tendency to reciprocate disfavors in some wars, where it increases hatred to a level causing very brutal conduct…

Reciprocity Tendency subtly causes many extreme and dangerous consequences, not just on rare occasions but pretty much all the time.

We already know from the Kantian fairness tendency that most people tend to return favours, but this system can be gamed such that bad actors may cause some to end up doing favours for others which they wouldn’t normally agree to do.

“Whose bread I eat, his song I sing.”

Warren Buffett

Now, the simple solution would be to become really well-versed at saying “No!” If that proves to be difficult, at least give yourself some thinking time before agreeing to anything or making any big decisions.

10. Influence-from-Mere Association Tendency

…there is another type of conditioned reflex wherein mere association triggers a response. For instance, consider the case of many men who have been trained by their previous experience in life to believe that when several similar items are presented for purchase, the one with the highest price will have the highest quality. Knowing this, some seller of an ordinary industrial product will often change his product’s trade dress and raise its price significantly hoping that quality seeking buyers will be tricked into becoming purchasers by mere association of his product and its high price.

Correlating price with quality has long been abused by marketers and brands… As luxury buyers, we know this too well. Sometimes you do get what you pay for, but for the most part, you’re paying extra for the brand.

Munger gives an example of someone who gambles for the first time on a low probability bet and wins. Then he repeats the bet and loses, but subsequently repeats the bet and loses… because he never bothered to consider the initial win was pure luck. The association of winning despite a low probability of winning, ends up compounding foolish decisions.

The solution is to evaluate your decisions independently of the result:

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.

11. Simple, Pain-Avoiding Psychological Denial

This phenomenon first hit me hard in World War II when the super-athlete, super-student son of a family friend flew off over the Atlantic Ocean and never came back. His mother, who was a very sane woman, then refused to believe he was dead. That’s Simple, Pain Avoiding Psychological Denial. The reality is too painful to bear, so one distorts the facts until they become bearable. We all do that to some extent, often causing terrible problems. The tendency’s most extreme outcomes are usually mixed up with love, death, and chemical dependency.

Denial compounds our problems. The straightforward solution is the realisation that not everything works out the way we expect it to, and despite how it makes us feel, life will go on...

In the stock market, or in watch collecting… losing sucks. The effort people will expend to avoid pain ultimately leads to the avoidance of any risk altogether - this is called loss aversion. Loss aversion as an approach to life, is tantamount to a guarantee of a mediocre life.

12. Excessive Self-Regard Tendency

We all commonly observe the excessive self-regard of man. He mostly misappraises himself on the high side, like the ninety percent of Swedish drivers that judge themselves to be above average. Such misappraisals also apply to a person’s major “possessions.” One spouse usually overappraises the other spouse. And a man’s children are likewise appraised higher by him than they are likely to be in a more objective view. Even man’s minor possessions tend to be overappraised. Once owned, they suddenly become worth more to him and he would pay if they were offered for sale to him and he didn’t already own them… And all man’s decisions are suddenly regarded by him as better than would have been the case just before he made them.

I discussed the endowment effect in this post: When something is ours, even if only for a brief period of time, we overestimate its value relative to the value of other things we don’t own. We overestimate our skills, decisions, and possessions, and we also prefer people similar to us, as discussed here. This often leads to groupthink or herd mentality.

13. Over-optimism Tendency

Demosthenes, the most famous Greek Orator, said, “What a man wishes, that also will he believe.”

Demosthenes, parsed out, was thus saying that man displays not only Simple, Pain-Avoiding Psychological Denial but also an excess of optimism even when he is already doing well.

How many people were blindly buying watches because they thought it was a (financial) no brainer in recent times? Even now, how many people are being preyed upon by dealers taking advantage of information lag - buying into what they believe to be highly desirable watches? Perhaps worst of all, how much money was wasted by people trying to ‘find the next Journe’ or ‘the next Rexhep?’

This force which drives people to believe they have found a direct path to quick riches is excessive optimism. Understanding basic math and probabilities is a useful reminder of how unpredictable the future really is.

14. Deprival Super Reaction Tendency

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. Moreover, if a man almost gets something he greatly wants and has it jerked away from him at the last moment, he will react much as if he had long owned the reward and had it jerked away…

In displaying Deprival Superreaction Tendency, man frequently incurs disadvantage by misframing his problems. He will often compare what is near instead of what really matters.

There is a lot going on here, and I have covered this in many ways but can’t think of a particular post to link to… but long-time readers will recognise the assertion that losses hurt twice as much as equivalent gains feel good. This links to the sunk cost fallacy, as well as loss-aversion, and perhaps the desire for people to chase their break-even. This is basically why the house always wins.

15. Social-Proof Tendency

The otherwise complex behavior of man is much simplified when he automatically thinks and does what he observes to be thought and done around him. And such followership often works fine. For instance, what simpler way could there be to find out how to walk to a big football game in a strange city than by following the flow of the crowd. For some such reason, 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.

Lord, this is basically Instagram-watch-collecting in a nutshell, is it not? This tendency played a huge part in the bubble of 2020/21, which demonstrated how quickly social proof drives people toward herd behaviour.

Most people take comfort in being wrong along with everyone else, but never in being wrong alone. Of course, the nature of cycles makes it more profitable to be independent of the crowd at the extremes of the cycle. This happens to be where we are at this moment in time!

The solution:

Learn how to ignore the examples from others when they are wrong, because few skills are more worth having.

16. Contrast-Misreaction Tendency

Because of the nervous system of man does not naturally measure in absolute scientific units, it must instead rely on something simpler. The eyes have a solution that limits their programming needs: the contrast in what is seen is registered. And as in sight, so does it go, largely, in the other senses. Moreover, as perception goes, so goes cognition. The result is man’s Contrast-Misreaction Tendency. Few psychological tendencies do more damage to correct thinking. Small-scale damages involve instances such as man’s buying an overpriced $1,000 dashboard merely because the price is so low compared to his concurrent purchase of a $65,000 car…

You may fail to observe them, but small changes add up really quickly. Compounding simply exacerbates this:

Cognition misled by tiny changes involving low contrast, will often miss a trend that is destiny.

One of Ben Franklin’s best-remembered and most useful aphorisms is “A small leak will sink great ships.” The utility of the aphorism is large precisely because the brain so often misses the functional equivalent of a small leak in a great ship.

Price anchoring and add-ons also take advantage of this. Even when buying watches, people rarely consider the added cost of storage, or insurance, or servicing. They also rarely consider the opportunity cost of capital due to watch ownership.

17. Stress-Influence Tendency

Everyone recognizes that sudden stress, for instance from a threat, will cause a rush of adrenaline in a human body, prompting faster and more extreme reaction. And everyone who has taken Psych 101 knows that stress makes Social-Proof Tendency more powerful.

In a phenomenon less well recognized, but still widely known, light stress can slightly improve performance — say, in examinations — whereas heavy stress causes dysfunction.

I don’t think anyone will dispute that being under stress can easily lead to sub optimal decision making. Removing things which cause stress or which have a tendency to lead to further stress, will help to improve decision-making.

18. Availability-Misweighing Tendency

The mental tendency echoes the words of the song: “When I’m not near the girl I love, I love the girl I’m near.”

Man’s imperfect, limited-capacity brain easily drifts into working with what’s easily available to it. And the brain can’t use what it can’t remember or what it is blocked from recognizing because it is heavily influenced by one or more psychological tendencies bearing strongly on it, as the fellow is influenced by the nearby girl in the song. And so the mind overweighs what is easily available and thus displays Availability-Misweighing Tendency.

In short, we tend to overweight whatever is right in front of us… if you see a person being mugged in London, your perception of safety in London versus just the previous day, will be drastically different despite the fact that you might have lived in London for 20 years, and the crime stats have barely changed.

If you have personally owned a troublesome watch, you will know this can often ruin the ownership experience and your own perception of the brand and its reliability - despite the fact that nobody else you know, has ever had as bad an experience as you have.

Adopting a process for developing your perspectives or a fact-checking and data-driven approach to reaching any conclusions, is a reliable way of avoiding this trap.

19. Use-It-or-Lose-It Tendency

All skills attenuate with disuse. I was a whiz at calculus until age twenty, after which the skill was soon obliterated by total nonuse.

I can relate to Munger’s loss of calculus capabilities... I once knew how to derive Itô's lemma - I can assure you that ability exited my brain within 3 seconds of confirmation I had passed and completed my degree in the field! This has little to do with watches, and perhaps just applies to your daily life. Whatever skills you have, be it a musical instrument, sports, or even speaking other languages. Stop practicing or using your skill, and you will lose it over time. Obvious, sure; but hey, I am doing the whole list!

20. Drug-Misinfluence Tendency

This tendency’s destructive power is so widely known to be intense, with frequent tragic consequences for cognition and the outcome of life, that it needs no discussion here to supplement that previously given under “Simple, Pain-Avoiding Psychology Denial.”

In chemical dependency, wherein morals usually break down horribly, addicted persons tend to believe that they remain in respectable condition, with respectable prospects. They thus display an extremely unrealistic denial of reality as they go deeper and deeper into deterioration… One should stay far away from any conduct at all likely to drift into chemical dependency. Even a small chance of suffering so great a damage should be avoided.

I won’t even get into Class A drugs and the negative side-effects… you aren’t that daft. That said, addiction is a dependency - it is a crutch, which can destroy you. Many addictions are actually overlooked as being an addiction at all. I was once so overloaded with caffeine that I was able to down a Red Bull or three, and go straight to bed. Within 90 minutes of waking up, if I had not ingested some caffeine, the headache would come rapidly… with a vengeance. Coffee doesn’t seem so bad, but I have since weaned myself off this addiction and I can now use caffeine strategically, when I require a little boost. I also don’t have to panic when I have no access to caffeine in a hurry, and my morning routine is better for it. I also have improved sleep quality.

Now, with watches, people think this is an addiction too; and it can be - but not the type of addiction you think. There are many different types of collectors, but the ones with an addiction problem are the ones who get a kick out of the eventual purchase, but who also tend to lose interest in these new purchases fairly quickly. At which point, their addiction leads them to find their next fix. For them, there is a particular feeling triggered by a new watch purchase (praise from friends, retail therapy, whatever) - and then this dopamine fades and they must chase some more. I wrote about this elsewhere, so let’s move on.

21. Senescence-Misinfluence Tendency

With advanced age, there comes a natural cognitive decay, differing among individuals in the earliness of its arrival and the speed of its progression. Practically no one is good at learning complex news skills when very old. But some people remain pretty good in maintaining intensely practiced old skills until late in life, as one can notice in many a bridge tournament.

This is quite similar to the use-it-or-lose-it tendency above. Curiosity, continuous learning, and regular practice are useful tools which can delay the natural side-effect of ageing. In addition, I think that keeping busy, or having some daily purpose also slows ageing. Retiring, and then sitting at home with nothing to do is a sure-fire way to begin an early decline. This is where many years of collecting watches in a community can help… if you have a good circle of friends who can routinely serve as social support in your later years, you’re likely to have many more enjoyable years in the twilight of your life.

22. Authority-Misinfluence Tendency

Living in dominance hierarchies as he does, like all his ancestors before him, man was born mostly to follow leaders, with only a few people doing the leading. And so, human society is formally organized into dominance hierarchies, with their culture augmenting the natural follow-the-leader tendency of man.

But automatic as most human reactions are, with the tendency to follow leaders being no exception, man is often destined to suffer greatly when the leader is wrong or when his leader’s ideas don’t get through properly in the bustle of life and are misunderstood. And so, we find much miscognition from man’s Authority-Misinfluence Tendency.

The irony of this one, is how so many people put their faith in Munger himself, and Buffett; and that turns out just fine - but of course, there are countless other examples in history where things turned out horribly. Remember Hitler?

The obvious implication: be careful whom you appoint to power because a dominant authority figure will often be hard to remove…

23. Twaddle Tendency

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.

This is better known as bullsh*tting. Fundamentally, it serves us well if we know our own limits and most of all… never be afraid of these three words: “I don’t know.”

24. Reason-Respecting Tendency

This tendency has an obvious implication. It makes man especially prone to learn well when a would-be teacher gives correct reasons for what is taught, instead of simply laying out the desired belief ex-cathedra with no reasons given…

In general, learning is most easily assimilated and used when, life long, people consistently hang their experience, actual and vicarious, on a latticework of theory answering the question: Why? Indeed, the question “Why?” is a sort of Rosetta stone opening up the major potentiality of mental life.

Unfortunately, Reason-Respecting Tendency is so strong that even a person’s giving a meaningless or incorrect reason will increase compliance with his orders and requests.

The simple process of explaining “Why?” has been proven to play a key role in driving behaviour. In this famous study, they uncovered one of the most powerful words we use to drive our behaviour: because. Psychologist Ellen Langer and her research team at Harvard University proved that as long as we could justify a behaviour in our brains (“I’m doing this because…”), we would perform the behaviour even if the reason didn’t make sense.

25. Lollapalooza

The tendency to get extreme consequences from confluences of psychological tendencies acting in favor of a particular outcome.

If you’ve been subscribed for a while, you have seen this before. Only a handful of Munger’s biases apply in a vacuum; Most of them work in parallel to produce particularly bad decisions. Going through all these tendencies as you would a checklist, is a pretty useful way to unravel the biases which might lead to irrational but avoidable mistakes.

End

Here’s a video with some fun animations, and an abridged version of a few points from the full speech. A pdf copy is available here as well. Hope you found this useful.

Update: Check out this awesome website from Stripe press.

1. I later decided to release it on Thursday instead to avoid a clash with the SDC Weekly, but backdate the article to align with the anniversary of his demise.

2. Here’s a link to a video - but the audio is what matters, it isn’t a video recording.