I find it fascinating that financial markets are perceived to be very theoretical and complex, where retail investors do not stand a chance but, in reality, are just a culmination of human behaviour. More than anything. It is as if society is looking into a mirror. The late legendary investor Charlie Munger, too, recognized the importance of knowing human behaviour, summarised the mistakes he has made over time, and spoke of twenty-five such tendencies that we must be aware of. This article is my attempt to summarise and interpret his speech and add any valuable insights I can give into the first ten tendencies.
Reward and Punishment super response theory
This is a potent tendency. It is the power of incentives. It drives people to work towards rewards and away from punishment. He gives two examples to emphasise incentives.
First is the story of Federal Express. It was required of FedEx employees to rapidly shift all the packages from one plane to another in one night. No matter how hard management tried or however many methods they used, the night shift would never get done on time.
Until they changed the payment structure, instead of being paid per hour, the employees were paid by shift, and if the work was done early, they could leave. Lo and behold, the solution worked. The only reason it wasn’t working was because employees feared they might not get paid, and with a simple change, their incentives aligned with the company and the work was done.
The other story is of Xerox. Joe Wilson, who was then in the government, had a similar experience. He had to return to Xerox because he couldn't understand why its new machine sold so poorly to its older and inferior machine. When he returned to Xerox, he discovered that the commission arrangement with the salespeople gave a large and perverse incentive to push the inferior machine on customers, he changed the commision structure and well, it worked again.
Incentives are a very powerful tool, the success of free market capitalism is built on incentives. Any part of life, it is very essential to ensure that the incentives of people are aligned with the final goal.
This thought process could be used in investing. The book" What I Learned about Investing from Darwin" discusses how the author never invests in MNCs as their incentives are not aligned with the retail investors but of the parent company in a foreign nation. Hence, their actions, too, will not always benefit retail investors.
"If you would persuade, appeal to interest and not to reason."
2. Liking/loving tendency
What would happen if you dared go close to the puppies of a stray/wild dog or the goslings of a goose? There is a high chance that the mother will chase you off. We don't know what the mother feels is 'love', but we can be sure that there is some attachment that a mother and an offspring share over time. Such observation is visible among humans, too. We, ourselves, have built hundreds of connections that are built on love/liking or trust. Life would be mundane without such attachments, so we embrace it despite the obvious pitfalls of letting emotions supersede objectivity. Munger has mentioned some consequences, such as ignoring the faults of people we love, favouring people we love/like and distorting other facts to facilitate love.
These feelings can develop for objects such as businesses, institutions, etc, which cannot reciprocate emotions. This tendency to judge in favour of things we like is the bias from liking and loving. If investors had not fallen in love with businesses such as Yes Bank, Satyam, etc, they could have saved their money.
It's easier said than done, as big institutional investors and venture capitalists have fallen prey to Theranos, Nikola, etc.
3. Disliking/Hating tendency.
Just as we like and love, we also dislike and hate.
The consequence of hatred has been undeniable in human history. Charlie Munger provides multiple examples such as numerous wars waged due to hatred towards individuals, religions, nations, etc. Find any war that took place, and I will point you to the love or hate that led to it.
It is tough not to hate. I don't think I can curb an emotion so strong for all my life(some can, I can not), but it is essential to actively try and not let this hate dictate important life decisions.
From a stock market POV, Real estate had become a sector that was once a darling of the markets, but post-2008, the narratives turned, and all dreaded it. I, too, overlooked the industry because "it's considered a bad business" until I noticed the massive rise in the prices of such businesses. Hence, it pays to let rationality dictate your thoughts in the market. Not love, hatred, fear or euphoria.
4. Doubt Avoidance tendency
Whenever there is doubt in our mind, we tend to make a quick, uninformed decision; this bias is the Doubt avoidance tendency. We despise uncertainty and, hence, make a quick decision backed by a hasty and flawed conclusion. I have been susceptible to this tendency quite a bit. Whenever there is a correction, I would sell parts of my portfolio without any reason except that "markets are crashing." However, I have come to realize the simplest way to beat this tendency not only in the stock markets but also in other parts of our lives. Instead of making a quick decision, I just say to myself, "Take a step back and think." And that's all that needs to be done. Trust me, it's a very effective action to follow.
5. Inconsistency-Avoidance Tendency
Simply put, this bias is the tendency not to change your habits, ideologies, and thought processes. The combination of Doubt avoidance and Inconsistency avoidance is a potent cocktail and can create decisions backed by innumerable errors and flaws. Charlie Munger gives the example of Einstein and Darwin, where Einstein never entirely accepted the implications of his theory but considers Darwin one of the greatest who beat these tendencies by not giving into first thought bias and confirmation bias. It is an uncomfortable feeling to get out of our usual habits, but the only way to grow is to adapt to change and repeat. I believe that the next tendency we discuss is very helpful to tackle this one.
6. Curiosity Tendency
The success of Humanity could be owed to our curiosity. Munger believes that curiosity combined with modern education helps avoid the pitfalls discussed above and the ones discussed below. This curiosity fixes the 'man with a hammer 'problem, who believes all the problems are 'nails' and have the same solution. In investing, it is essential to have this tendency because it motivates us to delve deeper and find all the 'whys' of the market and helps us become informed investors.
7. Kantian Fairness Tendency
Immanuel Kant was a German philosopher who developed Kantian theory. It talked of how we must behave, never treat people as a means to an end and sort of a "golden rule" that required humans to follow those behaviour patterns that, if followed by all others, would make the surrounding human system work best for everybody.
Life isn't fair, which is a sad truth; Munger gives an example of letting people pass in a one-way tunnel, knowing they would do the same for someone someday. Hence, it is okay to let go of things such as arguments or fights in life and let go of losses in investing because being the best version of yourself is not as related to outcomes as you might think. Detaching processes with outcomes is key.
8. Envy/Jealousy Tendency
We always want what the other has. This is the crux of the tendency to be jealous. Humans are never satisfied with their current belongings and are often envious of what others have, and in the process of attaining that, we end up less than we had. This is arguably the worst sin in Christianity; we never get anything while indulging in it, but it destroys what we have.
Jealousy/ envy is a strong tendency that has existed in us ever since we came to exist. Even in investing, people are unsatisfied with their results and hop to different strategies to achieve what someone on social media is doing when they should be content and focused instead. (Even I do this quite a bit, sadly.)
"It is not greed that drives the world, but envy."
9. Reciprocation Tendency
We like to enjoy returning favours, be it good or bad. The automatic tendency to do this is the Reciprocation Tendency. Munger gives examples of situations where this tendency could have done better for us. Munger provides a psychology experiment as an example where people were asked to take care of juvenile delinquents for two years and, after rejection, asked to take care of them for a day in the zoo. This method led to a 3x jump in yes compared to directly asking them for a day in the zoo.
An easy solution to this is to say “no".
10. Influence from Mere Association Tendency
People can be easily manipulated by mere association. We associate price with quality; it may or may not be, but we assume that a high price is a high quality. In investing, we associate a name or a business with shady accounting or loss-making. Real estate, for example, was always related to corporate governance issues. Hence, even businesses with fair accounting traded below the usual multiple because of their association with the sector. It is such a strong bias that we might do it every day without realising it, and the sad part is it can be straightforward to justify the reason. A solution to this is curiosity. Delving deep into matters and getting at their crux will help break influence from mere association tendencies.
Now that you know ten of the 25 tendencies (The original speech is quite long, and that's why I will release part 2 and maybe 3 in the near future), I hope you and I can think through these biases before making an important decision in life.
Until then, shoot me a message or an email and let me know which of these tendencies you have fallen prey to.
References
Psychology of human misjudgment (transcript) by Charlie Munger. Farnam Street. (2024, January 1). https://fs.blog/great-talks/psychology-human-misjudgment/
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