The Psychology of Human Misjudgment
The Psychology of Human Misjudgment by Charlie Munger.
I recently read through the transcript of “The Psychology of Human Misjudgment” by Charlie Munger and selected some of my favorite excerpts to expand on. It's an incredible piece of work, and I recommend everyone either read or listen to it in its entirety. Those unaware of the many psychological blind spots are as Charlie says, “a one-legged man in an ass kicking contest.”
“What made these economists love the efficient-market theory is the math was so elegant, and after all, math was what they'd learned to do. To the man with a hammer, every problem tends to look pretty much like a nail. The alternative truth was a little messy, and they'd forgotten the great economist Keynes, whom I think said, “Better to be roughly right than precisely wrong.”
In the messy reality of public markets, it's easy to get a false sense of confidence when you deduce all information into numbers. You think you are getting somewhere because you performed complex math instead of simple rational thinking. Try to keep things simple and understand that the market will do wild things occasionally. There will be moments of inefficiency, panic, and other variables that no mathematical model could have seen coming.
“Well what I'm saying here is that the human mind is a lot like the human egg, and the human egg has a shut-off device. When one sperm gets in, it shuts down so the next one can't get in. The human mind has a big tendency of the same sort. And here again, it doesn't just catch ordinary mortals, it catches the deans of physics. According to Max Planck, the really innovative, important new physics was never really accepted by the old guard.”
Many of these quotes might seem obvious when initially read, and that's exactly why they are so dangerous. When you are steeped in a practice that has authoritative figures deemed correct by reputable institutions, it is not only hard to expand or condense something from the existing theory, it’s dangerous. That certain model already exists in the minds of many, and has been used as a steppingstone to build upon, if you remove that step you could topple other ideas. This is true at an institutional level and personal level. When one commits to an idea after a lot of hard work and research, it's much easier to cast out new opposing information than accept it as possibly valid. When observing a business or person, many times we come to conclusions quickly through pattern recognition. Certain traits remind you of something, and you conflate the two. If you already have that person or business put in a box, it’s very hard to allow new information in. Make sure your conclusions are not final.
“Bias from over-influence by social proof, that is, the conclusions of others, particularly under conditions of natural uncertainty and stress”
“The prices on the market are the ultimate form of social proof, reflecting what other people think, and so the combination is very powerful.”
These two quotes are similar to the first quote. Except that instead of coming to a conclusion and stopping, this continues to reinforce one through social approval. This one has sent many new traders and investors to the poor house, including myself. When you are new, you trust others more than yourself. Sometimes its people you hardly know online, or a friend who made one good trade and is now an expert. In the beginning you have to learn the process instead of listening to the buying and selling of others. This is especially hard with the internet today. Many people are in chat rooms, on Twitter, and can see numerous views in a quick scroll. It’s very hard to ignore bubbles when everyone is buy and making money and posting it online. You come back from your day job wondering what kid of sucker you are. Well, three months later those people are all blown up wishing they had a steady income. Ignoring the crowd has always been hard, and has become even harder with the internet. The internet is always looking for the next trend to jump on. And when the market is hot, nothing sells like stock tips.
“I think time and time again, in reality, psychological notions and economic notions interplay, and the man who doesn’t understand both is a damned fool.”
Munger said this in the 90s. Today behavioral economics is more widely accepted. The economy is made up of humans. Human decisions drive output and markets. Of course, you're a “damned fool” if you can't reconcile that.
“You've got to array facts on theory structures answering the question why. If you don't do that, you cannot handle the world.”
The businesses we invest in all interact with the world, and the world itself is more interconnected than ever before with modern technology. It’s easy to get bogged down into specific questions regarding revenue growth, or the balance sheet. But, Charlie raises a big, and very hard question. Why? Why is this company seeing revenue grow? What are they doing at the business end, and at the consumer end to achieve this? Once you can really answer that question, other things will become more obvious. Zoom out and look at the company's mission, how it will change the world, and what the current alternative to them is. Big questions like this are hard to answer, and extremely value.
“Now, my prediction is when the economists take a little psychology into account that the reconciliation will be quite endurable. Here, my model is the procession of the equinoxes. The world would be simpler for a long-term climatologist if the angle of the axis of the Earth's rotation, compared to the plane of the Euclyptic, were absolutely fixed. But it isn't fixed. Over every 40,000 years or so there's this little wobble, and that has pronounced long-term effects. Well, in many cases, what psychology is going to add is just a little wobble, and it will be endurable. Here, I quote another hero of mine, who of course is Einstein, where he said, “The Lord is subtle, but not malicious.” And I don't think it's going to be that hard to bend economics a little to accommodate what's right in psychology. The final question is if the thought system indicated by this list of psychological tendencies has great value not widely recognized and employed, what should the educational system do about it? I am not going to answer that one now. I like leaving a little mystery.”
It is my opinion the educational system dislikes teaching something messy like behavioral economics in a basic economics class. Buts that’s ok because Charlie, and the internet, are fine teachers for those seeking.