Munger and Psychology of Misjudgment COBF Class idea

[LongHaul]

I was reading about Munger and how he said that fluency in important areas is critical. 

I think I could improve my understanding of psychological biases as they are really powerful on the human mind. 

It is actually really humbling to think of all the mistakes I have made from the biases.

 

What if I post 1 psychological bias every 2-7 days and then we can discuss it.  I will post from Munger's list and we can primarily do

discuss 2 things:

 

1.  Examples from real life.

2.  Antidotes for a particular bias.

 

I think it would be a great review and learning exercise for everyone involved.

 

Let me know if you are interested in participating and if there is enough interest I'll start posting.

 

Bias list.

https://novelinvestor.com/charlie-mungers-tendencies-of-human-misjudgment/

 

Edited for spelling, etc.

[valueinvestor]

I'm game.  :)

[Guest longinvestor]

Fantastic idea. Will try to contribute if I can. Pretty sure I am a pro at making these misjudgments.

 

Hope the thread doesn't get hijacked off course!

 

 

 

 

 

[D33pV4lue]

I'm in. I've worked at identifying my biases as part of my framework. Overcoming them is a different story.

[LongHaul]

Awesome.  I will start posting.  I think if we do 1 at a time and discuss and digest it will be more meaningful for long term understanding and connections and fluency.  I think real life examples and stories are fantastic for learning.

 

Mungers: The Psychology of Human Misjudgment - Charlie Munger Full Speech

 

 

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…

 

Rewards are a great motivator. Rewards also produce bad behavior or what Munger calls “incentives 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 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.

 

If the reward involves keeping a job or higher pay, it’s likely someone will game the system, especially when the consequences seem minimal. For instance, the recent Wells Fargo scandal where employees were pushed to meet account quotas, and with no checks on the system, Wells Fargo was soon awash in fake accounts. The scandal was compounded by the bias of social proof — it must be okay if every other employee is doing it too.

 

Commission-based advice is another potential conflict zone. A few months of insurance sales was enough to know at least a few agents would only push the higher commission policies whether it was best for the client or not. It’s not a stretch to think the same happens with most commission-based financial products. The solution in the case of incentivized “advice” is to be skeptical and double check anything you’re told.

 

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

 

The worst incentives tend to be short-term good, long-term bad.

[LongHaul]

Incentives are definitely a very powerful bias.

 

Examples that I have come across:

 

1.  Dentist trying to drill out my teeth by claiming I have 8 cavities when perhaps I had 1 small one.  Find a dentist that you can trust.

 

2.  Car Dealer Service agents AND mechanics getting commissions or by the job.  Ends up recommending all types of fraudulent shit that you totally don't need.  I specifically told the last service agent "I know the game - don't recommend anything I don't need, I work on my car and know it well".

The service agent say ok - I respect that.  They do a simple oil change and end up recommending all this unnecessary work still.  Crazy how powerful the incentives are that he still couldn't not help himself.  The entire dealership is a psychology lab to manipulate you btw.

 

3. I have heard that insurance salesmen sell the complex ripoff insurance (vs what is best for the customer) solely because of the big commissions.

 

 

Possible Antidotes:  Know the incentives of how people who are giving you advice are paid.  Know enough about your subject that you can call BS on them.  I ended up doing a ton or research of dentistry and another time a dentist said my son had a cavity and I asked if it was down the the dentin - and she immediately said no and backpedaled on her recommendation.  There have been many times though where I did not understand how people were paid and paid the price. 

[mjohn707]

Incentives are definitely a very powerful bias.

 

Examples that I have come across:

 

1.  Dentist trying to drill out my teeth by claiming I have 8 cavities when perhaps I had 1 small one.  Find a dentist that you can trust.

 

2.  Car Dealer Service agents AND mechanics getting commissions or by the job.  Ends up recommending all types of fraudulent shit that you totally don't need.  I specifically told the last service agent "I know the game - don't recommend anything I don't need, I work on my car and know it well".

The service agent say ok - I respect that.  They do a simple oil change and end up recommending all this unnecessary work still.  Crazy how powerful the incentives are that he still couldn't not help himself.  The entire dealership is a psychology lab to manipulate you btw.

 

3. I have heard that insurance salesmen sell the complex ripoff insurance (vs what is best for the customer) solely because of the big commissions.

 

 

Possible Antidotes:  Know the incentives of how people who are giving you advice are paid.  Know enough about your subject that you can call BS on them.  I ended up doing a ton or research of dentistry and another time a dentist said my son had a cavity and I asked if it was down the the dentin - and she immediately said no and backpedaled on her recommendation.  There have been many times though where I did not understand how people were paid and paid the price.

 

Incentives are incredibly powerful, but there’s one failure-proof way to beat this one.  What I like to do at say McDonalds when they ask me to “supersize” my dinner, is to fully and deliberately explain the super response tendency to them, which sometimes might entail a quick remedial lesson in marginal costs and marginal pricing beforehand.  In any case, I’ve tested this a few times times and I’ve found that in most cases after five to ten minutes of my explanations the drive-thru attendant not only relented with their spurious extra charges, but often waived the purchase price of my meal entirely.

 

It’s hard to know how much the cars honking behind me contributed to any of this, but experiments in social science are difficult.  In any case we can agree that the knowledge itself is an incredibly powerful antidote to this deep-rooted bias

[LC]

Some thoughts on incentives:

 

There are always multiple incentives at work; and surface-level incentives (or behavior) may only be a means to achieve deeper desires.

 

For example take a look at the urban office space thread. Here we see multiple incentives at play:

-Companies want to reduce costs while maintaining work quality & quantity. This is really companies wanting to be more efficient and durable. Long term, what is the effect? Will they be able to attract & retain the best employees?

 

-Employees want a variety of things, and often different employees want different things. Most want to improve their quality of life.  How does a WFH policy incentivize employee behavior in the short- and long- term in this context? Will it incentivize employees to move to lower-cost areas?

 

Personally I moved to Denver years ago and have been working remotely ever since. My incentive was to improve quality of life and this was a means to do so which benefited myself without harming my employer. Now given COVID, perhaps I could argue it achieves the incentives of both parties.

 

My point is that WFH is a surface level incentive. If you dig deeper you see it achieves deeper wants of both employers (become more resilient) and employees (increases quality of life - or at least provides an option to do so).

 

If you take it a step further, I would say the best incentives are not simply "long term" as CM suggests, but actually are meant to achieve deeper incentives for all parties involved.

[Guest longinvestor]

All of the helicopter money dropping in people and business pockets as we speak will surely lead to monster incentive caused biases. Consequence? We will find out in due course as it’s early days.

 

Since these misjudgments work together, Munger’s #23: Twaddle tendency is in full expression everywhere. Very best answer would be “I don’t know “

[Jurgis]

Incentives are incredibly complex topic (as LC has observed) and probably deserve a thread for themselves.

 

Overall, I think that a thread per bias would work better than single thread for multiple biases.

[DooDiligence]

How about the incentive to pump an equity when you own it.

 

This can solidify your own improper perceptions about a company, & cause you to gloss over, or ignore, the negatives & attack anyone who presents a legitimate bear case.

 

May lead to "buy in haste, repent at leisure".

[Guest longinvestor]

Or an incentive not to pump it because you have intention of buying lots of it. As in, say, Berkshire Hathaway?

[fkw1979]

Great topic! All good info stated above. Here are my 2 cents:

 

When it comes down to it we want to do what is in our best interest. That in itself is driven by incentive. We seek desire and that which we like and think helps us and shun pain and that which we think can harm us. That just might be the most basic fundamental building block of our genes, humanity and our species.

 

I think that may be a first principle from which everything else is derived.

 

So maybe the next question is so what is in our best interest. And that is subjective. If you define it and follow it it can guide you. If you do not define it your impulses and your pleasure may come to control you and then you may have all the biases come in to justify it (confirmation, pain avoiding denial, doubt avoidance, incentive caused bias, easily accessible, excessive self regard, twaddle, stress misinfluence, liking, reason respecting...). Because our mind works this way, we should probably do everything we can to avoid this path because the lolapalooza is so strong. Why wouldn't you?

 

So if we can recognize and avoid that, then we should address what is in one's best interest. And that I believe each person must answer that themselves. You must ask what do you value. What is important to you? What kind of person do you want to be? How do you want to live your life? In a way which you will be personally proud of yourself (inner scorecard)? How do you want to be remembered?

 

Rationality seems like the most logical thing to seek. To make the right decisions based on the facts of the situation. To do it because it is right. Then you have to define what is right for you. Right for your inner self and what you deem important and an important way to live given the way the world works. Perhaps right in the way you treat others and how it often gives you back so much more when done right. That's another longer conversation but something each person should do.

 

Some people may value money above all. That is their right, but I believe if they really went to first principles, if they dug deeper and asked the right questions until they got to the most basic fundamental premise for money, they would often find out they have been wrong. And that in itself can be a very valuable thing.

[Jurgis]

Becoming an expert in a field X to overcome incentives of the salesperson in field X is a possible solution, but it's also a costly solution. To take the OP example, you'll never be a real dentist (unless you go to dentist school ;)). You might be able to bullshit a level-1 dental procedure salesperson, but you won't be able to bullshit level-2 one. Also there is a risk: what if they agree with you that procedure is unnecessary (because they are level-1 in sales or because they don't want to argue), but then you discover in couple months that instead of a cheaper filling you now have to do a root canal or crown? Are you gonna seek second opinion? Are you gonna read dental x-rays yourself?

 

Ultimately, this is IMO not an easily resolvable problem apart from simple or (obviously) scammy situations. It is tough to know if:

1. The salesperson is just pushing unneeded product/service because of incentives.

2. They really think you need this product/service

3. They are misinformed and think that you need this product/service

and on your side

4. You really don't need this product/service

5. You are misinformed and need this product/service

 

-------------------------------------

 

Another subtopic is self-incentives or pros/cons for decisions (this goes a bit above just incentives).

There's a popular advice to write pros/cons for some decision (financial or not) to ease making the decision. The issue there is that sometimes the pros/cons are difficult to measure, evaluate, and compare. To take LC's example, moving to Denver from NYC would probably fill pages of pros and cons on a paper. How would one evaluate and weigh each of these? Even in a simpler case, how much one would value extra half hour commute vs. $XX cheaper or YY-sqft bigger house? People make these decisions, but I'd say they are mostly hand-waved even if they try to make a rational weighted decision. And BTW hand-waved or emotional decisions might be better than 10-spreadsheet ones...  ::)

[fkw1979]

In working and interacting with others which is net-net a win in life, other people's reputations matter, integrity and rationality of the other person matter, your opportunity cost matters and perhaps accepting some imperfection in transactional exchanges would be rational, the time value of your money matters, understanding how other people are biased and that it is very hard to be rational and non-biased matters, testing them & initiating short trial periods matter, giving people some slack matters, and understanding people are imperfect and that's often ok in the grand scheme of things.

 

Rational people make rational decisions given the circumstances and that is personal to each person. See the world for what it is and watch your back especially when it matters to you most.

 

Seeing it from the other parties point of view and how they may be thinking at that moment as well as considering some of the above depending on the circumstance is probably a good start.

[fkw1979]

Re Jurgis comment, pros and cons list seems like good idea and then properly weigh them, I believe that may be the Ben Franklin approach, it may be helpful when weighing to ask yourself  "What's really important to me to consider in this situation and why?", here clarity is key, if you don't know what you really want or what really matters most then that's a problem unless it isn't

[Broeb22]

Here's a more mundane example...that I guess is related to JIT inventories

 

Let's say you perceive that you have 50 days worth of raw materials on hand in an industry that should turn inventory 10-12x per year and when your lead time on that raw material is about 4 days.

 

You could say, hey, if the lead time is 4 days, then if I can plan production a week out, if I order the raw material the same time I schedule production, I will get my raw material a couple days before production starts and it will be turned into a finished good within 3 days.

 

In theory this could reduce my inventories from 50 days of production to approximately 6, a huge savings.

 

But what happens the first time this delicate balance breaks? You get screamed at by sales, operations, supply chain, management,  for missing

 

What happens when you simply hold too much inventory? Half-hearted pleas from finance to manage things better.

 

If you're a person who isn't thinking like an owner in your role and are more concerned with not rocking the boat until you retire, the choice here is really easy.

 

Which is where constant support from management to pursue practices like these even when they occasionally cause problems is very important.

[rkbabang]

Here's a more mundane example...that I guess is related to JIT inventories

 

Let's say you perceive that you have 50 days worth of raw materials on hand in an industry that should turn inventory 10-12x per year and when your lead time on that raw material is about 4 days.

 

You could say, hey, if the lead time is 4 days, then if I can plan production a week out, if I order the raw material the same time I schedule production, I will get my raw material a couple days before production starts and it will be turned into a finished good within 3 days.

 

In theory this could reduce my inventories from 50 days of production to approximately 6, a huge savings.

 

But what happens the first time this delicate balance breaks? You get screamed at by sales, operations, supply chain, management,  for missing

 

What happens when you simply hold too much inventory? Half-hearted pleas from finance to manage things better.

 

If you're a person who isn't thinking like an owner in your role and are more concerned with not rocking the boat until you retire, the choice here is really easy.

 

Which is where constant support from management to pursue practices like these even when they occasionally cause problems is very important.

 

The choices here are not 6 days or 50?  Maybe the best thing to do is reduce it to 15 days.  This way you realize most of the cost savings and still have some margin of safety for supply problems and delays.

 

[DooDiligence]

Or an incentive not to pump it because you have intention of buying lots of it. As in, say, Berkshire Hathaway?

 

That too.

 

Exception: Founder CEO's who've sandbagged their business prospects for decades & don't take advantage of "apparent" opportunities.

 

---

 

I think my initial example applies also to analysts who have conflict of interest.

[D33pV4lue]

I'll try to stick to one theme, incentives within a company. This can impact everyone from sales to management. One huge issue I have is with stock-based comp and bonus incentives. There is so much room for Management to implement policies that financially benefit themselves. Basing incentives on share price return or EPS growth vs. fundamental metrics (ROIC) can lead to companies approving a buyback with debt. Closely aligning shareholders and management incentives is something I look for, but even that can be manipulated. Independent board members and proper corporate governance are all ways to help mitigate this issue. At a lower level retaining the top employees often requires increasing compensation usually through stock-based comp at the expense of diluting shareholders. I get how offering stock benefits companies as it is added back in operating cash flow and time to vest may result in employees forfeiting rewards. Why can't companies issue cash to employees and allow them the option to buy back in the public market? At the lowest level sales incentives are equally important. Look at the shift in asset management from AUM based flat fee (RIA Model) vs commission (Broker-Dealer). Wall Street used to be incentivized to have a company split stock just so more shares could be traded. More recently a flat fee for commissions was commonplace now most places offer 0 commission trades. Part of this is disruption, incentives that hurt consumers were weeded out by companies that were offering a more cost-efficient model. This isn't always the case annuities, insurance, etc. The tough question is what is the balance between rewarding employees for good work without screwing over the client?

[Guest longinvestor]

Buffett’s favorites:

 

- The compensation consultant role in recommending true performance based compensation for the CEO

- many 100k’s or millions in BOD fees for “independent” directors for whom being on such boards is their livelihood.

 

 

 

[SharperDingaan]

In many firms it is common to return to work on January 02; to find multiple trailers in your yard - full of items your firm did not order. They are there because the sellers agent cleared out their warehouse as at midnight Dec-31, in order to inflate the prior years sales figures and their 'gateway' driven bonus (total YTD volume x higher rate). January 02, the selling agent 'bribes' the firms buyer to take the delivery and not return it - via steep price discounts; and the the firms treasurer to finance the purchase - via a deep discount for early payment. Press the agent and you'll be told that he/she is just 'priming the pump' - reciprocal selling.

 

Entirely incentive driven, but essentially a wash over the full year.

 

SD

[LongHaul]

Becoming an expert in a field X to overcome incentives of the salesperson in field X is a possible solution, but it's also a costly solution. To take the OP example, you'll never be a real dentist (unless you go to dentist school ;)). You might be able to bullshit a level-1 dental procedure salesperson, but you won't be able to bullshit level-2 one. Also there is a risk: what if they agree with you that procedure is unnecessary (because they are level-1 in sales or because they don't want to argue), but then you discover in couple months that instead of a cheaper filling you now have to do a root canal or crown? Are you gonna seek second opinion? Are you gonna read dental x-rays yourself?

 

Ultimately, this is IMO not an easily resolvable problem apart from simple or (obviously) scammy situations. It is tough to know if:

1. The salesperson is just pushing unneeded product/service because of incentives.

2. They really think you need this product/service

3. They are misinformed and think that you need this product/service

and on your side

4. You really don't need this product/service

5. You are misinformed and need this product/service

 

-------------------------------------

 

Another subtopic is self-incentives or pros/cons for decisions (this goes a bit above just incentives).

There's a popular advice to write pros/cons for some decision (financial or not) to ease making the decision. The issue there is that sometimes the pros/cons are difficult to measure, evaluate, and compare. To take LC's example, moving to Denver from NYC would probably fill pages of pros and cons on a paper. How would one evaluate and weigh each of these? Even in a simpler case, how much one would value extra half hour commute vs. $XX cheaper or YY-sqft bigger house? People make these decisions, but I'd say they are mostly hand-waved even if they try to make a rational weighted decision. And BTW hand-waved or emotional decisions might be better than 10-spreadsheet ones...  ::)

 

There are costs to figuring out if something is a good value and necessary.  Depends on situation if worth it.  But either way one is going to pay because if you are unwilling to do the work then more likely to get taken.

 

One trick is to just ask questions and get different opinions.  Mechanics will often give different opinions than service advisors.  Different Doctors may have different views, etc.  I actually enjoy sniffing out BS and learning.  Also - once you find a trusted service person - stick with them like glue.

 

Ben Franklin had an ingenious method for making a decision in a more rational manner.  I think it was taking a piece of paper, folding it in half and then writing the pros and cons of the decision and putting a numerical value next to it over a few days.  Then he could weigh each side and make a decision. 

[LongHaul]

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.

 

Being able to jump to conclusions comes in handy when chased by a man-eater. It’s less so when the instinctual need to run kicks in during a market crash.

 

But then there’s doubt in general, that can lead to added stress and anxiety around decisions. That can lead to putting off a decision entirely.

 

I would add that saying "I don't know can also be difficult to say/admit."  but if we put aside our egos that is often the best answer.

 

Antidote:  Thinking of how much we really know, may not know and leaving open the conclusion to disconfirming information until we get the right information. 

 

Thoughts? Stories?

[DooDiligence]

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.

 

Being able to jump to conclusions comes in handy when chased by a man-eater. It’s less so when the instinctual need to run kicks in during a market crash.

 

But then there’s doubt in general, that can lead to added stress and anxiety around decisions. That can lead to putting off a decision entirely.

 

I would add that saying "I don't know can also be difficult to say/admit."  but if we put aside our egos that is often the best answer.

 

Antidote:  Thinking of how much we really know, may not know and leaving open the conclusion to disconfirming information until we get the right information. 

 

Thoughts? Stories?

 

I think this has contributed to the popularity of questionable media outlets, including hyped up financial news / analysis.

 

People are lazy and like to have difficult things explained to them (religion, politics, finance) & will accept most of what comes from pretty pundits at face value.

 

Then again, what do I know?