Almost 20 years ago, Berkshire Hathaway (NYSE:BRK-B) vice-chairman Charlie Munger gave a talk called "The psychology of human misjudgment" at Harvard. He's given dozens of talks since, but I don't think any match its wisdom and usefulness.
I recently came found the talk on video. You can listen to the whole thing here, and I highly encourage you to if you have an hour to spare.
For the impatient, the talk discusses about 18 separate biases that cause people to fool themselves make bad decisions. I've summarized them here, along with a few comments from Munger.
1. Under-recognition of the power incentives. "I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it. Never a year passes that I don't get some surprise that pushes my limit a little farther."
2. Simple denial. "If you turn on the television you find the mothers of the most obvious criminals that man could ever diagnose and they all think their sons are innocent. The reality is too painful to bear so you just distort it until it's bearable. We all do it to some extent. It's a common psychological misjudgment that causes terrible problems."
3. Incentive-caused bias. "Both in one's own mind and that in one's trusted advisor ... It causes perfectly terrible behavior. Take sales presentations of brokers of commercial real estate businesses. I'm 70 years old and I've never seen one that I thought was even within hailing distance of objective truth."
4. Bias from consistency and commitment tendency. "The human mind is a lot like the human egg, in that the human egg has a shut-off device. One sperm gets in, and it shuts down so that the next one can't get in. The human mind has a big tendency of the same sort ... According to Max Plank, the really innovative and important new physics was never really accepted by the old guard. Instead, a new guard came along that was less brain-blocked by its previous conclusions. And if Max Plank's crowd had this consistency and commitment tendency that kept their old conclusions intact despite disconfirming evidence, you can imagine what the crowd that you and I are a part of behaves like ... What people are shouting out they are pounding in."
5. Bias from Pavlovian association. "Practically three-quarters of advertising works on pure Pavlov. Just think how pure association works. Take Coca-Cola (NYSE:KO), where we're the largest shareholder. They want to be associated with ever-wonderful images -- heroics, the Olympics, music, you name it. They don't want to be associated with presidents' funerals. The association really works ... at a subconscious level, which makes it very insidious. The Persians really did kill the messenger that brought the bad news. Do you think that is dead?"
6. Bias from reciprocation tendency. "The human mind, on a subconscious level, can be manipulated and you don't know it. I always use the phrase, 'You're like a one-legged man in an ass-kicking contest.' ... A guy named Zimbardo had people at Stanford divide into two pieces: one were the guards and the other were the prisoners. And they started acting out roles as people expected. He had to stop the experiment after about five days. He was getting into human misery and breakdown and pathological behavior ... What you think may change what you do, but perhaps even more important, what you do will change what you think."
7. Bias from over-influence by social proof. "Big-shot businessmen get into these waves of social proof. Do you remember some years ago when one oil company bought a fertilizer company, and every other major oil company practically ran out and bought a fertilizer company? And there was no more damned reason for all these oil companies to buy fertilizer companies, but they didn't know exactly what to do, and if Exxon was doing it, it was good enough for Mobil, and vice versa. I think they're all gone now, but it was a total disaster."
8. Bias from contrast-caused distortions of sensation, perception, and cognition. "In my generation, when women lived at home until they got married, I saw some perfectly terrible marriages made by highly desirable women because they lived in terrible homes. And I've seen some terrible second marriages which were made because they were slight improvements over an even worse first marriage. You think you're immune from these things, and you laugh, and I want to tell you, you aren't."
9. Bias from over-influence by authority. "They don't do this in airplanes, but they've done it in simulators. They have the pilot to do something where an idiot co-pilot would know the plane was going to crash, but the pilot's doing it, and the co-pilot is sitting there, and the pilot is the authority figure. Twenty-five percent of the time, the plane crashes. I mean this is a very powerful psychological tendency."
10. Bias from deprival super-reaction syndrome. "Take the Munger dog, a lovely, harmless dog. The only way to get that dog to bite you is to try and take something out of its mouth after it was already there. If you've tried to do takeaways in labor negotiations, you'll know that the human version of that dog is there in all of us. I have a neighbor, and his next-door neighbor put a little pine tree on it that was about three feet high, and it turned his 180 degree view of the harbor into 179 and three-quarters. Well they had a blood feud like the Hatfields and McCoys. People are really crazy about minor decrements down."
11. Bias from envy and jealousy. "I've heard Warren [Buffett] say a half a dozen times, 'It's not greed that drives the world, but envy.' And you go through the psychology survey courses, and you go to the index: envy, jealousy, in a 1,000-page book -- it's blank! There's some blind spots in academia, but it's an enormously powerful thing."
12. Bias from chemical dependency. "We don't have to talk about that. We've all seen so much of it. But it's interesting how it'll always cause this moral breakdown if there's any need, and it always involves massive denial."
13. Bias from misgambling compulsion. "You have a lottery where you get your number by lot, and then somebody draws a number by lot, it gets lousy play. You have a lottery where people get to pick their number, you get big play. People think if they have committed to it, it has to be good. The minute they've picked it themselves it gets an extra validity. After all, they thought it and they acted on it."
14. Bias from liking distortion. "The tendency to especially like oneself, one's own kind and one's own idea structures, and the tendency to be especially susceptible to being misled by someone liked."
15. Bias from the non-mathematical nature of the human brain. [I'm paraphrasing this one] A boss catches an employee stealing from the cash register. The employee says, "I've never done it before and I'll never do it again." What are the odds that they've never done it before? Very small. But you biasedly ignore that probability because you like them. Munger says: "In the history of the See's Candy Company they always say, 'I never did it before, and I'm never going to do it again.' And we cashier them. It would be evil not to, because terrible behavior spreads."
16. Failure to obtain deserved influence caused by not properly explaining "why?" "We all know people who've flunked, and they try and memorize and they try and spout back. It just doesn't work. The brain doesn't work that way. You've got to array facts on the theory structures answering the question 'Why?' If you don't do that, you just cannot handle the world."
17. Bias from stress-induced mental changes. "[Pavlov] had all these dogs in cages, which had all been conditioned into changed behaviors, and the great Leningrad flood came and it just went right up and the dog's in a cage. And the dog had as much stress as you can imagine a dog ever having. The water receded in time to save some of the dogs, and Pavlov noted that they'd had a total reversal of their conditioned personality. And being the great scientist he was, he spent the rest of his life giving nervous breakdowns to dogs, and he learned a helluva lot that I regard as very interesting."
18. Development and organizational confusion from say-something syndrome. "A honeybee goes out and finds the nectar and he comes back, he does a dance that communicates to the other bees where the nectar is, and they go out and get it. Well some scientist decided to do an experiment. He put the nectar straight up. Way up. Well, in a natural setting, there is no nectar where they're all straight up, and the poor honeybee doesn't have a genetic program that is adequate to handle what he now has to communicate. And you'd think the honeybee would come back to the hive and slip into a corner, but he doesn't. He comes into the hive and does this incoherent dance. All my life I've been dealing with the human equivalent of that honeybee. It's a very important part of human organization so the noise and the reciprocation and so forth of all these people who have what I call say-something syndrome don't really affect the decisions."
Watch the whole video here. It's well worth your time.
Fool contributor Morgan Housel has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway and Coca-Cola. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.