The Psychology of Human Misjudgement - Charlie Munger Full Speech

Well I am very interested in the subject of human misjudgment and Lord knows I've created my well a good bit of it I don't think I've created my full statistical share and uh I think that one of the reasons was that I tried to do something about this terrible ignorance I left the Harvard Law School with when I saw this patterned irrationality which was so extreme and I had no Theory or anything To to to deal with it but I could see that it was extreme and I could see that it was patterned I just

started to create my own system of psychology uh partly by casual reading but largely from personal experience and I used that pattern to help me get through life fairly late in life I stumbled into this book influence by a psychologist named Bob seini who became a super tenured hot shot on a 2000 person faculty at a very young young Age uh and he wrote this book which is now sold 300 odd th000 copies which is remarkable for uh semi well it's a academic book aimed at a popular audience and uh and that filled in a

lot of holes in my crude system and when those holes had had filled in I uh I thought I had a system that was a good working tool and I'd like to uh share that one with you and I came here because behavioral economics how could economics not be behavioral if it isn't Behavioral what the hell is it uh and uh I think it's fairly clear that all reality has to respect all other reality if you come to inconsistencies they have to be resolved and uh so the idea of if there's anything valid in Psychology

economics has to recognize it and and vice versa so I think the people that are working on this Frame between economics and and psych and psychology are are absolutely right to be there and I think there's been plenty Wrong over the years well let me romp through my as much of this list as I have time to get through 24 standard causes of of human misjudgment first under recognition of the power of what psychologists call reinforcement and and economic and Economist call incentives well you can say everybody knows that well 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 Underestimated it and never a year passes but what I get some surprise that push pushes my limit a little farther so one of my favorite cases about the power of incentiv power of incentives is a federal express case we heart and soul of the Integrity of the system is that all the packages have to be shifted rapidly in one central location each night and the system has no Integrity if the whole shift can't be done

fast and Federal Express had one hell of a time Getting the thing to work and they tried moral suasion they tried everything in the world and finally somebody got the happy thought that they were paying the night shift by the hour and that maybe if they paid them by the shift the system would work better and lo and behold the that solution worked early in the history of Xerox Joe Wilson who was then in the government had to go back to Xerox because he couldn't understand how their better new machine was selling so Poorly in

relation to their older and inferior machine of course when he got there he found out that the commission arrangement with the salesman gave a tremendous incentive to the inferior machine and uh here at Harvard in the shadow of BF skanner U there was a man who really was into reinforcement as a powerful as a powerful thought and you know Skinner has lost his reputation in a lot of places but if you were To analyze the entire history of experimental science at Harvard he'd be in the top handful his experiments were very ingenious the results were

counterintuitive and they were important it is not given to experimental science to do better what gummed up Skinner's reputation is that he developed a case of what I always call man with a hammer syndrome to the man with a hammer every problem tends to look pretty much like a nail and and Skinner had one of the more Extreme cases in the history of Academia and this syndrome doesn't exempt bright people it's just a man with a hammer and Skinner is a extreme example of that and uh later as I on my list let's go back

and try and figure out why people like Skinner get man with a hammer syndra incidentally when I was at the Harvard Law School there was a professor naturally at Yale who uh was derisively discussed at Harvard and they used to say poor old Blanchard he thinks Declaratory judgments will cure cancer and and that's the way Skinner got and uh and not only that he got very uh he was literary and he scorned opponents who had any different way of thinking or thought anything else was important this is not a way to make a lasting reputation

if the other people turn out to also be doing something important my second factor is simple psychological denial this first really hit me between the eyes when a friend of Our family had a super athlete super student son who flew off a carrier in the North Atlantic and never came back and his mother who had was a very sane woman just never believed that he was dead and of course 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 uh simple psychological denial The reality is too too painful to bear so you just distort it until it's bearable we all do that to some extent and uh it's a common psychological misjudgment that causes terrible problems third incentive caused bias both in one's own mind and that of one's trusted advisor where it creates what economists call agency costs here my early experience was a doctor who sent bushel baskets full of normal gallbladders down to the Pathology Lab in a leading Hospital in Lincoln Nebraska and with that quality control for which Community Hospitals are famous

about 5 years after he should have been removed from the staff he was and uh the one of the old doctors who parti participated in the removal was also a family friend and I asked him I said tell me did he think here's a way for me to exercise my talents this guy was very skilled technically and uh and and make a high living by doing a few Mings and murders every year along with some frauds he said hell no Charlie he thought that the gallbladder was the source of all medical evil and that if

you really Lov your patients you couldn't get that organ out rapidly enough uh now that's an extreme case but in lesser strength it's present in in in every profession and in every human being and uh it causes perfectly terrible Behavior if you take Sales presentations of Brokers of commercial real estate and business businesses I'm 70 years old I've never seen one I thought was even within hailing distance of objective truth and and if you want to talk about the power of incentives and the power to rationalize terrible Behavior after the defense department had had enough

experience with Cost Plus percentage of cost contracts the reaction of our Republic was to make it a crime for the Federal government to write one and not only a crime but a felony and and by the way the government's right and uh but a lot of the way the world is run including most law firms and a lot of other places they've still got a cost plus percentage of cost system and human nature with its version of what I call incentive caused bias causes this terrible abuse and many of the people who are doing it

you would be glad to have Mary into your family compared to What you're otherwise going to get now there are huge implications from from from the fact that human mind is is put together this way and that is that people people who create things like cash registers which make misbehavior hard are some of the effective Saints of our civilization and the cash register was a great moral instrument when it was created and uh and Patterson knew that by the way he had a little store and People were stealing him blind and never made any money

and people sold him a couple of cash registers and it went to profit immediately and of course he closed the store and went into the cash register business and uh with results which are are so this is a huge important thing if you read the psychology text you will find that if they're a thousand pages long there's one sentence somehow incen of caused bias has escaped the standard Survey course in Psychology fourth and this is a superpower in error causing psychological tendency bias from consistency and commitment tendency including the tendency to avoid or promptly resolve

cognitive dissonance includes the self-confirmation tendency of all conclusions particularly expressed conclusions and with a special persistence for conclusions that are hard one but 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 plank the really Innovative 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 inclusions intact in spite of disconfirming evidence you can imagine what the crowd that you and I are part of behaves like uh and of course if you make a public disclosure of your conclusion you're pounding it in to your own head many of these students that are screaming at us you know they aren't convincing us but They're they're forming

mental chains for themselves because what they're shouting out they're pounding in and uh and I think educational institutions that create a climate where too much of that goes on are uh in a fundamental sense they're irresponsible institutions uh it's very important to not put your brain and chains Too Young by what you shout out uh and all these things like painful qualifying and initiation rituals and all those Things pound in your your commitments and your ideas and the Chinese brainwashing system which was for war prisoners which was way better than anybody else's they maneuvered people

into making tiny little commitments and declarations and then they'd slowly build that worked way better than torture uh sixth bias from pavlovian Association misconstruing past correlation is a reliable basis for decision making I never took a course in Psychology or economics either for that matter and uh but I did learn about Pablo in high school biology and uh and the way they taught it you know so the dog salivated when the bell rang so what you know nobody made the least effort to tie that to the wide world the truth of matter is that pavlovian

Association is an enormously powerful psychological force in the daily life of all of us and indeed in economics we wouldn't have Money without the role of so-called secondary reinforcement which is a pure psychological uh phenomenon demonstrated in the in the laboratory practically I'd say 3/4 of advertising works on pure paavo I mean think how Association pure Association Works take Coca-Cola company where we're the biggest shareholder they want to be associated with every wonderful image heroics and The Olympics wonderful music you name it they don't want to be associated with president's funerals and so forth when

have you seen a Coca-Cola and and the the association really works and all these psychological Tendencies work largely or entirely at a on a subconscious level which is which makes them very Insidious then You' got Persian messenger syndrome the Persians really did Kill the Messenger who brought the bad news you think that is Dead I mean you should have seen bill py in his last 20 years he didn't hear one damn thing he didn't want to hear people knew that it that that it was bad for the messenger to to to bring Bill py things

he didn't want to hear well that means that the leader gets in an Cocoon of unreality that's a great big Enterprise and boy did he make some dumb decisions in the last 20 years and know Persian me messenger syndrome is Alive and Well When I saw some years ago Arco and Exxon arguing over a few hundred millions of ambiguity in their North Slope treaties before a superior court judge in Texas with armies of lawyers and experts on each side this is a madh Hatter's tea party two engineering style companies can't resolve some ambiguity without spending

tens of millions of dollarars and some some Texas Superior Court in my opinion what happens is that nobody wants to Bring the bad news to the executives up the line that here's a few hundred million dollars you thought you had that you don't and it's much safer to act like the Persian messenger who goes away to hide rather than bring home the news of the battle lost talking about economics you get a very interesting phenomenon that I've seen over and over over again in a long life you've got two products suppose they're complex Technical product

now you think under the laws of Economics that if product a costs X if product y costs x minus something it will sell better than if it sells at X plus something but that's not so in many cases when you raise the price of the alternative product it'll get a larger market share than it would when you make it lower than your competitor's product that's because the Bell a pavlovian bell I mean ordinarily there's a correlation between price and value you have an information inefficiency and so when you raise the price the sales go up

relative to your competitor that happens again and again and again it's a pure paoan phenomenon and and uh and you can say well the economists have figured this sort of thing out when they started talking about information inefficiencies but that was fairly late in economics that They found such an obvious thing and of course most of them don't ask what causes the information inefficiencies well one of the things that causes it is pure old Pablo and his dog now you've got bias from skinnerian Association operant conditioning you know where you give the dog a reward

and uh and and and pound in the behavior that uh preceded the dogs getting the award and of course Skinner was able to create Superstitious pigeons by having rewards come you know by accident with certain occurrences and of course we all know people who are the human equivalents of superstitious pigeons that's a very powerful phenomenon and of course operant conditioning really works I mean the people in the center who think that operant conditioning is is important are are are very much right it's just that the Skinner overdid it a little where you see in business

just perfectly Horrible results from psychological psychologically rooted Tendencies is in accounting if you take Westinghouse which blew what 2 or three billion dollar pre-tax at least loaning developers to build hotels and virtually 100% loans now you say any idiot knows that there's one thing you don't like it's a developer another you don't like it's a hotel and to make a 100% loan to a developer is going to build a Hotel but but this guy he probably was an engineer or something and he didn't take psychology anymore than I did and he got out there in

the hands of these slick salesmen operating under their version of incentive caused by us where any damn way of getting westing house to do it was considered normal business and they just blew the that would never have been possible if the accounting system hadn't been such that for the initial phase of every transaction it Showed wonderful Financial results so people who have loose accounting standards are just inviting perfectly horrible behavior in other people uh and it's a sin it's an absolute sin to if you carried bushel baskets full of money through the ghetto and made

them made it easy to steal that would be a considerable human sin because you'd be causing a lot of bad behavior and the bad Behavior would spread similarly an institution that Gets sloppy accounting uh commits a real human sin and it's also a dumb way to do business as westing house is so wonderfully proved oddly enough nobody mentions at least nobody I've seen what happened with jojet and ker Peabody the truth of the matter is the accounting system was such that by punching a few buttons the Jo Jets of the world could show profits and

Prophets that showed up and things that resulted in rewards and esteem and Every other thing that human being well the Joe jets are always with us and they're not really to blame in my judgment at least but that bastard who who created that foolish accounting system who so far as I know has not been played alive ought to be seventh bias from reciprocation tendency including the tendency of one in a role to act as other persons Expect well here again cini does a magnificent job at this and you're all going to be given a copy

of seal de's book and if you have half as much sense as I think you do you will immediately order copies for all of your children and several of your friends you will never make a better investment it is so easy to be a Psy for what he calls the compliance practitioners of this life and uh but at any rate reciprocation tendency is a Very very powerful phenomenon and se de demonstrated this by running around a campus and he asked people to to take juvenile delinquents to the zoo and it was a campus and so

one and six actually agreed to do it and uh and after he' accumulated the statistical output he went around on the same campus and he asked other people he he said g would you devote two afternoons a week to taking juvenile Delinquent somewhere and suffering greatly yourself to help them and there he got 100% of the people to say no but after he made the first request he backed off a little he said well would you at least take them to the zoo one afternoon he raised the compliance rate from a third to a half

he got three times the success by just going through the little asper lot and back off now if the human mind on a subconscious level can Be manipulated that way and you don't know it well I always use the phrase you're like a one-legged man in an ass kicking contest I mean you are I mean you are really giving a lot of quarter to the external world that you you you can't afford to give and uh on this so-called role Theory where you tend to act in the way that other people expect that's reci if

you think about the way Society is Organized and a guy named zardo had people at Stanford divide into two pieces one were the guards and the other with the prisoners and they started acting out roles as people expected he had to stop the experiment after about 5 days he was getting into human misery and breakdown and pathological Behavior I mean it was it was it was awesome however timbar was great misinterpreted it's not just reciprocation tendency and role theory That caused that it's consistency and commitment tendency each person as he acted as a guard or

a prisoner the action itself was pounding in the idea wherever you turn this consistency and commitment tendency is is affecting you in other words what you think may change what you do but perhaps even more important what you do will change what you think and you can say everybody knows that I want to tell you I didn't know it well enough early Enough eight now this is a laaloa and Henry Kaufman wisely talked about this bias from over influenced by social proof that is the conclusions of others particularly under conditions of natural uncertainty and stress

and here one of the cases the psychologist use is Kitty jovy where all these people I don't know 50 60 70 of them just sort of sat and did nothing while she was slowly murdered now one of the explanations is is Everybody looked at everybody else and nobody else was doing anything and so there's automatic social proof that the right thing to do is nothing that's not a good enough explanation for Kitty Jesy in my judgment that's only part of it there are microeconomic ideas and gain loss ratios and so forth that also come into

play I think time and time again in reality psychological Notions and economic Notions interplay and the man who doesn't understand both Is a damn fool 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 damn reason for all these oil companies to buy fertilizer companies but they didn't know exactly what to do and the vexon was doing it it was good enough for mobile

or vice versa And of course the I think they're all gone now it it was a total disaster now let's talk about Efficient Market Theory a wonderful economic doctrine that had a long Vogue in spite of the experience of burshire Hathaway in fact one of the economists who won he shared a Nobel Prize and as he looked at berer haway year after year which people would throw in his faces saying maybe the market isn't quite as efficient as you think he Said well it's a two zma event then he said we were a three zigma

event and then he said we were a four zma event and he fin they got up to six sigmas better to add a sigma than change a theory just because the evidence comes in differently and of course when this share of a Nobel Prize wi in the money management himself he sank like a stone if you if you think about the doctrines I've talked about namely one the power of Reinforcement after all you do something and the market goes up and you get paid and rewarded and plotted and what have you you're getting a lot

of refor reinforcement if you make a bet in a market and the market goes with you also they're social proof I mean the the prices in the market are the ultimate form of social proof reflecting what other people think and so the combination is very powerful why would you expect General market Levels to always be totally efficient say even in 19734 at the pit or in 1970 two or whatever it was when the nifty50 were in their Heyday if these psychological Notions are correct you would affect you would expect some waves of irrationality which which

carry general levels to to uh to um so they're inconsistent with with with reason Nine 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 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 KES whom I think said better to be roughly right than precisely wrong nine biased from contrast cause distortions of sensation perception and Cognition here the great experiment that seini does

in his class is he takes three buckets of water one's hot one's cold and one's room temperature he has the student stick his left hand in the hot water and his right hand in the cold water then he has them remove the hands and put them both in the room temperature bucket and of course with both hands in the same bucket of water one seems hot the other seems cold because the sensation Apparatus of man is over influenced by contrast it has no absolute scale it's got a contrast scale in it and it's a scale

with Quantum effects in it too it takes a certain percentage change before it's noticed maybe you've had an magician remove your watch I certainly have without your noticing it it's the same thing he's taking taking advantage of your of your of contrast type troubles in your sensory apparatus but here the Great truth is that cognition mimics sensation and the Cog manipulators mimic the watch REM removing magician in other words people are manipulating you all day long on this contrast phenomenon seal D sites the case of the real estate broker and you got the ru that's

been transferred into your town and the first thing you do is you take the ru out to two of the most awful overpriced houses you've ever seen And then you take the ru to some moderately overpriced house and then you stick them and it it works pretty well which is why the real estate salesmen do it and uh it's always going to work and the accidents of Life can can do this to you and it can ruin your life in my generation when women lived at home until they got married I saw some perfectly terrible

marriages made by by highly desirable women because they lived in terrible Homes and uh and I've seen some terrible second marriages which were made because were slight improvements over an even worse first marriage and you think you're immune from these things and you laugh and I want to tell you you aren't and the uh my favorite analogy I can't vouch for the accuracy of I have this worthless friend I like to play bridge with and he's a total intellectual amateur that Lives un inherited money but he told me want something I really enjoyed hearing he

said Charlie he says if you throw a frog into very hot water the Frog will jump out but if you put the frog in room temperature water and just slowly heat the water up the Frog will die there now I don't know whether that's true about a frog but it sure is held true about many of the businessmen I know and there again it is the it is the contrast phenomenon these Are Hot Shot high powered people I mean these are not fools if it comes to you in small pieces you're likely to miss so

you have to if you're going to be a person of good judgment you have to do something about this warp in your head where it's so misled by by mere contrast bias from over influenced by Authority we here the mgrm experiment as it's caused I think there have been, 1600 psychological Papers written about mgam and he had a Person posing as an authority figure uh uh trick Ordinary People into giving what they had every reason to expect was Heavy torture by electric shock to perfectly innocent fellow citizens and the experiment has been he was trying

to show that why Hitler succeeded and a few other things and uh and uh so this really caught the fancy of the world partly it's so politically correct and uh and uh and uh Over influenced by Authority has another very you this will you'll like this one you got a pilot and a co-pilot the pilot is the authority figure they don't do this in airplanes but they've done it in simulators they have the pilot do something where the co-pilot who's been trained in simulators a long time he knows he's not to allow the plane to

crash 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 25% of the time the plan crashes I mean this is a very powerful psychological tendency it's not quite as powerful as some people think and I'll get to that later 11 bias from deprival Super reaction syndrome including bias caused By present or threaten scarcity including threatened removal of something almost possessed but never possessed here I took the Munger dog

lovely harmless dog the one way the only way to get that dog to bite you was to try and take something out of its mouth after it was already there and any of you have tried to do takeaways and labor negotiations we'll know that a human version of that dog is there in all of us and uh I had a neighbor on a neighbor A predecessor on a little island where I have a house and his next door neighbor put a little Pine Tre in that was about 3 ft high and it turned his 180°

view of the harbor into 179 and 3/4 well they had a blood Feud like the Hat fields in a koise and it went on and on and on and I mean people are really crazy about Minor decrements down and uh and then if you act on them you get into reciprocation tendency because you don't just reciprocate affection you Reciprocate animosity and the whole thing can escalate and so huge insanities can come from from just subconsciously overweighing the importance of what you're losing or almost getting and not getting and uh the extreme business case here was

New Coke now Coca-Cola has the most valuable trademark in the world where the major Sherer I mean we I think we understand that trademark Koke has armies of brilliant Engineers Lawyers psychologists advertising Executives and so forth and they had a trademark on a flavor and they' spent better part of a hundred years getting people to believe that trademark had all these intangible values too and people Associated it with the flavor and so they were going to tell people not that it was improve cuz you can't improve a flavor flavor is a matter of taste I

mean you may improve improve a detergent or something but Telling you're going to make a major change in a in a flavor I mean so they got this huge depression super reaction syndrome Pepsi was within weeks of coming out with old Coke in a Pepsi bottle which would have been the biggest Fiasco in modern times perfect PL Perfect Insanity and by the way both go and Kio are just wonderful about it I mean they just joke I mean they Kio always says I must have been away on vacation he participated in Every single he's wonderful

guy and by the way go is a wonderful smart guy an engineer smart people make these terrible boners how can you not understand deprival Su super reaction syndrome but people I mean people do not react symmetrically to loss and gain now maybe have great bridge player like zacker does but that's a trained response uh Ordinary People Subconsciously affected by their inborn Tendencies uh bias from Envy jealousy well Envy jealousy made what two out of the 10 commandments those of you who have raised siblings you know about or tried to run a law firm or Investment

Bank or even a faculty I've heard Warren say a half a dozen times it's not greed that drives the world but Envy here again you go through the psychology survey courses and you go to the index Envy Jealousy thousand page book it's blank there's some blind spots in Academia but it's an enormously powerful uh thing and it operates to a considerable extent on a subconscious level and anybody who doesn't understand it is is uh is taking on defects he shouldn't have bias from chemical dependency well we don't have to talk about that we've all seen

so much of it but it's interesting how it always causes moral Breakdown if there's any need and uh and it always involves massive denial see it's just it aggravates what we talked about earlier in the Aviator case the tendency to distort reality so that it's endurable uh bias from Mis gambling compulsion well here Skinner made the only explanation you'll find in the standard psychology survey course he of course created a variable reinforcement rate for his pigeons his Mice and he found that that would pound in the behavior better than any other enforcement pattern and he

says aha I've explained why gambling is such a powerful addictive force in a civilization I think that is to a very considerable extent true but being Skinner he seemed to think that was the only explanation but the truth of the matter is that the devisers of these modern machines and techniques know a lot of things that Skinner didn't know For instance a lottery you have a lottery where you get your number by lot and then somebody draws a number by lot it gets lousy play you get a lottery where people get to pick their number

get big play again it's this consistency and commitment thing people think that if they've committed to it it has to be good and the minute they' picked it themselves it gets an extra validity after all they thought it and they Ed on it and uh then if you take Slot machines you get bar bar lemon it happens again and again and again you get all these near misses well that's deprival super reaction syndrome and boy to the people who who create the machines understand human psychology and if you got for the high iqq crowd they've

got poker machines where you make choices so you can play Blackjack so to speak With the machine it's wonderful what we've done with our computers to ruin a civilization and uh but any Mis gambling compulsion is a very very powerful and important thing look at what's happening to our country every Indian Reservation every river town and uh and look at the people who were ruined by it with the aid of their stock Brokers and others and uh again if you look in the in the Standard textbook of psychology you'll find practically nothing on it except

maybe one sentence talking about skinners rats that is not an adequate coverage of the subject bias from liking Distortion including 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 disliking Distortion bias from that the reciprocal of liking Distortion and the tendency not to learn appropriately from someone disliked well here again we've got hugely powerful Tendencies and if you look at the wars in part of the Harvard Law School as we sit here you can see that very brilliant

people get into this almost pathological behavior and uh these are very very powerful basic subconscious psychological Tendencies or at least partly Subconscious now let's get back to BF scanner man with a hammer syndrome Revisited why is man with the Hammer syndrome always present well if you stop to think about it say he have caused bias his professional reputation is all tied up with what he knows he likes himself and he likes his own ideas and uh and he's expressed them to other people consistency and commitment tendency I mean you got four or five of these

Elementary psychological Tendencies combining to create this man with a hammer syndrome I want you realize that that you can't really buy your thinking done partly you can but largely you can't in this world you have learned a lesson that's very useful in life George Bernard Shaw said and had a character saying the doctor's dilemma in the last analysis every profession is a Conspiracy against the Le but he didn't have it quite right because isn't so much conspiracy as it is a subconscious psychological tendency the guy tells you what is good for him he doesn't recognize

that he's doing anything wrong any more than that doctor did when he was pulling out all those normal go laders and he believes that his own idea structures will cure cancer and he believes that that uh that the guardian that the demons that he's the guardian Against are the biggest demons and the most important ones and in fact they may be very small demons compared to the demons that you face so you're getting your advice in this world from your paid adviser with this huge load of Gastly bias and woe to you there are only

two ways to handle it you can hire your adviser and then just apply a windage factor like I used to do when I was a rifle shooter I just injust for so many miles an hour of wind and or you Can learn the basic ele ments of your advisor's trade you don't have to learn very much by the way because you learn just a little and you can make him explain why he's right and those two Tendencies will take part of the warp out of the thinking you've tried to hire done by and large it

works terribly I have never seen a Management Consultant report in my long life that didn't end with the following paragraph what this Situation really needs is more management Consulting never once I always turn to the last page of course berch outway doesn't hire them so I only do this on sort of a voyerism in a nonprofit where some idiot hires one 17 bias from the non-mathematical nature of the human brain in its natural state as it deals with probabilities employing Crude juristic and is often misled by mere contrast a tendency to overweigh conveniently available information

and other psychologically rooted misthink Tendencies on this list when the brain should be using the simple probability mathematics of faat and Pascal applied to all reasonably obtainable and correctly weighted items of information that are of value in predicting outcomes the right way to think is the way Zack Hower plays Bridge it's just that Simple and your brain doesn't naturally know how to think the way Zack Hower knows out of play bridge now you notice I put in that availability thing and there I mimicking some very eminent psychologists donman I I hope I pronounce that right

and derski who who who raised the idea of availability to a whole heuristic of misjudgment and you know they are very substantially right I mean ask the Coca-Cola company which has raised availability to a secular religion if availability changes Behavior you will drink a hell of a lot more coke if it's always available I mean availability does change behavior and cognition nonetheless even though I recognize that and applaud to verki and conman I don't like it for my personal system except as part of a greater subsystem which is is you got to think The way

Zack aler plays the bridge it isn't just the lack of availability that distorts your judgment all the things on this list distort judgment and I want to train myself to kind of mentally run down the list instead of just jumping on availability so that's why I state it the way I do in a sense these psychological Tendencies make things unavailable because if you quickly jump To one thing and then because you've jumped to it the the consistency and commitment tendency makes you lock in boom that's error number one or if something is very Vivid which

I'm going to come to next that will really pound in and the reason that the thing that really matters is now unavailable and what's extra Vivid wins is I mean it the the extra vividness creates the Unavailability so I think it's much better to have a whole list things that that cause you to be less like zacker than it is just a jump on one factor uh here I think we should discuss John good friend this is a very interesting human example which will be taught in every decent professional school for at least a full

generation good friend has a trusted Employee and it comes to light not through confession but by accident that the trusted employee has lied like hell to the government and manipulated the accounting system and it was really equivalent to forgery and uh and uh and uh the man immediately says I've never done it before I'll never do it again it was an isolated example and of course it was obvious that He wasn't trying to he was trying to help the government as well as himself CU he thought the government had been dumb enough to pass a

a rule that he'd spoken against and after all if a government's not going to pay attention to bond Trader at Solomon what kind of a government can it be and and uh at any rate and this guy has been part of a little click that has made well way into way over a billion dollars for Solomon in the very recent past and it's a little handful of people so there are a lot of psychological forces at work and you know you know the guy's wife and and he's right in front of you and there's human

sympathy and he's sort of asking for your help which is the form which encourages reciprocation and there all these psychological Tendencies are working plus the fact he's part of a group that made a lot of money for you at any rate Good friend does not cashier the man and of course he had done it before and he did do it again well now you look as though you almost wanted him to do it again or God knows what you look like but it isn't good and uh and and that simple decision destroyed John goodr and

uh and it's so easy to do now let's think it through like the bridge player like zacker you find an isolated example of a little old lady in the SE candy company one of our Subsidiaries getting into the till and what does she say I never did it before I'll never do it again this is going to ruin my life please help me and you know her children and her friends and she's been around 30 years and standing behind a candy counter with swollen ankles and you're an old lady isn't that glorious a life and

you're rich and powerful and there she is I never did it before I'll never do it again well How likely is it that She never did it before if you're going to catch 10 embezzlements a year what are the chances that any one of them applying what tersi in common call Baseline information will be somebody who only did it this once and the people who have done it before and are going to do it again what are they all going to say well in the history of the Seas Cy 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 terribly Behavior spreads remember what was it Sero I mean you you let that stuff you got social proof you got incentive cause bias you got a whole lot of psychological factors that will cause the evil behavor year to spread and pretty soon the whole damn your place is rotten the civilization is Rotten it's not the right way to behave and uh and uh I will admit that I have when I knew the wife and

children I have paid severance pay when I fire somebody for taking a mistress on a extended foreign trip it's not the adultery I mind it's the embezzlement and uh but there I wouldn't I wouldn't do it where a good friend did it where they've been cheating somebody else on my Behalf there I think you have to cashier but if they're just stealing from you and you get rid of them I don't think you need the last ounce of Vengeance I think I don't think you need any Vengeance I don't think vengeance is much good the

um now we come biased from over influence by extra evidence here's one I'm at least 30 million poor as I sit here giving this little talk because I once bought 300 Shares of a stock and the guy called me back and said I got 1,500 more I said will you hold it for 15 minutes while I think about it and the CEO of this company I have seen a lot of vivid peculiarities in a long life but this guy set a world record I'm talking about the CEO and I just Mis weighed it the truth

of the matter is his situation was foolproof he was soon going to be dead and I turned down the extra 1500 shares And that's now cost me $30 million and that's life in the big city and it wasn't something where stock was generally available and uh so it's very easy to mway the vivot evidence and good friend did that when he looked into the Man's eyes and forgave the colleague and uh 22 stress induced metal changes small and large temporary and permanent the the uh oh no no no I I've skipped one mental Confusion caused

by information not arrayed in the mind in theory structures creating sound generalizations developed in response to the question why also Mis influence from information that apparently but not really answers the question why also failure to obtain deserved influence caused by not properly explaining why well we all know people who flunk and they try and memorize and they try and spout back and they just doesn't work the brain doesn't Work that way you've got to array facts on Theory structures answering the question why if you don't do that you just you cannot handle the world and

now we get to forstein who was the general counsel of Solomon when good friend made his big error and Forin knew better he told good friend you have to report this as a matter of morality and prudent business judgment he said it's probably not illegal there's probably no legal duty to do it but you have to do It as a matter of of prudent conduct and and proper dealing with your main customer and he said that to good friend on at least two or three occasions and he stopped and of course the persuasion failed and

when good friend went down forstein went with him and it ruined a considerable part of for Stein's life well forstein was a member of the Harvard Law review who made an elementary psychological mistake you want to persuade somebody You really tell them why and what have we learned in lesson one incentives really matter he should have told and Vivid evidence really works he should have told good good friend you are likely to ruin your life and disgrace your family and lose your money and is mojer worth this I know both men that would have worked

so forstein flunked Elementary psychology this very sophisticated Brilliant lawyer don't you do that it's not very hard to do you know just to to remember that qu is terribly important uh other normal limitations of sensation memory cognition and knowledge well I don't have time for that uh stress induced mental changes here my favorite example is is is the great pavlof and he had all these dogs of cages which had all been conditioned into change behaviors and the great Leningrad flood came and the just went right up and the dog's in a cage and the dog

was had as much stress as you can imagine a dog ever having and the water receded in time to save some of the dogs and and pavlof noted that they'd had a total reversal of their conditioned personality well being a great scientist he was he spent the rest of his life giving nervous breakdowns to dogs and and he learned a A hell of a lot that I regard is very interesting I have never known any fraan analyst who knew anything about the last work of P POF and I never met a lawyer who understood that

what pavlof found out with those dogs had anything to do with programming and deprogramming and Cults and so forth I mean the amount of of Elementary psychological ignorance is out there in high levels is is very sub then we've got other common mental illnesses and declines temporary and Permanent including the tendency to lose ability through disuse and then I've got mental and organizational confusion from say something syndrome and here my favorite thing is the bee the honeybee and 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 who was clever like BF skanner decided to do an experiment he put the nectar straight up Way up well in a natural setting there is no nectar way the hell 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 slink into a corner but he doesn't he comes into the hive and does this incoherent dance and

all my life I've been dealing with the human equivalent of that honeybee and and it's a very important Part of human organization to set things up 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 now the time has come to ask two or three questions this is the most important question in this whole talk what happens when these standard psychological Tendencies combine what happens when the situation or The Artful Manipulation of man causes several of these Tendencies to operate

on a person toward the same end at the same time the clear answer is the combination greatly increases power to change Behavior compared to the power of merely one tendency acting alone examples are Tupperware parties Tupperware has now made billions of dollars out of a few manipulative psychological tricks it was so Schock that directors of Justin dart's company Resigned when he crammed it down his board throat and he was totally right by the way judged by economic outcomes Mooney conversion methods boy do they work he just combines four or five of these things together the

system of Alcoholics Anonymous a 50% no drinking rate outcome when everything else fails it's a very clever system that uses four or five psychological systems at once toward I might say a very good end the mgrm experiment see mgrm it's been Widely interpreted as mere obedience but the truth of the matter is that the experimentor who got the students to give the heavy shocks and mgram he explained why it was a false explanation we need this to look for scientific truth and so on that greatly changed the behavior of the people and number two he

worked them up tiny shot little larger little larger so commitment and consistency tendency and the contrast principle we both working in favor of This Behavior so again it's four different psychological Tendencies that's when you get these laapoa effects you will almost always find find four or five of these things working together when I was young there was a houdon it hero who always said share sham and what you should search for in life is the combination is the combination is likely to do you in or if you're the inventor of Tupperware Parties it's likely to

make you enormously Rich if you can stand shaving when you do it then one of my favorite cases is the McDonald Douglas airliner evacuation disaster the government requires that airliners pass a a bunch of tests one of them is evacuation get everybody out I think it's 90 seconds or something like that it's some short period of time government has rules make it very Realistic so on and so on you can't select nothing but 20-year-old athletes to evacuate your airliner so McDonald Douglas schedules one of these things in a hanger and they make the hanger dark

and the concrete floor is 25 ft down and they got these little rubber shoots and they got all these old people and they ring the bell and they all rush out and in the morning when the first test is done they create I don't know 20 Terrible injuries people go off to hospitals and of course they scheduled another one for the afternoon by the way they didn't meet the time schedule either in addition to causing all the injuries well so what do they do they do it again in the afternoon now they create 20 more

injuries and one case of a severed spinal column with permanent unfixable paral is these are Engineers these are brilliant people this is thought over Through in a big bureaucracy again it's a combination of attendance authorities told you to do it he told you to make it realistic you've decided to do it you've decided to do it twice incentive caused bias if you pass you save a lot of money you got to jump this hurdle before you can sell your new airliner again three four five of these things work together and it turns human brains into

mush and maybe you think this doesn't happen in making Investments if so you're living in a different world than I am finally the open outcry auction the open outcry auction is just made to turn the brain into mush you get social proof the other guy is bidding you get reciprocation tendency you get deprival super reaction syndrome the thing is going away I mean it's just absolutely designed to to manipulate people into idiotic Behavior finally the institution of the board of Directors of a major human American company well the top guy is sitting there he's an

authority figure he's doing aine things you look around the board nobody else is objecting social proof it's okay reciprocation tendency he's raising the director's fees every year he's flying you around in the corporate airplane to look at interesting plants or whatever the hell they do and you go and you really get extreme dysfunction as a Corrective decision-making body and the typical American board of directors they only act again the power of incentives they only act when it gets so bad that starts reflecting making them look foolish or threatening legal liability to them that's monger's rule

I mean they're occasional uh things that don't follow munger's rule but by and large the board of directors is a very ineffective corrector of the if the top guy is a Little nuts which of course frequently happens the second question isn't this list of standard psychological Tendencies improperly tautological compared with the system of uid that is aren't there overlaps and can't some items on the list be derived from combinations of other items the answer to that is plainly yes three what good is in the Practical world is the thought system indicated by the list isn't

practical benefit prevented because These psychological Tendencies are programmed into the human Mind by broad evolution so we can't get rid of broad Evolution I mean the combination of genetic and cultural Evolution but mostly genetic well the answer is the Tendencies are partly good and indeed probably much more good than bad otherwise they wouldn't be there by and large these rules of thumb have worked pretty well for man given his limited mental capacity and that's why they were Programmed in by by broad Evolution at any rate they can't be simply washed out automatically and they shouldn't

be nonetheless the psychological thought system described is very useful in spreading wisdom and Good Conduct when when one understands it and uses it constructively here are some examples Carl Bron's communication practices he designed oil refineries with spectacular skill and Integrity had a very simple rule remember I said why is important you got fired in the Brun company you had to have five W's you had to tell who what you wanted to do where and when and you had to tell him why and if you wrote a communication and left out the why you got fired

cuz Braun knew it's complicated building an O Refinery can blow up all kinds of things happen and he knew that his communication system work better if you always told Him why that's a simple discipline and boy is it work two the use of simulators in Pilot training here again abilities attenuate with disuse well the simulator is God's gift because you can keep them fresh the system of Alcoholics Anonymous that's certainly a constructive use of somebody understanding psychological Tendencies I think they just blundered into it as a matter of fact so you can regard it as

kind of an evolutionary outcome but just because they blundered Into it doesn't mean you can't in invent its equivalent when you need it for a good purpose clinical training in medical schools here's a profoundly correct way of Understanding Psychology the standard practice is watch one do one each one Bo does that pound in what you want pounded in again the consistency and commitment tendency and uh that is a profoundly correct way to teach clinical medicine The rules of the US constitutional Comm convention totally secret no vote until the final vote then just one vote on

the whole Constitution very clever psychological rules and if they had a different procedure everybody would have been pushed into a corner by his own pronouncements and his own oratory and his own and and no recorded votes until the last one and uh and they got it through by a whisker with those wise Rules we wouldn't have had the Constitution if our forefathers hadn't been so psychologically acute and look at the crowd we got now six the use of granny's rule I love this one of the psychologists who works with the center gets paid a fortune

running around America and he teaches Executives to manipulate themselves now Granny's rule is you you don't get the ice cream unless you eat your carrots well granny was a very wise woman that Is a very good system and uh so this guy very eminent psychologist he runs around the country telling Executives to organize their day so they force themselves to do what's unpleasant and important by doing that first and then rewarding themselves with something they really like doing he is profoundly correct seven the Harvard Business school's emphasis on decision trees when I was young and

foolish I used to laugh at the Harvard Business School I said They're teaching 28-year-old people that high school algebra Works in real life we're talking about elementary probability but later I I wised up and I realized that it was very important than they do that and better late than never eight the use of post-mortems at Johnson and Johnson at most corporations if you make an acquisition and it works out to be a disaster all the paperwork and presentations that caused the dumb Acquisition to be made are quickly forgotten you got denial you got everything in

the world you got pavlovian Association tency nobody wants to even be associated with the damn thing or even mention it Johnson and Johnson they make everybody revisit their old Acquisitions and Wade through the presentations that is a very smart thing to do and by the way I do the same thing routinely N9 the great example of Charles Darwin is he avoided Confirmation bias Darwin probably changed my life because I'm a biography nut and and I when I found out the way he always paid extra attention to the disconfirming evidence and all these little psychological tricks

I also found out that he wasn't very smart by the standards the ordinary standards of human Acuity yet there he is buried in Westminster Abbey that's not where I'm going I'll tell you and and I said my God a guy that by all objective evidence is not nearly as smart as I am and he's in Westminster Abbey he must have tricks I should learn and I started wearing little hair shirts like Darwin to try and train myself out of these subconscious psychological tendencies that cause so many errors it didn't work perfectly as you can tell

from listening to this talk but it would would have been even worse if I hadn't hadn't done what I Did and you can know these psychological Tendencies and avoid being the y of all the people that are trying to manipulate you to your disadvantage like Sam Walton Sam Walton will let a purchasing agent take a handkerchief from a Salesman he knows how powerful the subconscious reciprocation tendency is that is a profoundly correct way for Sam Walton to behave then there's the Warren Buffett rule for open out cry auctions don't Go we don't go to the

close bit auctions too because they that's a counterproductive way to to do things ordinarily for a different reason which zuser would understand four what special knowledge problems lie buried in the thought system indicated by the list well one is paradox now we're talking about a type of human wisdom that the more people learn about it the more attenuated the wisdom gets that's an intrinsically paradoxical Kind of wisdom but we have Paradox of mathematics and we don't give up mathematics I say damn the par this stuff is wonderfully useful and by the way the the Granny's

rule when you apply it to yourself is sort of a paradox in a paradox the man the manipulation still works even though you know you're doing it and I've seen that done by one person to another I drew this beautiful woman as my dinner partner a few years ago and I'd never seen her before although she's married to a prominent Angelino and she sat down next to me and she turned her beautiful face up and she said Charlie she said what one word accounts for your remarkable success in life now I knew I was being

manipulated and that she'd done this before and I just loved it I I I never see this woman without a little lift in my spirits and by the way I told her I was Rational you'll have to judge yourself whether that's true I I may be demonstrating some psychological tendency I hadn't planned on demonstrating how should the best parts of psychology and economics interrelate in an enlightened Economist mind two views that's the thermodynamics model you you know you can't derive thermodynamics from from Newtonian uh gravity and and uh laws of mechanics even though it's a

lot of Little particles interacting and here's this wonderful truth that you can sort of develop on your own which is thermodynamics and some economists and I think Milton fredman is in this group but I may be wrong on that sort of like the thermodynamics model I think Milton Reen Freedman who has a Nobel Prize is probably a little wrong on that I think the thermodynamics analogy is overstrained I think Knowledge from these different soft Sciences have to be reconciled to eliminate conflict after all there's nothing in thermodynamics that's inconsistent with Newtonian mechanics and gravity and

I think that some of these economic theories are not totally consistent with other knowledge and they have to be bent and I think that these behavioral economics or economists are probably the ones that are bending them in a correct direction now my prediction is when the Economists take a little psychology into account that the reconciliation will be quite urable and here my model is the procession of the equinoxes the world would be for a long-term climatologist if the angle of the axis of the Earth's rotation compared to the plane of the ecliptic 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 uh here I I quote Another Hero of mine who of course is Einstein where he said the Lord is subtle but not malicious and I I don't think it's going to be that hard to bend economics a little to to um 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 I like leaving a little mystery and I used up all the time so there's no time for questions I think I think that what we're going to do is we're going to borrow a little bit of time from the end ofday sumary questions and we're going to move in and allocated To people question by the way the dean of the Stanford law school is here today Paul brast

and he is trying to create a course at the Stanford law school that tries to work stuff similar to this into worldly wisdom for lawyers which I regard as a profoundly good idea and he wrote an article about it and you'll be given a copy along with seal de's Book Questions yeah able to get a yes I presume there would be one curious man And I have it I'll put it over there on the table but don't take more than one because I didn't anticipate such a big crowd and if we run short I'm sure

the center is up to making other copies and question yeah well let me just ask one question if I listen to talk I might that you were a psychologist if I had listened to this talk I might have thought that uh Charles Munger was a psychology Professor operating at a business school every once in a while on a micro issue you told us uh how you would have dealt with one of these issues for example with the uh unfortunate lady from C's but you didn't tell us how these Tendencies affected you and what's probably the

most important or one of the most important elements of your success which was deciding where to invest your money and I'm wondering if uh you might relate some of these Principles to some of your past decision that way well of course an investment decision in the common stock of a company frequently involves a whole lot of factors interacting usually of course there's one big simple model and uh a lot of those models are are microeconomic and I have a little list of it wouldn't be nearly 24 uh of those but I don't have time for

for that one and I I don't have too much interest in teaching other people how to get rich uh my personal and that isn't because I fear the competition uh or anything like that uh Warren has always been very open about about what he's learned and uh I I share that ethos my personal behavior model is is Lord can's I wanted to get rich so I could be Independent uh and so I could do other things like give talks on the intersection of psychology and economics uh I didn't want to turn it into total Obsession

yeah out of those 24 could you tell us the one rule is most important I would say the one thing that causes the most trouble is when you combine a bunch of these together you get this laapoa effect and if you again if you read the psychology textbooks they don't discuss how these Things combine at least not very much do they multiply do they add what how does it work I think it would be just an automatic subject for for research but it doesn't seem to turn the psychology establishment on I think this is a

like this is a man for Mars approach to psychology I just reached in and took what I thought I had to have that is a different set of incentives from rising in an economic establishment where the reward system Again the reinforcement comes from being a truffle Hound that's what Jacob Viner the great Economist called it the Truffle Hound an animal so bred in trained for one narrow purpose that he wasn't much good at anything else and that is the reward system in a lot of academic departments it is not necessarily for the good it may

be fine if you want new drugs or something you want people stunted in a lot of different directions so they can grow in One narrow Direction but I don't think it's good teaching psychology the the the masses in fact I think it's terrible e