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Thursday, 9 November, 2006

Charlie Munger on Psychology of Human Misjudgement

For anyone who wants to start investing, this has to be the first thing.

Charlie Munger talks about a set of psychological biases that enable or rather disable to take appropriate decisions. Needless to say, because of these biases, we (wanna investors like us) end up loosing a lot of money. Very very highly recommended article.

Charlie Munger talks about 24 "mental models" that affect us on a cognitive level and we end up making some real bad decisions. These bad decisions could be in personal life, in investing, in dealing with people and what not. Of these 24, following are a few favorite ones...

1. The Superpower of 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've underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.

2. Pavlovian Association:
And all these psychological tendencies work largely or entirely on a subconscious level, which makes them very insidious. Now you've got Persian messenger syndrome. The Persians really did kill the messenger who brought the bad news.

3. Reciprocation:
Cialdini demonstrated this by running around a campus, and he asked people to take juvenile delinquents to the zoo. And it was a campus, and so one in six actually agreed to do it. And after he'd accumulated a statistical output he went around on the same campus and he asked other people, he said, "Gee, would you devote two afternoons a week to taking juvenile delinquents somewhere and suffering greatly yourself to help them," and there he got 100% of the people to say no. But after he'd made the first request, he backed up a little, and he said, "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 ask-for-a-lot-and-back-off.

4. Envy/Jealousy:
I've heard Warren say a half a dozen times, "It's not greed that drives the world, but envy."

5. Social Proofing:
... 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.

I have listed just 5 of the 24. The article is must read for everyone. Complete Text is available here (and its free unlike a lot of things).

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