Charlie Munger on investing biases

Munger, Buffett's right-hand man, is one of the smartest minds in investing.

a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Almost 20 years ago, Berkshire Hathaway (NYSE: BRK-B) vice-chairman Charlie Munger gave a talk called "The psychology of human misjudgement" 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. For the impatient, the talk discusses about 18 separate biases that cause people to fool themselves and make bad decisions. I've summarised the first nine here, along with a few comments from Munger. I'll bring you the final nine next week.

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 misjudgement 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 behaviour. 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, 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 behaviour … 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 fertiliser company, and every other major oil company practically ran out and bought a fertiliser company? And there was no more damned reason for all these oil companies to buy fertiliser 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 aeroplanes, 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 per cent of the time, the plane crashes. I mean this is a very powerful psychological tendency."

Munger is one of the sharpest minds in investing – and when he talks, investors would be well to listen… especially when it comes to the biases that we'd otherwise overlook.

The Australian Financial Review says "good quality Australian shares that have a long history of paying dividends are a real alternative to a term deposit." Get "3 Stocks for the Great Dividend Boom" in our special FREE report. Click here now to find out the names, stock symbols, and full research for our three favourite income ideas, all completely free!

More reading

A version of this article, written by Morgan Housel, originally appeared on fool.com.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »