We Study Billionaires - The Investor’s Podcast Network - TIP571: Charlie Munger & The Psychology of Human Misjudgment

Starting point is 00:00:00 You're listening to TIP. One of the most important things to behaving more rationally is understanding our countless behavioral biases at play when making decisions. And that is why in today's episode, I'm going to be sharing the psychology of human misjudgments that have been explored extensively by legendary investors such as Charlie Munger. To help guide us through this journey of exploring human psychology, I picked up Peter Bevelin's wonderful book called Seeking Wisdom. This book dives into the wisdom of some of the world's world.

Starting point is 00:00:30 greatest thinkers, including Charlie Munger, Warren Buffett, and Charles Darwin. In part two of the book, Bethlehem dives into 28 misjudgments explained by psychology, many of which I'll be walking through during this episode. This episode will touch on the power of incentives, how we as humans are impatient, our desire to remain consistent with prior actions, the anchoring bias, authority bias, social proof, our desire to attach meaning to outcomes and determine the causes of why things happen and much more. As I read through these great examples in the book, I'm reminded just how often we humans behave irrationally, and we do so without even knowing it as we're very emotionally

Starting point is 00:01:09 driven creatures. I don't want to give too much away here at the beginning, so with that, I hope you enjoy today's discussion covering Peter Bevelin's book, Seeking Wisdom. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. So like I mentioned at the top, I'm going to be chatting about some of the things I learned from reading Seeking Wisdom by Peter Bevelin. I previously hadn't heard of this book before, but I first heard about it from a recommendation

Starting point is 00:01:54 from Godham Bade. Back in April 2023, we started what we call our TIP Mastermind Community, where we have a network of like-minded investors, where we discuss ideas and we network with others. We brought Gottem in for a Q&A session with the TIP Mastermind Community, and one of the community members asked him for his book recommendations. And one of the books he recommended was Seeking Wisdom, which is what he also recommended in the podcast episode I had with him back on episode 566. If the TIP Mastermind community is something you think you'd be interested in checking out,

Starting point is 00:02:27 you can learn more by visiting theinvestorspodcast.com slash mastermind. Stig and I also talk quite a bit about the Mastermind community on episode 557 in the last 15 minutes of that episode. The community is currently full, but we do have a wait list you can sign up for to be notified of when we open up the group back to new members. So turning back to the psychology of human misjudgment. This is what is covered in part two of Peter Bevelin's book Seeking Wisdom. If you're not familiar with Peter Bevelin, Nassine Teleb referred to him as one of the smartest people on the planet. He's the author of four books, and it's funny because when I search his name, there's very little about him on the internet. I just did a quick search, and I really couldn't find too much about him, and I didn't see any public appearances that he's done.

Starting point is 00:03:13 So it seems pretty clear to me that Bevlin is all about just sharing this wisdom he's learned from studying the great minds, from Buffett, Darwin, Munger, and he's really not promoting himself or any products or anything else, really. The quote he has here at the start of this section is from Diochrististan, a Greek philosophy. Why O.Y are human beings so hard to teach, but so easy to deceive. Charlie Munger has stated, if you want to avoid irrationality, it helps to understand the quirks in your own mental wiring, and then you can take appropriate precautions. In Bevelin outlines 28 different reasons for misjudgments that can be explained by the makeup of our human psychology. These things are hardwired into us, and most often it's happening subconsciously, so we

Starting point is 00:03:59 aren't even aware of these irrational tendencies that we are all susceptible to. And for each of these 28 different misjudgments we're susceptible to, Bevelin gives an explanation as to why we're susceptible to them and what we can do to overcome them. Just to name a few here to give you an idea, we have bias from mere association, underestimating the power of rewards and punishments, self-serving bias or overconfidence, bias from anchoring, bias from over-influenced by social proof, etc. Bevelin explains that these tendencies have been verified by a number of experiments, and each of us are more or less susceptible to each of these by varying degrees. In action that might be totally irrational to one person, may be totally rational for another person because that's just the way

Starting point is 00:04:43 we're hardwired, and the experiences that each of us have helps form our view of the world in the way we think. Let's start with the first human misjudgment that Bevlin lists here, which is the bias from Mere Association. Bevelin writes, We automatically feel pleasure or pain when we connect a stimulus with an experience we've had in the past or with values or preferences we are born with.

Starting point is 00:05:05 As we've learned, we move towards stimuli we associate with pleasure and away from those we associate with pain. One example that Bevelin shares to describe how Mere Association can influence us is the case of a supplier taking out a customer named John to the best steakhouse in town and then picking up the tab.

Starting point is 00:05:24 So when the time comes for John to go out and buy new supplies, John associated the supplier with pleasant feelings. And it ties into the point here that humans can be really susceptible to act off our emotions and our feelings rather than stone cold facts and logic. He explains further, people can influence us by associating a product, service, person, investment, or a situation with something we like. Many times we buy products, interrelationships, and invest our money merely because we associate

Starting point is 00:05:55 them with positive things. No wonder advertisers or politicians connect what they want to sell with things we like and avoid associating themselves with negative events, end quote. And this also ties to why companies and politicians, they'll try and paint their competitors in a negative light and then they get people to associate their competitors as something to dislike by mirror association. As investors, we want to be mindful of this principle, as many managers and CEOs, we know they can be pretty promotional and be pretty charismatic. Just because you naturally like someone, you like a CEO, you like the management team, it doesn't mean that we should invest alongside them.

Starting point is 00:06:33 Or even just looking at a product. How many people have rode in a Tesla car and they fell in love with it and they said, I just have to own this stock. This doesn't have to necessarily be a bad thing either. I generally like to go to stores or go to restaurants where I like the way that employees treat people. And I want to support these types of businesses rather than going to businesses that treat their customers poorly. He also points out that people generally don't like delivering bad news. People tend to perceive someone differently if they are the bearer of bad news. For example, in Antigone, a messenger feared for his own life since he knew that the king would be unhappy with the bad news

Starting point is 00:07:13 that he would be bringing. This especially can be difficult when you're delivering bad news to someone like a CEO, and that's someone who is typically in a position of power. Regarding giving bad news, Buffett says that for those who work with him, they should think like owners and deliver bad news immediately, because the last thing someone like Buffett wants is for bad news to be delivered too late. Tips that Bevelin shares to counter this misjudgment of bias from association is evaluate things, situations, and people based on their own merits.

Starting point is 00:07:47 Encourage people to tell you bad news immediately. Be aware that just because you associate some stimulus with pain or pleasure, it doesn't mean that that stimulus will cause the same pain or pleasure in the future. And remember that individuals are neither good nor bad merely because we associate them with something positive or negative. I, of course, don't want to make this podcast hours long and cover every misjudgment, but I did want to cover these next two that Bevelin lifts here, which are related to incentives. I cover this subject during my series on The Joys of Compounding by Godham Bade, and that starts on episode 534 here on the podcast feed.

Starting point is 00:08:24 Goddham had an entire chapter in his book covering the power of incentives. So the second misjudgment he lists here is titled Reward and Punishment, and then the third one is self-interest and incentives. Starting with the second one, he starts with a Charlie Munger quote. The iron rule of nature is you get what you reward for. If you want ants to come, you put sugar on the floor, end quote. So what we do is seek what is rewarding to us and avoid what we're punished for. We learn what's right and what's wrong from the consequences of our own actions.

Starting point is 00:08:57 So behavior that feels rewarding or pleasurable, it tends to be repeated. And once these behaviors get reinforced, they start to be set in stone and become stronger and stronger over time and then they become a habit. Samuel Johnson, in 18th century, English writer said, The chains of habit are too weak to be felt until they are too strong to be broken. And Bevelin talks about how people act with regards to social programs or certain programs that may be available through their work and then take advantage of these things that they don't necessarily need.

Starting point is 00:09:29 For example, he shares a story that Charlie Munger has told related to the New York Police Department. Their pension system was set up to pay out depending on what their pay was in their final year of service. And remember, you're going to get the outcome that you incentivize. So what the police officers would do is that when they would reach their final year of employment, everyone would just cooperate and then let the officer take a thousand hours of overtime to maximize their pay in that final year. Absolutely nobody would have shame in taking advantage of such a system

Starting point is 00:10:01 because they each expected to benefit from that program. Munger has stated, they soon get the feeling that they're entitled to do it. Everybody did it before and everybody's doing it now. So they just keep doing it, end quote. Bevelin also shares how this can relate to investing. When people start to make money investing, they think they're geniuses and they become overly optimistic risk takers.

Starting point is 00:10:25 And then after they see some failures or when they start losing money in stocks, they become overly pessimistic in risk averse. People have a tendency to overreact to recent experience. Just like how a child won't risk touching a stove that may be hot twice, a retail investor that loses a ton of money in a biotech pick isn't likely to buy into another biotech in the future because of that negative association that they now have. It's also important to remember that good consequences don't necessarily mean we made a good decision, and bad consequences don't necessarily mean we made a bad decision.

Starting point is 00:11:00 If you're a manager, a leader, or a parent that wants to incentivize good behavior and disincentivize bad behavior, Bevelin suggests that pleasurable experiences should be broken into segments, and painful experiences should be given all at once. Have you ever been to a birthday party where kids' presents were all put into one box? Well, typically, all the gifts are in a ton of different boxes. Giving rewards frequently feels better. It feels better to get $50 twice than a lot. to get $100 once.

Starting point is 00:11:32 And it feels less bad to lose $100 once than it does to lose $50 twice. We also prefer a sequence of experiences that improve over time. It feels better to lose $100 than gain $50 than to gain $50 than lose $100. Again, we prefer a sequence of experiences that improve over time. Bevelin has a lot here that we should keep in mind in relation to the second misjudgment. He says that praise is more effective in changing behavior than punishment is, and it is better to encourage what is right than to criticize what is wrong. Second, we should tie incentives to performance to the results that you want to achieve,

Starting point is 00:12:14 and make people share in both the upside and the downside. Make sure they understand the link between their performance, the reward, and what you want to accomplish yourself, and do your best to not incentivize behaviors that you don't want. ideally undesirable behavior should be costly, he writes, the painful consequences of undesirable behavior must outweigh its pleasurable consequences. For example, the consequences of spending time in jail ought to be more painful than the pleasure of getting away with burglary, end quote. When I think about executive compensation in relation to this, I want to own businesses that

Starting point is 00:12:50 are working to maximize long-term shareholder value. Executives who own a lot of stock, and they've done so for many years, years, they're incentivized to think long term. Whereas managers who are paid primarily based on stock options that increase in value with short-term price increases, they're incentivized to push for that short-term performance. And then there's this quote here I really like that he has from Upton Sinclair, an American novelist. It is difficult to get a man to understand something when his salary depends upon him not understanding it, end quote. And Bevelin also says to reward individual performance in not effort or length in an organization and reward people

Starting point is 00:13:30 after and not before their performance. It somewhat baffles me when I see companies have their very structured and hierarchical approach to business where you can only get promoted after so many years of service. And it essentially gives their employees the path to management and it primarily bases it based on how many years they've been with the company. We should also be careful about allowing money to be the only motivation. If you turn it into all about money, then work that somebody enjoys may turn into something they really don't enjoy. The reward itself can change the perception. Hevelin writes, a reward for our achievements makes us feel that we are good at something, thereby increasing our motivation. But a reward that feels controlling and makes us

Starting point is 00:14:15 feel that we are only doing it because we're paid to do it, it decreases the appeal, end quote. And there's a quote here from Blaze Pascal that I really like as well, we are generally better persuaded by the reasons we discover ourselves rather than by those given to us by others, end quote. And then the last point here from Bevelin, decision makers should be held accountable for their consequences of their actions. Munger has stated, An example of a really responsible system is the system the Romans used when they built an arc.

Starting point is 00:14:45 The guy who created the ark stood under it as the scaffolding was removed. It's like packing your own parachute." All right. So turning to the third misjudgment that is directly related to this, this is titled Self-interest and Incentives. Right off the bat, Bevelin shares a story that I wanted to read here. The organizers of a tennis tournament needed money. So they approached the CEO of TransCorp and they asked him to sponsor the tournament.

Starting point is 00:15:12 The CEO asked how much? And then they said, $1 million. The CEO said, that's too much money. And then they responded, not if you consider, the fact that you personally can play one match, you can sit in the honorary stand next to a member of the presidential family, and be the one that hands over the prize at the end, replied the organizer. Then the CEO says, where do I sign? People do what they perceive is in their best interest and they're biased by their incentives.

Starting point is 00:15:40 There's the classic saying that you should never ask the barber if you need a haircut. Everyone, including lawyers, accountants, doctors, consultants, salesmen, organizations, the media, and, admittedly myself, we're all biased by our own incentives. And remember that what is good for them may not be good for you. Financial advisors are typically paid salesmen, and they may trick you into buying things that you don't really need, which in my opinion is all too prevalent in the financial services industry. It's also worth mentioning the incentives of Wall Street and the incentives of the media.

Starting point is 00:16:15 Wall Street wants you to act and to constantly be buying and selling, because they make a killing on the spreads and the transactions fees from you constantly trading. Investment bankers get paid hefty commission checks when you buy into their overpriced and overhyped new hot IPO. So if you want to change someone's behavior, see if you can change their incentives. Benjamin Franklin stated, when you persuade, speak of interest, not of reason, end quote. It's likely unwise to straight up tell someone what they should do. and most people are likely better off acting out of their own free will. I can't think of too many people that enjoy being given demands constantly,

Starting point is 00:16:56 especially on things they don't really want to do. It reminds me of some parents that are just watched dogs for their children, and it sometimes leads to the children even rebelling and doing the opposite of what the parent wants because they've taken it too far and they've gone overboard. Warren Buffett once said, We want the manager of each subsidiary to run their business in the way they think is best for their operation. We'll never tell a subsidiary manager which vendor to patronize or anything of that sort. Once we start making those decisions for our managers, we become responsible for the operation

Starting point is 00:17:29 and they're no longer responsible for the operation. That's the Berkshire approach. I think on balance, our managers like it that way because they're not going to get second-guessed and nobody will go over their heads, end quote. So key takeaways here and things to keep in mind include always consider the incentives, benefits, and interests at play of counterparties you're dealing with, and understand people's motivations and what makes them tick. This could be financially related or related to other things such as status, reputation, power, envy, ethics, morality, etc. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible

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Starting point is 00:21:55 Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify. slash WSB. All right, back to the show. The fourth human misjudgment I wanted to mention is titled, Self-Serving Tendencies and Optimism, and this ties into our bias of being overconfident. Most people tend to naturally think that they're special.

Starting point is 00:22:26 They think that bad things that have happened to others aren't going to happen to themselves. And of course, this can lead to some people just behaving totally recklessly before they learn their lesson. Bevelin writes, most of us believe we are better. performers, more honest and more intelligent, and have a better future, have a happier marriage, are less vulnerable than the average person, etc. But we can't all be better than average. We tend to overestimate our ability to predict the future. People tend to put a higher probability on desired events than on undesired events. Optimism is good, but when it comes to important decisions, realism is better, end quote. Another point he ties into this is

Starting point is 00:23:07 investors naturally attributing any gains in investing to skill and any losses in investing to just bad luck. Experiments have shown that when we're successful, whether that be chance or skill, we tend to credit our own character or our own ability. We really need to be aware of our own egos at play here and recognize that overconfidence can lead to unrealistic expectations and make us prone to making poor investment decisions. Bevelin writes, recognize your limits. How well do you know what you don't know? Don't let your ego determine what you should do.

Starting point is 00:23:42 Charlie Munger says, it is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid instead of trying to be very intelligent. There must be some wisdom in the folks saying, it's the strong swimmers who drowned, end quote. Rather than solely focusing on the upside, be acutely aware of the downside and what can go wrong.

Starting point is 00:24:04 Build in a margin of safety and have a plan of action. if things happen to turn south. And oftentimes, when it comes to investing, we may hear ideas from people who sound extremely smart and extremely confident. That is all too common with so many people and businesses trying their very best to sell you something. But for investing, we'll want to always consider the track record of that promoter. Do they have a track record of consistently being right or are they wrong more often than

Starting point is 00:24:30 not? I think a lot of investors get led astray by following the recommendations of promoters that that really have no track record at all. And it could be really difficult to look at track records of many people who are promoters. Tweets can be deleted. We can't see maybe prior emails they've sent and other recommendations they've made. Continuing along with the fifth one he brings in here, it's really interesting, I think.

Starting point is 00:24:52 It's titled Self-Deception and Denial. It's so interesting that there is no easier person to fool than ourselves. Richard Feynman once stated, the first principle is that you must not fool yourself, and you are the easiest person to fool, end quote. Mevalin writes, we deny and distort reality to feel more comfortable, especially when reality threatens our self-interest. To quote the Austrian psychologist Sigmund Freud,

Starting point is 00:25:19 illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We view things the way we want to see them. We hear what we want to hear and deny what is inconsistent with our deeply held beliefs. We deny unpleasant news and prefer comfort to truth. We make sense of bad events by telling ourselves comforting stories that give them meaning, end quote. The main takeaway is that if we want to be great investors, we have to see the world as it is, and not for what we want it to be. Refusing to look at the downside or things we don't like doesn't make those things disappear.

Starting point is 00:25:57 Bevelin says that bad news that is true is better than good news that is wrong. I'm finding it hard to skip any of these misjudgments knowing that I'm not going to be able to fit all 28 of them into this episode, but the 6-1 he lists here is related to consistency. I think it's just so, so important. John Maynard Keynes, the famous British economist, he once stated, The difficulty lies not in the new ideas, but in escaping the old ones, which ramify for those brought up as most of us have been into every corner of our minds, end quote. Once humans make a commitment, such as a promise, a choice, or even envisaged,

Starting point is 00:26:31 invested time, money, or effort. We generally want to remain consistent with that commitment. And the more we have committed or the more that we've invested into it, the harder it is for us to change our minds. We're biologically hardwired to want to maintain a positive image. And if we're viewed as someone who can't be trusted and can't be consistent, then that may end up hurting our own image. Many of the guests we bring on to the podcast don't like to talk about companies in their portfolios because they know it messes with their psychology of how, they view that company. If me or anyone else were to talk positively about a company in public, then it becomes really

Starting point is 00:27:08 hard to say that we're wrong about it and to change our minds. But it's funny because sometimes I do come across the occasional guests, Chris Mayer is one that comes to mind. And he says that he has absolutely no issue with changing his mind and potentially selling out of that position when the facts change related to his original thesis. As Keynes once stated, when somebody persuades me that I am wrong, I change my mind. What do you do? This also reminds me of the sunk cost fallacy.

Starting point is 00:27:36 Many investors oftentimes have a hard time letting go of investments that they know have gone bad. I know I've had some losers that I held on to for way too long when the thesis wasn't playing out how I originally expected. And Buffett has this quote that the most important thing to do when you find yourself in a hole is to stop digging. And that's a lesson I have learned, the hard way especially. Remember that you don't have to make your money back the same way that you lost. it. So when you realize that you've made a mistake, not based on the movement of the stock price, but you've made a mistake when looking at your actual thesis, then it's probably best to move on to other ideas that offer a better opportunity. To sell a stock is to admit that you were wrong

Starting point is 00:28:16 on your original thesis. Psychologically, we've been invested into the company with our desire to be consistent. But the business and the stock don't know and they don't care whether we own it or not. It's going to do what it's going to do. I actually have to be. I actually have to be a lot of the business. this encounter recently with a charity organization that used this trick of me wanting and desiring to be consistent. So someone approached me and my brother down in Florida and they asked us whether we've been to a hospital. And they mentioned that our experience likely wasn't that great. So we just simply agreed with them. And then the next thing you know, they're pitching us on donating to a children's hospital that's in need of whatever they were raising money for. And they were clearly

Starting point is 00:28:57 playing on the psychological tactic of us needing to be consistent. We had said that hospitals probably could be a bit better at times, so if we wanted to remain consistent, then we needed to donate money to them. By the way, the trick did work on me. Robert Chaldeenie, I believe, also has a chapter on this psychological tactic in his famous book, Influence, which is another great read for understanding human behavior. Strong convictions can be really dangerous, especially when they're almost ideological. This could be investing or really anything else.

Starting point is 00:29:30 When our thoughts default to some ideology, our brains, they sort of turn off and they go on autopilot, so we need to make sure our decisions are active and we're thinking rationally, as Munger would say. Munger said, we've done a lot of that, scrambling out of wrong decisions. I would argue that's a big part of having a reasonable record in life, end quote. I'm no poker expert, although I wish I were, but once you have your money in the pot, You can't change that. Once you've lost money on an investment, that can't be changed all of a sudden. Just because you've put money into the pot or you've put money into an investment,

Starting point is 00:30:06 it doesn't mean you have to continue doing so. Time, money, and effort that has been spent is now gone. Bevelin writes, decisions should be based on where you want to be, not where you've been. You should base decisions on the present situation and future consequences, end quote. Jumping to the eighth misjudgment here covering the status quo and the do-nothing syndrome, humans also have a natural tendency to stick with the status quo. Oftentimes, there are good reasons for this.

Starting point is 00:30:36 Simply sticking to the tried and true method is what generally works. This is also the path of least resistance. You don't have to think about what would happen if you chose another option. Humans are also very habitual. They have their routines rather than continually switching things up. Bevelin writes, the more emotional a decision is, or the more choices we have, the more we prefer the status quo. This is why we stick with our old jobs, our typical brand of car, etc. Even in cases where the cost of switching are very low, end quote.

Starting point is 00:31:08 I can't help but think about the pushback that people get when they leave a promising career to chase something that they're passionate about or maybe chasing a new business opportunity. Bevelin also argues that people tend to prefer to play it safe within action. rather than trying something new and risking harm. He writes, We feel worse when we fail as a result of taking action than when we fail from doing nothing. We prefer the default option, for example, the alternative that is selected automatically unless we change it, end quote. Then his takeaways here are deciding to do nothing is also a decision, and the cost of doing nothing could be greater than the cost of taking action.

Starting point is 00:31:48 Also remember what you actually want to achieve, not what you actually want to achieve, not what. anyone else wants you to achieve. The ninth misjudgment points to an opportunity for much of our audience, which is filled with long-term investors. The misjudgment is impatience. People want the quick fix, the easy money and the jackpot today. It reminds me of the marshmallow test where these children could either get one marshmallow now or two marshmallows in 15 minutes. And it points to what each person's time preference is and it really tested their patience. Human impatience is a reason why so many people have stacked up debt, they're taking the rewards today and pushing any costs into the future to be paid back later. I like to think about what I believe to be

Starting point is 00:32:33 one of my biggest advantages as a long-term investor, and it's time arbitrage. I'm willing to purchase a durable and a growing business today, but I'm willing to sit on it for years while many other shareholders are worried about the EPS numbers for the latest quarter, looking at it down to the nearest penny, and whether they hit or miss their Wall Street target. And then they're watching how the stock pounces up and down day by day. The goal for me anyways is trying to be patient, ignoring the noise, and focusing on the businesses' underlying fundamentals, and where it's heading for the long run. I think that people really are too impatient.

Starting point is 00:33:08 They think they need to be doing something every day. Warren Buffett maybe makes a few sizable trades a year. And Chris Mayer, who I interviewed on the show here and just recently interviewed for the second time, Chris said in 2022, he added one company to his portfolio and removed one company. That's it. Most of the time, these great investors are exercising patience and they're letting their businesses compound for them. When making any decision, you need to weigh the positives and the negatives. Short-term pleasure may lead to long-term suffering, and short-term suffering may lead to long-term pleasure. This could relate

Starting point is 00:33:45 to health and fitness, relationships, your career, your business, investments, or really, whatever else. The 11th misjudgment he lists here is the contrast comparison. Bevelin uses the example of having three buckets of water, one cold water, one hot water, and then one's room temperature. If you put one hand in the cold water and one hand in the hot water, and then you put them both in the bucket with that is room temperature, then your cold hand feels warmer and your warm hand feels colder. The point is that we judge stimuli by differences and changes and not by absolute magnitudes.

Starting point is 00:34:20 So everything seems to be relative, and it depends on the context of the situation. Then he pulls in a few other examples here. If you go shopping and you purchase a $1,500 suit, then adding $100 tie doesn't really seem all that bad. The $100 tie doesn't seem like very much because we're automatically contrasting it to the $1,500 suit. I can just imagine this getting so tricky with really big purchases. You might be going and purchasing a higher-end car, and then you'll be going to buy a higher-end car,

Starting point is 00:34:49 and then you have all the commissions and the add-ons that they'll try and tack on to that, or even purchasing a home and the commissions associated with that, and the fees that go with the mortgage, because in my mind, it's so easy for the bank to just lump everything into the mortgage so the consumer doesn't really feel the pain when they sign that dotted line. They're just excited to move into the new home. You can also consider how companies price things as well, and they pull in the contrast comparison.

Starting point is 00:35:16 For example, if you go to a movie theater and you were offered a large popcorn for $12, you might say that's just a ridiculous price and you just simply pass on it. But if the theater also offered a small popcorn for $10 and then you still had the large for $12, then the large may appear it looks like a bargain because you get a lot more popcorn relative to the small for only $2 more. The product itself didn't change, but adding in the inferior option can change people's perception towards a particular product. And oddly enough, this can be a situation where people feel like they're getting a bargain, even though they're essentially paying top dollar prices.

Starting point is 00:35:57 Another issue with the contrast comparison is that we may be susceptible to not discovering problems until it's too late, because the problems arise very gradually. When things change very quickly, it understandably takes us by surprise. But the things that really blindside us are the things that happen very gradually over time that really can't be reversed. When change is slow enough, we don't really notice the effects. This could be a company very gradually manipulating their financials, or relationships slowly going south as you let more and more issues sort of slip by.

Starting point is 00:36:32 Bevelin writes, sometimes it is a small, gradual, invisible changes that harm us the most, end quote. To use personal finance as an example, two, one $500 monthly car payment likely isn't going to cause you to go broke. or bankrupt you. It's the incremental things that add up over time that amount to getting you in a place that's nearly impossible to dig yourself out of. The credit card bills stack up, you live outside your means, you buy an extra car, you buy a house, you can't really afford and so on. And that's just to use money here as an example for the contrast comparison.

Starting point is 00:37:07 Another misjudgment that most of our audience is going to be aware of is anchoring, which directly relates to this contrasting concept. Anchoring is when we become over. over-influenced by certain information, and it acts as a reference or anchor for future judgments. For example, if you buy a stock for $50 in January, and the stock now trades for $40 in August, then some might say you've made a bad investment just because the price today is less than what you originally paid, and they don't even consider what they believe to be the actual value of that company. Or some people might get fixated on the $50 and say, since it was at $50 for quite some time and now it trades for $40 all of a sudden,

Starting point is 00:37:49 then they might assume that $40 is a bargain. The point is that we shouldn't put too much weight on the price and telling us what the true underlying value is of the company. Someone who bought meta stock in July of 2022 at $170 might have been laughed at by their friends when the stock was trading for $90 in November 2022. And at the time of this recording, that person would be up substantially on. on their investment at 170, even though they looked probably pretty dumb for some period of time. Remember that price can deviate drastically from the underlying value for relatively long periods

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Starting point is 00:41:41 at Fundrise.com. This is a paid advertisement. All right, back to the show. As I chatted about during my episode on Howard Marks' book, Mastering the Market Cycle, the market is largely driven by human psychology, by greed, fear, and overall sentiment. If sentiment is really bad, then price can go well below intrinsic value until sentiment picks back up again. Bevelin writes, the present price of a stock in relation to some past quote,

Starting point is 00:42:11 doesn't mean anything. The underlying business value is what matters, end quote. Now, this concept of anchoring, I think, we should all be mindful of when dealing with negotiations as well. Say if a car salesman tells you the price of a car, let's just say it's $30,000, what you feel is a bit of a stretch relative to what you're getting from the car. Let's say going into the deal, you thought you might not want to pay more than $20,000 for the car.

Starting point is 00:42:38 Well, the salesman might understand your hesitancy, and he pulls a special discounted deal out of his back pocket, and it's a deal that happens to expire that day. So if you want the discount, then you need to act now, and then he offers the car for $26,000, and it includes even these extra special features that you didn't think you were going to get originally. Well, since he originally offered $30,000, $26,000 doesn't really sound so bad because we now have that anchor of $30,000, that price is anchored. in our mind. So the takeaways Bevelin list here is consider choices from a zero base level and remember what you actually want to achieve. So in the case of the car, maybe you don't even

Starting point is 00:43:18 want the extra features, but it's something that you're actually paying for and it's baked into the price. And then second is adjust information to reality. Reciprocity is another popular bias that is explained in Robert Chaldeen's book, Influence, which Bevlin also ties into his book here. Marcus Cicero wrote, there is no duty more indispensable than that of returning a kindness. All men distrust one forgetful of a benefit, end quote. You can think about how when somebody does something very kind to us, psychologically we feel that we are now in debt to that person. We tend to repay in kind what others have done for us, whether it's good or bad. This is my guess as to why grocery stores just give free samples of various products or

Starting point is 00:44:04 some website gives you a seven-day free trial period. Reciprocity is something I feel I've experienced here at TIP as well. T-IPS of thousands of people listen to our show each week, and they get to do so for free while having to deal with the occasional ad break, of course. Since our listeners didn't have to pay anything to listen to our show, when I go and meet people in person, they tend to almost feel like they just owe a great deal to TIP with all the value that we've provided to them at no cost. And TIP isn't particularly special. There are plenty of other podcasts out there

Starting point is 00:44:38 that do the same and provide content for free. And I think reciprocity is something that many successful people understand. I think of people who are hardwired to just give, and that's with no expectation of getting anything back in return. And behold, after all of that giving that they've done over a long period of time, on the back end, they may come to find

Starting point is 00:44:59 that they've received 10x the value in return in some way, shape, or form. It reminds me of how Goddum Bay talks about in his book, The Compounding of Goodwill. And then Guy Speer talks about this as well in his book. Goddum had compounded goodwill with various people he had worked with, and he helped them with their own investments and whatnot. And one person he was connected with had warned him about the issues that were happening within a company that Gottem wasn't aware of and he had owned that company.

Starting point is 00:45:26 So he had gotten out of the stock that was in trouble before the market realized the issue. and that only happened because of all that compounding of goodwill over time, and then that old co-worker shed light on the issues that were happening within that business. And if he hadn't compounded that goodwill in the way that he did, then he never would have been shown where the business was heading in the future. Bevelin also has another example of people being treated one way or another. He states, I praised him for a job well done, and I received a motivated employee. I told him about a mistake and he became hostile towards me.

Starting point is 00:46:01 We respond the way we are treated. If we are unfair to others, people are going to be unfair back. If people trust us, we tend to trust them. If people criticize us, we criticize them back. If people we don't like do us a favor, we reciprocate anyway, end quote. And Bevelin also talks about how Warren Buffett has this challenge where around three quarters of his managers are financially independent. They don't have to work for Berkshire, but they still choose to do so.

Starting point is 00:46:30 Buffett thinks to himself, how can I make these managers want to work for Berkshire? One way he does this is to give managers ownership over their work, so they feel like they're running the show, they don't have a watchdog keeping an eye on their every move, and then second-guessing them or telling them how to run their business. In many ways, this is something that is very rare, at least in my experience, I think. So these managers, they have ownership over their work, and they really appreciate Buffett just staying out of their business. So many of these managers are probably reciprocating by paying Buffett back and treating them in a way that they wish to be treated. And then they go and do great things with their business.

Starting point is 00:47:09 Then Bevelin, of course, lists many things we can keep in mind related to this. People don't want to feel indebted. We are disliked if we don't allow people to give back what we've given them. So allow people to give back to you if you are compounding goodwill in some way and giving to them. This second point here also fascinates me, quote, A favor or gift is most effective when it is personal, significant, and unexpected, end quote. It's so fascinating to me that people will like you more if you give them something that they totally don't expect, especially if it's really personalized.

Starting point is 00:47:45 I think there is something innate within most humans that they really just do not want to stand out from them. crowd, which is why it's so interesting to study investing and study all these great investors because by definition, in order to outperform the crowd, your opinions, your actions, and your investments need to deviate from the crowd. American philosopher Eric Hofer said, when people are free to do as they please, they usually imitate each other, end quote. People tend to believe what other people believe and do what other people do. If someone else avoids something, we're more likely to avoid it as well.

Starting point is 00:48:20 If other people endorse a product and tell us how much they love it, we're more likely to follow their lead and purchase that product. And social proof is why most managers tend to stick with the status quo in order to avoid standing out and looking foolish for making an unconventional decision. As many of the listeners know, this social proof idea and this tendency, it leads to terribly irrational things when it comes to the markets. Warren Buffett said that, as happens in Wall Street all too often, what the why is do in the beginning, the fools do in the end." When we see crowds of people doing something, we're more

Starting point is 00:48:56 likely to follow suit, even if the prospects of the investment are too good to be true or the numbers just don't add up or make sense. This is how Bernie Madoff was able to get away with market beating returns year after year after year, even though his so-called investment strategy was back tested and it was actually found that achieving such returns using the approach that he said that he used, it was literally impossible. People don't care about logic when they seem to be getting rich by doing something irrational. When people act within a group or they act within a crowd, we feel that we have less responsibility to make a thoughtful decision. And this can lead us to becoming overconfident because everyone else is doing the exact same thing. So overconfidence

Starting point is 00:49:41 also ties into this social proof idea. Buffett stated, we don't derive comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don't. Benjamin Graham stated, have the courage of your knowledge and experience. If you have formed a conclusion from the facts, and if you know your judgment is sound, act on it. Even though others may hesitate or differ, you are neither right nor wrong because the crowd disagrees with you.

Starting point is 00:50:10 You are right because your data and reasoning are right, end quote. Nowadays with social media, it's easy to fall into groupthink and fall into. to these eco chambers of being surrounded by people who think the exact same as you. The social media algorithms may even be pushing this to your feed, so you mostly see this content that you already agree with. Probably the best way to combat this is to seek out viewpoints that you disagree with and seek out those alternative viewpoints that see things differently. Another bias in relation to investing is authority bias.

Starting point is 00:50:42 Many investors, including myself, check out what other big name investors are buying or what they already own. In a way, I imagine part of our brains just turning off when we see an investor we deeply admire purchase large amounts of a stock, and we may do less due diligence than we otherwise would. Of course, this may sometimes turn out to be fine for us, but there may be cases where this can really get us into trouble as well. Authority bias is why advertisers use famous people to endorse their products. I've recently been rewatching The Last Dance, which covers the story of Michael Jordan,

Starting point is 00:51:14 and the Chicago Bulls winning their sixth championship in the 90s. And I think about the last dance and how much of Nike's success came from exploiting the authority bias. And they are partnering with top athletes such as Michael Jordan and Tiger Woods. And another idea I've been thinking about a lot lately is that with investing, we are always experiencing times of uncertainty. And because we're always facing the uncertainty of the future, we turn to experts who sound like they know what they're talking about. If someone doesn't necessarily understand the details of an investment, they may trust the opinion of someone they perceive as an expert.

Starting point is 00:51:52 For the normal, everyday person, this may mean purchasing an obscure financial product from their local financial advisor, or maybe for podcast listeners, this means taking someone's opinion as fact just because they sound really smart and it sounds like they know exactly what they're talking about. Buffett once said, techniques, shrouded in mystery, clearly have value to the purveyor of investment and advice. After all, what doctor has ever achieved fame and fortune by simply advising take to aspirants? End quote. This gets to the point of oftentimes in life, the solution to many of our problems is the straightforward solution and the straightforward advice that many of us already know and already understand. And the comments around uncertainty also tie into the bias of sense making. Oscar Wilde once said, the public have an insatiable curiosity to know everything,

Starting point is 00:52:44 except what is worth knowing, end quote. Then Bevelin writes, We don't like uncertainty. We have a need to understand and make sense of events. We refuse to accept the unknown. We don't like unpredictability and meaninglessness. We therefore seek explanations for why things happen, especially if they are novel, puzzling, or frightening.

Starting point is 00:53:05 By finding patterns in causal relationships, we get comfort and learn for the future, end quote. After an event has taken place, people love to attribute one factor into describing why the event played out the way it did. The challenge with looking back at the past to try to prepare for the future, with regards to markets at least, is that there are so many factors that play into it. So determining this cause and effect relationship can be really, really difficult oftentimes. Charlie Munger has a quote about forecasts and predictions that Bevlin shares here.

Starting point is 00:53:37 Around here, I would say that if our predictions have been a little better than other people's, it's because we've tried to make fewer of them. So the big takeaway from me with regards to our bias for preferring certainty, first come to terms with the fact that the world is fundamentally uncertain. And as far as I know, we'll always be that way. When people are most fearful and uncertainty seems to be the highest, keep in mind that that is when the best investment opportunities are going to come around. Most people are going to want to wait out the storm and wait for the future to become more clear.

Starting point is 00:54:08 and by the time that happens, the incredible investment opportunities will have already passed by. My second takeaway is that we humans, we want to try and think of the world in a very simple, cause and effect type way. If X happens, then Y will happen. If interest rates fall, then stocks will rise, for example. But keep in mind that the world and especially markets are practically never as simple as we'd like them to be. There are a my rate of factors that play into why things play out the way they do.

Starting point is 00:54:38 and we likely can't reduce it down to just one single variable. Then my third takeaway is that everything seems obvious in hindsight. How many people in 2010, when the S&P 500 was trading for $1,100 would say that in 2023, we'd be trading at $4,500, given that, you know, we'd experience things like a global pandemic, global geopolitical tensions, multiple issues with the debt ceiling, U.S. and China, you know, global dynamics there, yet another big. banking crisis, and so on. Even if we know what events will play out in the future, we still can't be certain what that will mean for stock prices. It's a reminder for me to always be humble

Starting point is 00:55:19 and always keep my own humility in check and how much I think I know. That wraps up the piece I wanted to do chatting about the misjudgments. There are a number of them I didn't get to today, so I'd encourage you to pick up the book, which we will be sure to link in the show notes if you're interested in picking that up. Real briefly, skipping ahead past the 28 misjudgments we've been covering here, Bevelin has this piece on contextual influences and touches on a couple of the examples here that I thought our audience would really enjoy. Oftentimes, people's view of something changes based on the way that something is framed. To use an example, a label that shows 95% fat-free is perceived much differently than a label that shows 5% fat. A search

Starting point is 00:56:03 procedure with a 40% success rate is perceived much better than a surgical procedure with a 60% failure rate. When it comes to money, people tend to do a lot of mental gymnastics when it comes to where money comes from. If someone earns $1,000 through hard work, then they're going to value it much more than had they want $1,000 from the casino or off a scratch-off ticket. Both of the $1,000 spend the exact same way, but we tend to view it much different. Bevelin argues that we should view our assets in terms of their entirety. A dollar is a dollar independent of where it comes from. And then Bevelin shares three pieces of advice from Charlie Munger that really attributes

Starting point is 00:56:46 to a lot of what he's talking about in this book. I quote, I don't want you to think we have any way of learning or behaving so you won't make a lot of mistakes. I'm just saying that you can learn to make fewer mistakes than other people. And how to fix your mistakes faster when you do make them. There's no way that you can live an adequate life without making many mistakes. In fact, one trick in life is to get so you can handle mistakes.

Starting point is 00:57:11 A failure to handle psychological denial is a common way for people to go broke. You've made an enormous commitment to something. You've poured effort and money in it. And the more you put in, the more the whole consistency principle makes you think, now it has to work. If I put in just a little more, then it'll work. Then skimming ahead a bit, life in part is like a poker game, wherein you have to learn to quit sometimes when holding a much loved hand, end quote.

Starting point is 00:57:36 Then the second part here, I've gotten so that I now use a kind of two-track analysis. First, what are the factors that really govern the interests involved, rationally considered? And second, what are the subconscious influences where the brain at a subconscious level is automatically doing these things, which by and large are useful, but which often dysfunction? One approach is rationality. the way you'd work out a bridge problem. By evaluating the real interests, the probabilities, and so forth. And the other is to evaluate the psychological factors that cause subconscious conclusions,

Starting point is 00:58:11 many of which happen to be wrong, end quote. Then the last point is that Munger recommends using a checklist using all the main models from psychology, reviewing them, and then consider the combined effects of what Munger calls the Lallapalooza effect and how that may play into a given situation. At the end of the day, we need to remember that our minds and our bodies aren't adapted to the modern world. The ancestral environment that were hardwired to rewarded actions before thought, and emotion before reason. With the modern world, it's very much the opposite, especially when it comes to investing, which rewards

Starting point is 00:58:45 thought and reason above actions and emotions. A Chinese philosopher Lao Zhu once said, He who knows men is clever. He who knows himself has insight. He who conquers men has force, and He Who Conquers Himself is Truly Strong, end quote. Well, that wraps up this episode covering Seeking Wisdom by Peter Bevelin. I hope you enjoyed this episode covering the book. And if you did enjoy it, we'd really appreciate it if you took a minute and helped out our show. This might mean sharing the episode with a friend, leaving a rating of review on the podcast app you're on, leaving a like or comment if you're listening on YouTube. We very much appreciate you supporting the show.

Starting point is 00:59:23 And I hope to see you again next week. Thanks for tuning in. Thank you for listening to TIP. Make sure to subscribe to millennial investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional.

Starting point is 00:59:49 This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting. Thank you.

We Study Billionaires - The Investor’s Podcast Network - TIP571: Charlie Munger & The Psychology of Human Misjudgment

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