Sunday, 11 September 2016

Charlie Munger on Thinking errors and Misjudgements (Summary)


Do we behave to environmental stimuli like ants?

1.  Reward and Punishment Super-response Tendency 
(Incentive and disincentive-caused bias.  It is imperative to understand the role of incentives and disincentives in changing cognition and behavior. The power of incentives can be used to produce desirable behavioural changes.  An incentive-caused bias can tempt people into immoral behaviour.  If you rip apart any system and look at its core design, you will find mainly two things: incentives and disincentives. Communism has failed due to the absence of exactly those incentives. The US financial crisis was an outcome of wrong incentives and absence of disincentives.   It is quite clear that man responds more often and more easily to incentives than to reason and conscience. )

2.  Liking and Loving Tendency 
(This tendency to love has its own set of side effects.  Don't fall in love with your stocks.  Fall in love and protect your capital.  Be a disciplined value investor!)

3. Doubt-avoidance Tendency
(Quick conclusions and quick decisions are often preferred instead of the burden of doubts and ambiguity.  When neither under pressure nor threatened, a person should ideally not be prompted to remove doubt through rushing to some decision.)

4.  Inconsistency-avoidance Tendency 
(We tend to filter away any piece of information which may be inconsistent with our ideas and beliefs.  Be disciplined with your approach:  play the devil's advocate or have processes and procedures in place that tend to minimize hasty and biased decision making.  Adjourn your stock purchases till you are sure.  Stock markets will always keep swinging higher and lower.  Investing opportunities will be there.)

5.  Envy and Jealousy Tendency  
(Greed is fuelled by envy.  Everyone is here not just to make money, but to make more money than what the next person is making.  Comparison and competition are intense, creating a perfect recipe for jealousy tendency.  The important point to take home is to not let such negative emotions affect your investment decisions. Avoid discussions that would trigger feelings of jealousy.  Keep extremely low profile and keep discussions to stock ideas and business fundamentals.)

6.  Over-optimism tendency  
(Excess of optimism is the normal human condition.  "What a man wishes, that also will he believe."  The best way is to acknowledge that this bias exists in the first place.  Challenge your views by asking yourself as many questions as possible to see if your views can stand the attack of reason.)

7.  Social proof tendency
( It is an automatic tendency to think and act the way people around you are thinking and acting.  The evil of corruption continues to persist because of the Serpico Syndrome, which is created by the social proof tendency and the power of incentives.  It dominates how investors behave in stock markets, how company managements (institutional imperative) do business and so on.  Have the management act as if they were the owners.  Buffett says, "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.)

8.  Contrast Misreaction Tendency 
(We perceive everything in relative terms.  It influences how we think about economic news and information, corporate performance, stock prices and so on.  Contrast misreaction cause people to make wrong judgements based on misleading contrasts between two or more things and situations.  For example, a person shifting to another city and looking for a new house and his estate agent using this trick on him.  For the investor, why he did not buy the stock at 140 (because it rose from 90) and then he bought the same stock at 300 (because it fell from 450)?  A stock with P/E of 50 in past and is now at P/E of 30 does not mean it is a lucrative buying opportunity.  Look at the company's business fundamentals and its past financial track record.  Valuing the company based on such important parameters will help you avoid false comparisons.)

9.  Availability-misweighing Tendency  
(Due to the relentless flow of news and information, the human mind has a tendency to focus on what's easily available.  In doing so, often tend to give undue importance to it.  In the absence of relevant information, investors often end up giving undue importance to such insignificant matters.  Adopt Charles Darwin's approach.  He would try to gather evidence to disconfirm it.  Challenge the merit of the idea.  Look for potential risks and concerns that could adversely affect the company.  The ultimate investing decision should be based solely on your understanding and insght and not from borrowed optimism.  Be discipline.  To avoid falling prey to this tendency is to prepare an investment check list and adhere to the process in a disciplined manner.)

10.  Use-it-or-lose-it Tendency  
(The importance of regular practice is especially very vital in skills of a very higher order.  Many people take investing as a side business which can be done without putting in too much time and effort.  And that is one of the biggest fallacies.  Legendary investors such as Warren Buffett, Charlie Munger and Peter Lynch did not create great fortunes out of thin air. They are known to be rigorous practitioners of their art.  They all read extensively and spend a huge amount of their daily routine analysing companies.  By using their mental skills meticulously, they have become successful pilots of the investing world.)

11.  Senescence-misinfluence Tendency  
(At an age when you may not be in the best physical frame to travel distances and perform demanding tasks, what could you do for an alternative source of income?  The answer is investing.  The real risk of significant losses lies in speculative short-term trading.  If you choose the path of long term value investing, you will not only live with minimal risk, but the chances of immense profits will be significantly high.  Remember, in the long run, equities tend to outperform all major asset classes.  If you develop useful skills early in your life and practice them rigorously over the years, you could manage to retain those skills for a much longer period, despite the aging process.)

12.  Authority-misinfluence Tendency  
(Uncertainty and risk have a big influence on how independently people take their decisions.  This makes the stock market a place that is incurably afflicted by the authority-misinfluence tendency.  Just spare a moment and ponder about how exactly you decide when to buy or sell a stock.  What makes you follow these experts?  It is important that you exercise your own independent judgement to the opinions of others.  "Mr. Market is there to serve you, not to guide you."  The greatest investors in the world are those who do not give in to the moods of Mr. Market.  (Mr. Market is a parable told and popularised by Benjamin Graham, teacher of Warren Buffett.)

13.  Twaddle Tendency  
(Man often indulges in petty small talks and chatter.  They only become a nuisance when they come in the way of some serious work that is in progress.  This twaddle tendency, like the twaddle dance of the honey bees, can lead to unproductive results.  And this is what we need to keep a check on.   Better to stay in a quiet corner meantime rather than doing something silly, irrelevant or unproductive.)

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