Charlie Munger: The Psychology of Human Misjudgment [Outliers]
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I came to the psychology of human misjudgment almost against my will. I rejected it until I realized that my attitude was costing me a lot of money and reduced my ability to help everything I loved. That's a quote by Charlie Munger, and that's what we're going to talk about today. The psychology of human misjudgment. Welcome to The Knowledge Project. I'm your host, Shane Parish. This podcast is all about learning from others, mastering the best of what they figured out so you can use their lessons in your life. Charlie Munger was a lawyer from Omaha who taught himself psychology because Harvard Law School refused to. Munger was the partner of Warren Buffett, and together they created one of the best track records the world has ever seen.
And they used psychology to do it. In 1995, Munger formalized what he'd learned into a speech at Harvard. He called it the psychology of human misjudgment. And in it, he identified 24 psychological tendencies that cause systematic errors in thinking. Ten years later, at age 81, he rewrote it from memory, expanding it to 25 tendencies. I published the full updated version on fs.blog with his personal permission. We're the only website, to my knowledge, that has this permission to post it. I'll put the link in the description. The psychology of human misjudgment is one of the most valuable frameworks for understanding human behavior ever created. It's Munger's map of how your brain systematically fools you and how to fight back.
Let's dive in. Pattern one, reward and punishment super response tendency. Munger opened his talk with what he felt is one of the most important and underrated patterns, what he called reward and punishment super response tendency, otherwise known as just incentives and disincentives.
Munger starts by saying, well, I think I've been in the top 5% of my age cohort all my life and understanding the power of incentives and all my life I underestimated it and I Never a year passes but I get some surprise that pushes my limit a little farther.
Munger was perhaps one of the smartest people in business. Someone who spent decades intensely studying this topic in his spare time. And he said he still underestimated how powerful incentives are. The simple maxim Munger came up with for this is never ever think about something else when you should be thinking about the power of incentives. Munger's favorite example of getting the incentives right is Federal Express. We had a whole episode on Fred Smith and Federal Express a few months ago, and this story is part of it, but I'm going to repeat it here because it's so revealing about incentives. FedEx built their entire business model on one thing, speed. Packages had to move through one central airport hub every single night, get sorted rapidly, and then get on planes heading to their final destination.
The whole system depended on these night shift workers unloading and then loading these planes all in one overnight shift. By daybreak, all planes had to be in the air. But they always had issues getting it done before sunrise. Night after night, at the end of the shift, there would still be planes on the ground not loaded. They tried everything to speed things up. They tried threats, training programs, more supervisors. Nothing worked. Finally, somebody realized they were paying the workers by the hour. Think about Munger's statement from a minute ago. Never, ever think about something else when you should be thinking about the power of incentives. What was FedEx incentivizing on the night shift when they paid workers by the hour?
To work slowly. Because if they stretched the job out, they'd get paid more money. A longer shift meant a bigger paycheck. Finally, someone had the obvious realization, pay them by the shift, so when they're done, they can just go home. The problem ended literally overnight. Another short and memorable example of incentive is never ask your barber if you need a haircut. One of Munger's most famous quotes is simple, show me the incentive and I'll show you the outcome.
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