Charlie Munger's Lollapalooza Effect and This Credit Fiasco

Charlie Munger, Warren Buffett's brilliant sidekick, has expounded many times on innate human biases and incentive effects. For anyone interested in this topic, I highly recommend you read the transcript of an amazing speech he delivered in 1995, called The Psychology of Human Misjudgement. I have read this speech at least a dozen times and each time I glean something new and valuable. At first it may seem somewhat rambling and confusing, but I think anyone who can get a grip on this material will have a leg up in life on the average Joe who has no idea about these important concepts.

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Mr. Munger's treatise is clearly directed towards understanding how biases and incentive effects drive much of human behavior, and are not directed specifically at investing. However, the field of behavioral finance has grown to study many of these same concepts as they apply to financial decisions.

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A major point here is that you can never underestimate the power of incentives. One should always ask themselves in any human interaction what the incentives (or reinforcement effects) of the counter party are, especially when money is involved. Munger quips, "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."

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Book with Charlie Munger's speeches and other wisdom: Poor Charlie's Almanack