Behavioral Finance – Getting a Grip on Patterned Irrationality

I am an admirer of the investor Warren Buffet and his partner at Berkshire Hathaway, Charlie Munger. There is no denying their success and commitment to value investing. They seem to be unique in the way they make decisions and are often requested to expound on their investment philosophies.

One of the more interesting speeches concerning behavioral finance was given by Charlie at the Harvard Law School in 1995. Using the framework of Charlie Munger’s speech on the psychology of human misjudgment, I have created a blog series. The series includes an examination of several of the causes of human misjudgment and how they play a role in the decisions we make in life and of course, finances.

Why study human behavior in relation to finances?
Recognizing and understanding why people do the things they do, what drives them, and what are innately human tendencies is the first step in overcoming your own self and making sound decisions! We want to make rational, logical decisions concerning financial investments but emotions and irrational tendencies sometimes get in the way.

These behaviors are not all bad, many are good in some way - that is why they survived. In fact, these behaviors served a purpose that helped extend life at some time in the evolutionary process.

To allow a thorough discussion, each post in the series will examine one or two of the 21 following behaviors that Charlie covered in his speech:

Underestimating the Power of Incentives
Psychological Denial
Incentive-cause Bias
Consistency and Commitment Tendency
Pavlovian Association
Reciprocation Tendency Bias
Over-influence by Social Proof Bias
Available Tool Bias
Contrast-caused Distortions of sensation, perception and cognition
Over-influence by Authority Bias
Deprival Super-reaction Syndrome Bias
Envy/Jealousy Bias
Chemical Dependency Bias
Mis-gambling Compulsion Bias
Distortion by Likes and Dislikes
Tendency to Overweigh conveniently available Information
Over-influence by Extra-vivid Evidence
Mental confusion caused by information not arrayed in the mind
Stress-induced mental changes
Tendency to lose ability through Disuse and Common mental declines
Development and Organizational Confusion from Say-something Syndrome