When it comes to investing, few people inspire and command as much respect as Charlie Munger: legendary investor, trusted partner to Warren Buffett and former Vice Chairman at Berkshire Hathaway. What makes Munger so fascinating isn’t just his ability to pick great investments — it’s how deeply he understands human psychology and the way our natural biases shape our decisions, often without us even realising it.
In his book, Poor Charlie’s Almanack, Munger highlights 25 key psychological tendencies that influence the way we think and make decisions (investment decisions and otherwise). By recognising these latent biases, we can avoid certain mistakes and become smarter, more rational investors. Below are the 25 tendencies. And we’ll be analysing each, piece by piece, through the lens of investing.
- Reward and Punishment Super Response Tendency
- Liking/Loving Tendency
- Disliking/Hating Tendency
- Doubt-Avoidance Tendency
- Inconsistency-Avoidance Tendency
- Curiosity Tendency
- Kantian Fairness Tendency
- Envy/Jealously Tendency
- Reciprocation Tendency
- Influence-from-Mere-Association Tendency
- Simple, Pain-Avoiding Psychological Denial
- Excessive Self-Regard Tendency
- Overoptimism Tendency
- Deprival-Superreaction Tendency
- Social-Proof Tendency
- Contrast-Misreaction Tendency
- Stress-Influence Tendency
- Availability-Misweighing Tendency
- Use-It-or-Lose-It Tendency
- Drug-Misinfluence Tendency
- Senescence-Misinfluence Tendency
- Authority-Misinfluence Tendency
- Twaddle Tendency
- Reason-Respecting Tendency
- Lollapalooza Tendency (the convergence of multiple biases, resulting in extreme consequences)
Today, we’re looking at the Reward and Punishment Super Response Tendency.
What is it?
Simply put, it is the power of incentives. It is human nature to work towards rewards and avoid punishment. And it is this behaviour – the tendency to respond strongly to rewards and punishments – that forms the principle of the Reward and Punishment Super Response Tendency.
Charlie Munger illustrates this (incentives) with the example of Federal Express. FedEx night shift employees had a gruelling task: sort and shift all packages rapidly among airplanes in one central airport every night. But the night shifters could never get this done on time. And no matter what management tried, the night shift was never finished on time.
But when management revised the payment structure. Instead of paying the night shift workers by the hour (which incentivised them to stay longer instead of finishing up and going home), they started paying them by shift. That changed when they adjusted the payment structure. So if they finished early, they’d get paid and they could go home. And the pace picked up and packages were sorted on time.
The delay wasn’t because of laziness or inefficiency — employees were simply worried about losing pay-by-the-hour. Once their incentives aligned with the company’s goals, the work got done.
Munger also describes how incentives can go the other way: where bad conduct or unscrupulous behavior is rationalised in order to achieve the incentive. Munger says, “For instance, a sales force living only on commissions will be much harder to keep moral than one under less pressure from the compensation arrangement.” Similarly, punishments also strongly influence behaviour, instilling fear and sometimes changing behaviour altogether.
How does this tendency play out in the world of investing?
Investors naturally gravitate toward assets that offer quick rewards. When a stock they own surges in value, they feel validated and excited, which reinforces the desire to keep investing in similar assets. This is why people chase hot stocks—companies that have recently performed well— or fads, without necessarily considering whether the idea is still a good buy. An example of chasing what’s hot would be the “crypto craze,” where people tend to bet big on crypto – only to suffer the consequences later!
Losing can also trigger a strong emotional response, even more than winning, which leads to a little something called loss aversion, or risk aversion, in investing. The fear of losing money somewhere down the line can lead to poor decision-making (and maybe even losing out on a great opportunity in the long run).
This is why seasoned and smart investors will advise you to never fall in love with a stock. Let’s say you buy a stock at INR 100, and it drops to INR 80. Even if the market, the fundamentals, and logic suggest that the stock is not worth holding on to, you may continue to keep it, in the hopes it will recover. This is called the sunk cost fallacy, or refusing to cut your losses because you are emotionally tied to your past decision (in this case, the stock you lovingly purchased).
Investing is a cycle of ups and downs, greed and fear, of chasing returns/rewards and avoiding losses/punishments. So by recognising these biases and the reward/punishment super response tendency, you, as an investor, need to take the middle path and counter-act those emotional behaviours.
- Define your goals. And set some rules and guidelines to achieve them. Maybe you will invest only in a few bluechip stocks with strong fundamentals and avoid betting on what’s trending.
- Think long-term. Avoid short-term selling and chasing quick profits. Discipline and patience trump impulsive and rash decisions.
- Be systematic. Putting a certain amount aside consistently on a fixed basis gives you less room to buy on a whim or panic sell on a bad day.
- Keep it balanced. Quick rewards can lead to overconfidence, punishments can create excess fear and drive you to not invest at all. Go back to point 2 (think long-term), and remember that it’s about the long-term and that gains and losses are part of the investor journey. As they say – only invest what you can afford to lose!
To wrap it up…
Like Charlie Munger says, human beings are deeply driven by incentives and can react strongly to both rewards and punishments. And this may lead to irrational behaviour, especially if people chase incentives even when it leads to disastrous long-term results/negative consequences.
So instead of constantly chasing short-term gains or being completely risk-averse, as an investor, you should define your financial goals, set some ground rules, focus on long-term goals, be systematic, and maintain a balanced outlook.
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