charlie-munger

Charlie Munger

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Charlie Munger, the legendary vice chairman of ​Berkshire Hathaway​ (​Warren Buffet’s investing powerhouse​), passed away at the age of 99, leaving a profound impact on the investing world, and not only that!

Indeed, Munger dedicated his life to the discovery, development, and interiorization of a bunch of ​heuristics (thinking tools)​ which he used throughout his life to make decisions in business, along the way.

Munger’s impact on Buffett’s investment approach was significant, and their collaboration played a crucial role in the success of Berkshire Hathaway.

Despite Munger’s preference to stay in the background and let Buffett be the face of Berkshire, his wisdom and participation were instrumental in building the company into an investment powerhouse.

The key insights from Charlie Munger are multiple, and they move along three lines of thoughts:

  1. The Pursuit of Worldly Wisdom: Munger emphasized the importance of outsmarting rather than outworking others. He advocated for asking questions and using models to reveal and explain mistakes, viewing it as a puzzle to be solved.
  2. Engagement in Rarely Used Skills: Munger believed in practicing useful, rarely used skills outside one’s discipline as a duty to one’s better self, which he considered essential for avoiding errors and the “man with a hammer” tendency.
  3. Psychology of Human Misjudgment: Munger’s insights on psychological tendencies, such as inconsistency-avoidance, curiosity, envy, and social-proof tendencies, provided a framework for understanding human behavior and making better decisions.

His wisdom extended beyond investing, influencing countless individuals.

Munger’s remarkable insights and teachings were a cornerstone of the annual Berkshire Hathaway meetings, attracting thousands of investors eager to learn from his wisdom.

Thus, Munger’s legacy is not just about investing; it’s about the enduring impact of his wisdom and wit, which will continue to inspire and guide investors for years to come.

Charlie Munger’s heuristics encompass a range of principles that guided his decision-making and contributed to his success. Some of these heuristics include:

Munger’s study on Human Misjudgment

Early in his life, Munger figured out that human judgment was somehow influenced by a set of social cues, which he cataloged, studied, and learned from experience, in what he called Human Misjudgment, or a set of heuristics that drove his decision-making process, throughout his life!

These are:

  1. Reward and Punishment Superresponse Tendency: Incentives and disincentives have a tremendous impact on human action. To persuade, appeal to interest, not to reason.
  2. Liking/Loving Tendency: People tend to judge in favor of individuals and symbols they like. This tendency can lead to wrong decisions when individuals deliberately ignore or distort negative facts because they come from friends or admired sources.
  3. Disliking/Hating Tendency: The opposite of the liking/loving tendency, this tendency leads individuals to ignore the positive qualities in a person or entity they dislike and hate all associated things. In investing, it’s important not to let personal dislike influence decision-making.
  4. Doubt-Avoidance Tendency: This is the inclination to make quick, poorly thought-out decisions under stress. The pressure to remove doubt can lead to ill-informed choices. To counter this, deliberate delays can be created when under pressure.
  5. Inconsistency-Avoidance Tendency: Humans are creatures of habit, and their brains tend to conserve energy and space by avoiding inconsistency and being reluctant to change. In investing, it’s important to keep an open mind to new facts to arrive at the best possible decision.
  6. Curiosity Tendency: People have a natural inclination to seek more information, which can be beneficial for staying informed. However, overdoing it can complicate decision-making.
  7. Kantian Fairness Tendency: This tendency relates to the desire for fairness and reciprocity in human interactions.
  8. Envy/Jealousy Tendency: This tendency can lead to negative emotions and behaviors, affecting decision-making and relationships.
  9. Reciprocation Tendency: People tend to reciprocate behaviors, both positive and negative. In investing, it’s important to be cautious of potential ulterior motives behind certain behaviors.
  10. Influence-from-Mere-Association Tendency: People often perceive things based on who or what they are associated with. Careful consideration is needed to avoid being misled by accidental, non-causative factors.
  11. Simple, Pain-Avoiding Psychological Denial: This tendency involves avoiding facing painful truths, which can lead to poor decision-making.
  12. Excessive Self-Regard Tendency: Overestimating one’s abilities and knowledge can lead to arrogance and poor decision-making.
  13. Overoptimism Tendency: Being overly optimistic can lead to underestimating risks and making poor decisions.
  14. Deprival-Superreaction Tendency: People tend to react strongly to the feeling of deprivation, which can lead to irrational decision-making.
  15. Social-Proof Tendency: People tend to follow the actions of others, even if it’s not the best course of action.
  16. Contrast-Misreaction Tendency: This tendency involves reacting strongly to contrasts, which can lead to distorted perceptions and decisions.
  17. Stress-Influence Tendency: Under stress, individuals may make quick, poorly thought-out decisions, leading to ill-informed choices.
  18. Availability-Misweighing Tendency: This tendency involves giving undue weight to information that is readily available, leading to biased decision-making.
  19. Use-It-or-Lose-It Tendency: People tend to use skills and knowledge they have, or they lose them. This can lead to a reluctance to learn new things.
  20. Drug-Misinfluence Tendency: The influence of drugs can lead to impaired judgment and decision-making.
  21. Senescence-Misinfluence Tendency: As people age, their judgment and decision-making abilities may decline.
  22. Authority-Misinfluence Tendency: People tend to be influenced by authority figures, even when it’s not in their best interest.
  23. Twaddle Tendency: This tendency involves using jargon and complex language to obscure the truth.
  24. Reason-Respecting Tendency: People tend to be influenced by reasoning, even when it’s flawed.
  25. Lollapalooza Tendency: This is the combination of multiple tendencies acting in the same direction, leading to extreme outcomes.

Let’s get into each of them and their real-world applications!

Reward and Punishment Superresponse Tendency:

The “Reward and Punishment Superresponse Tendency” underscores the significant influence of incentives and disincentives on human behavior. It suggests that individuals are highly responsive to the prospect of gain or the fear of loss, sometimes to the detriment of logical reasoning. In practical terms, this means that people may be more motivated by financial rewards or penalties than by objective evidence or reasoned arguments.

Real-world Application: This tendency has critical implications for various fields, from business and finance to public policy. For instance, businesses often use financial incentives to motivate employees to meet performance targets. In investing, understanding how this tendency operates can help investors avoid making impulsive decisions based solely on the allure of potential profits or the fear of losing money.

Liking/Loving Tendency:

The “Liking/Loving Tendency” is rooted in the human inclination to judge in favor of individuals and symbols they have positive feelings toward. This bias can lead individuals to ignore or downplay negative information about people or things they like, potentially resulting in flawed decision-making.

Real-world Application: This tendency is frequently observed in everyday life. People may trust the advice or recommendations of friends or admired figures, even when those suggestions are not based on sound reasoning or evidence. In business and marketing, it underscores the value of building positive brand associations and customer loyalty.

Disliking/Hating Tendency:

Conversely, the “Disliking/Hating Tendency” leads individuals to ignore positive qualities in a person or entity they dislike or hate. This can result in a distorted and one-sided perception, potentially leading to irrational decision-making.

Real-world Application: In investing, it is crucial not to let personal biases and animosities influence financial decisions. For instance, disliking the management of a company should not cloud one’s judgment when evaluating the company’s investment potential objectively.

Doubt-Avoidance Tendency:

The “Doubt-Avoidance Tendency” refers to the tendency to make hasty, ill-informed decisions under stress or pressure. The desire to eliminate doubt can lead to impulsive choices, sometimes to the detriment of one’s long-term interests.

Real-world Application: In high-stress situations, such as financial crises or emergency decision-making, this bias can lead to snap judgments that are not well-considered. Creating deliberate delays or utilizing structured decision-making processes can help counteract this tendency and lead to better outcomes.

Inconsistency-Avoidance Tendency:

Humans have a natural aversion to inconsistency and change. The “Inconsistency-Avoidance Tendency” explains our reluctance to alter established habits or beliefs, even when presented with new information that contradicts them.

Real-world Application: In the context of investing, this tendency can hinder adaptability and open-mindedness. To make sound investment decisions, it is essential to remain receptive to new facts and be willing to adjust one’s strategies when warranted.

Curiosity Tendency:

The “Curiosity Tendency” highlights the innate human inclination to seek more information and knowledge. While curiosity can be a valuable trait, overindulging in the pursuit of information can complicate decision-making.

Real-world Application: In the digital age, information overload is a common challenge. People often spend excessive time gathering data but may struggle to distill it into actionable insights. Effective decision-makers strike a balance between satisfying their curiosity and making timely choices.

Kantian Fairness Tendency:

The “Kantian Fairness Tendency” is rooted in the human desire for fairness and reciprocity in social interactions. People tend to value equitable treatment and fairness in their dealings with others.

Real-world Application: This tendency underpins the concept of fairness in legal and ethical systems. In business and leadership, it highlights the importance of transparent and equitable practices to maintain trust and cooperation.

Envy/Jealousy Tendency:

Envy and jealousy can trigger strong negative emotions, affecting decision-making and relationships. The “Envy/Jealousy Tendency” can lead to biased judgments and actions driven by rivalry and resentment.

Real-world Application: Understanding this tendency is crucial in personal and professional relationships. It is also relevant in marketing and advertising, where companies may leverage consumers’ desire to outdo others or acquire what their peers possess.

Reciprocation Tendency:

The “Reciprocation Tendency” suggests that people tend to reciprocate both positive and negative behaviors. In the context of investing, it is essential to be cautious of potential ulterior motives behind certain actions, as favors or gifts may come with expectations of reciprocity.

Real-world Application: This tendency is prevalent in social interactions, where individuals often feel obligated to return favors. It can be leveraged in marketing through strategies like offering free trials, knowing that customers may reciprocate by making a purchase.

Influence-from-Mere-Association Tendency:

The “Influence-from-Mere-Association Tendency” explains how people often perceive things based on their associations. Careful consideration is necessary to avoid being misled by accidental, non-causative factors.

Real-world Application: This tendency can manifest in various ways, from the influence of product packaging on consumer perception to the impact of endorsements by celebrities on public opinion.

Simple, Pain-Avoiding Psychological Denial:

The “Simple, Pain-Avoiding Psychological Denial” tendency involves avoiding facing painful truths, which can lead to poor decision-making. People often engage in denial as a coping mechanism to shield themselves from discomfort.

Real-world Application: This bias can have significant consequences in personal health decisions, where individuals may ignore symptoms or medical advice to avoid acknowledging a serious health issue.

Excessive Self-Regard Tendency:

The “Excessive Self-Regard Tendency” refers to the propensity to overestimate one’s abilities and knowledge. This can lead to overconfidence and poor decision-making.

Real-world Application: Overconfidence can impact professional judgment and decision-making in various fields, from finance and entrepreneurship to healthcare and education.

Overoptimism Tendency:

The “Overoptimism Tendency” involves an exaggerated optimism that can lead to underestimating risks and making poor decisions. Individuals may underestimate the likelihood of negative outcomes.

Real-world Application: In financial markets, overoptimism can lead to speculative bubbles and investment decisions based on unrealistic expectations.

Deprival-Superreaction Tendency:

The “Deprival-Superreaction Tendency” suggests that people react strongly to the feeling of deprivation, which can lead to irrational decision-making. Loss aversion, a related concept, is part of this tendency.

Real-world Application: In marketing, creating a sense of urgency or scarcity can trigger consumers’ fear of missing out, influencing their purchasing decisions.

Social-Proof Tendency:

The “Social-Proof Tendency” reflects the human inclination to follow the actions of others, even if it may not be the best course of action. This can result in herd behavior and conformity.

Real-world Application: Social proof is a powerful marketing tool, with companies often showcasing testimonials, user reviews, or social media engagement to influence consumer behavior.

Contrast-Misreaction Tendency:

The “Contrast-Misreaction Tendency” involves reacting strongly to contrasts, which can lead to distorted perceptions and decisions. People may overemphasize differences when comparing two or more items or situations.

Real-world Application: Understanding this tendency can be valuable in contexts such as negotiation and pricing strategies, where the framing of comparisons can influence decisions.

Stress-Influence Tendency:

Under stress, individuals may make quick, poorly thought-out decisions, leading to ill-informed choices. Stress can impair cognitive functioning and rational thinking.

Real-world Application: Stress-influence tendency is relevant in various high-pressure situations, such as emergency response, crisis management, and decision-making during turbulent market conditions.

Availability-Misweighing Tendency:

The “Availability-Misweighing Tendency” involves giving undue weight to information that is readily available, leading to biased decision-making. Information that is easily accessible may be overemphasized, while less accessible information is overlooked.

Real-world Application: This tendency can impact journalism, where the media may focus on readily available, sensational stories, potentially distorting public perception of important issues.

Use-It-or-Lose-It Tendency:

The “Use-It-or-Lose-It Tendency” suggests that people tend to use their skills and knowledge actively, or they risk losing them. This can lead to a reluctance to learn new things or adapt to changing circumstances.

Real-world Application: In education and professional development, this tendency underscores the importance of continuous learning and skill maintenance to remain competitive and adaptable.

Drug-Misinfluence Tendency:

The “Drug-Misinfluence Tendency” highlights how the influence of drugs can impair judgment and decision-making. Substance use can lead to irrational behaviors and choices.

Real-world Application: Substance abuse can have devastating consequences on an individual’s decision-making, affecting personal and professional life.

Senescence-Misinfluence Tendency:

As people age, their judgment and decision-making abilities may decline. The “Senescence-Misinfluence Tendency” acknowledges the impact of aging on cognitive function.

Real-world Application: This tendency is relevant in areas such as healthcare and elder care, where understanding the cognitive changes associated with aging is essential for providing appropriate support and care.

Authority-Misinfluence Tendency:

The “Authority-Misinfluence Tendency” suggests that people tend to be influenced by authority figures, even when it may not be in their best interest. Individuals may defer to experts or leaders without critically evaluating the merits of their arguments.

Real-world Application: This tendency can have significant implications in contexts where authority figures hold sway, such as political decision-making, organizational leadership, and consumer endorsements.

Twaddle Tendency:

The “Twaddle Tendency” involves using jargon and complex language to obscure the truth. People may employ convoluted language to sound knowledgeable or authoritative.

Real-world Application: Clear and effective communication is crucial in various fields, from academia and law to business and healthcare. Recognizing and avoiding twaddle can promote transparency and understanding.

Reason-Respecting Tendency:

The “Reason-Respecting Tendency” suggests that people tend to be influenced by reasoning, even when it’s flawed. Individuals may be swayed by the presentation of arguments, regardless of their quality.

Real-world Application: This tendency underscores the importance of critical thinking and evaluating the strength of reasoning in debates, decision-making, and argumentation.

Lollapalooza Tendency:

The “Lollapalooza Tendency” is a unique concept that represents the combined impact of multiple cognitive biases and psychological tendencies acting in the same direction. It can result in extreme and often unexpected outcomes.

Real-world Application: The lollapalooza effect can be observed in various situations, such as financial market bubbles or sudden shifts in public opinion driven by a convergence of different biases and factors.

Real World Case Studies

  • Reward and Punishment Superresponse Tendency: Berkshire Hathaway’s compensation structure for its managers is designed to align their interests with those of the company and its shareholders. By tying rewards to long-term performance, they create incentives that encourage managers to make decisions that benefit the company in the long run.
  • Liking/Loving Tendency: Munger and Buffett have been known to invest in companies with strong management teams that they admire and trust. For example, their investment in GEICO was partly driven by their admiration for GEICO’s management and their belief in the company’s long-term potential.
  • Disliking/Hating Tendency: Munger and Buffett have avoided investing in businesses they dislike or do not understand, such as technology companies during the dot-com bubble. This approach has helped them avoid making poor investment decisions based on personal biases.
  • Doubt-Avoidance Tendency: Munger and Buffett have been known to take their time when making investment decisions, carefully analyzing the available information and avoiding impulsive decisions. This approach has helped them avoid making ill-informed choices under pressure.
  • Inconsistency-Avoidance Tendency: Berkshire Hathaway’s long-term investment approach reflects Munger’s belief in the importance of consistency. By sticking to their core investment principles, they have been able to achieve consistent success over time.
  • Curiosity Tendency: Munger and Buffett’s continuous learning and reading habits exemplify their curiosity and desire to seek more information. This tendency has helped them stay informed and make well-informed investment decisions.
  • Kantian Fairness Tendency: Berkshire Hathaway’s reputation for treating its acquired companies fairly and allowing them to maintain their autonomy reflects Munger’s emphasis on fairness and reciprocity in human interactions.
  • Reciprocation Tendency: Munger and Buffett have built strong relationships with their business partners and managers by treating them fairly and with respect, fostering a culture of trust and reciprocity within Berkshire Hathaway.
  • Influence-from-Mere-Association Tendency: Munger and Buffett have been cautious about the influence of mere association on their investment decisions. For example, they have avoided investing in companies with questionable accounting practices or unethical business practices, regardless of their association with well-known brands or individuals.
  • Simple, Pain-Avoiding Psychological Denial: Munger and Buffett have been open about their mistakes and have used them as learning opportunities. By acknowledging and learning from their errors, they have been able to improve their decision-making processes.
  • Excessive Self-Regard Tendency: Munger and Buffett have often spoken about the dangers of overconfidence in investing. They have emphasized the importance of humility and the willingness to admit when they are wrong, which has helped them avoid costly mistakes driven by excessive self-regard.
  • Overoptimism Tendency: Munger and Buffett have been known for their conservative approach to investing, which reflects their awareness of the overoptimism tendency. They have often preferred to err on the side of caution, which has helped them avoid overly optimistic projections that could lead to poor investment decisions.
  • Deprival-Superreaction Tendency: Berkshire Hathaway’s long-term investment approach reflects Munger’s understanding of the deprival-superreaction tendency. By focusing on long-term value rather than short-term gains, they have been able to avoid overreacting to temporary losses or missed opportunities.
  • Social-Proof Tendency: Munger and Buffett have often gone against the crowd in their investment decisions, reflecting their awareness of the social-proof tendency. For example, they avoided investing in technology companies during the dot-com bubble when many others were piling into these stocks.
  • Contrast-Misreaction Tendency: Munger and Buffett’s approach to evaluating investment opportunities reflects their understanding of the contrast-misreaction tendency. They have been known to evaluate each investment on its own merits, rather than comparing it to other opportunities.
  • Stress-Influence Tendency: Munger and Buffett’s calm and patient approach to investing reflects their awareness of the stress-influence tendency. By avoiding impulsive decisions under stress, they have been able to make more rational and informed investment decisions.
  • Availability-Misweighing Tendency: Munger and Buffett’s thorough due diligence process when evaluating potential investments reflects their understanding of the availability-misweighing tendency. They have been known to gather as much information as possible, rather than relying on readily available information.
  • Use-It-or-Lose-It Tendency: Munger and Buffett’s continuous learning and adaptation reflect their awareness of the use-it-or-lose-it tendency. They have been known to continuously update their knowledge and skills, which has helped them stay relevant in a rapidly changing business environment.
  • Drug-Misinfluence Tendency: While this tendency may not directly apply to their investment decisions, Munger and Buffett’s emphasis on ethical business practices reflects their understanding of the potential negative impacts of unethical behavior, such as drug misuse.
  • Senescence-Misinfluence Tendency: Despite their advanced age, Munger and Buffett have remained active and engaged in their work, reflecting their awareness of the senescence-misinfluence tendency. They have been able to maintain their mental sharpness and productivity, which has contributed to their continued success[2].
  • Authority-Misinfluence Tendency: Munger and Buffett have often emphasized the importance of independent thinking in investing, reflecting their understanding of the authority-misinfluence tendency. They have been known to question conventional wisdom and make their own judgments, rather than blindly following the advice of authorities.
  • Twaddle Tendency: Munger and Buffett’s clear and straightforward communication style reflects their awareness of the twaddle tendency. They have been known to avoid unnecessary jargon and complexity in their communications, which has helped them convey their ideas more effectively.
  • Reason-Respecting Tendency: Munger and Buffett’s rational approach to investing reflects their understanding of the reason-respecting tendency. They have been known to base their decisions on sound reasoning and evidence, rather than on emotions or biases.
  • Lollapalooza Tendency: Munger and Buffett’s success can be seen as a result of the combined effect of many of these tendencies. Their ability to understand and manage these tendencies has helped them make better decisions and achieve extraordinary success.
  • Envy/Jealousy Tendency: Munger and Buffett have often spoken about the dangers of envy and jealousy in investing. They have emphasized the importance of focusing on one’s own goals and performance, rather than comparing oneself to others, which has helped them avoid poor decisions driven by envy or jealousy.

Recap

Charlie Munger’s Key Insights:

  • Pursuit of Worldly Wisdom: Outsmart rather than outwork.
  • Engagement in Rarely Used Skills: Diversify skills to avoid errors.
  • Psychology of Human Misjudgment: Understand human behavior for better decisions.

Charlie Munger’s Heuristics:

  • Reward and Punishment Superresponse Tendency: Incentives and disincentives strongly influence behavior.
  • Liking/Loving Tendency: People favor individuals and symbols they like, potentially leading to biased decisions.
  • Disliking/Hating Tendency: People ignore positive qualities in those they dislike, distorting perception.
  • Doubt-Avoidance Tendency: Stress leads to hasty decisions; deliberate delays can counteract this.
  • Inconsistency-Avoidance Tendency: People avoid change and inconsistency, hindering adaptability.
  • Curiosity Tendency: People seek more information, but overindulgence can complicate decision-making.
  • Kantian Fairness Tendency: Desire for fairness and reciprocity in human interactions.
  • Envy/Jealousy Tendency: Negative emotions can affect decision-making and relationships.
  • Reciprocation Tendency: People reciprocate behaviors, both positive and negative.
  • Influence-from-Mere-Association Tendency: People perceive things based on associations, requiring careful consideration.
  • Simple, Pain-Avoiding Psychological Denial: Avoiding painful truths can lead to poor decisions.
  • Excessive Self-Regard Tendency: Overestimating abilities can lead to arrogance.
  • Overoptimism Tendency: Exaggerated optimism can lead to underestimating risks.
  • Deprival-Superreaction Tendency: Strong reactions to deprivation can result in irrational decisions.
  • Social-Proof Tendency: People tend to follow the actions of others, even if it’s not the best course of action.
  • Contrast-Misreaction Tendency: Reacting strongly to contrasts can lead to distorted perceptions.
  • Stress-Influence Tendency: Stress can lead to quick, poorly thought-out decisions.
  • Availability-Misweighing Tendency: Giving undue weight to readily available information.
  • Use-It-or-Lose-It Tendency: People tend to use skills and knowledge actively, or they lose them.
  • Drug-Misinfluence Tendency: The influence of drugs can impair judgment.
  • Senescence-Misinfluence Tendency: Aging can impact judgment and decision-making.
  • Authority-Misinfluence Tendency: People tend to be influenced by authority figures.
  • Twaddle Tendency: Using complex language to obscure the truth.
  • Reason-Respecting Tendency: People tend to be influenced by reasoning.
  • Lollapalooza Tendency: The combination of multiple tendencies leading to extreme outcomes.

Real-World Case Studies:

  • Munger’s principles have practical applications in fields such as investing, psychology, marketing, and ethics.
  • Berkshire Hathaway’s success reflects Munger’s insights in compensation structures and investment decisions.
  • Munger and Buffett’s emphasis on critical thinking and humility contributes to their success.
  • Munger’s awareness of cognitive biases and tendencies informs decision-making in various domains.
  • Charlie Munger’s heuristics provide valuable guidance for individuals and organizations seeking rational decision-making.

Other Mental Models from The Business Engineer:

Connected Thinking Frameworks

Convergent vs. Divergent Thinking

convergent-vs-divergent-thinking
Convergent thinking occurs when the solution to a problem can be found by applying established rules and logical reasoning. Whereas divergent thinking is an unstructured problem-solving method where participants are encouraged to develop many innovative ideas or solutions to a given problem. Where convergent thinking might work for larger, mature organizations where divergent thinking is more suited for startups and innovative companies.

Critical Thinking

critical-thinking
Critical thinking involves analyzing observations, facts, evidence, and arguments to form a judgment about what someone reads, hears, says, or writes.

Biases

biases
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman in 1972. Biases are seen as systematic errors and flaws that make humans deviate from the standards of rationality, thus making us inept at making good decisions under uncertainty.

Second-Order Thinking

second-order-thinking
Second-order thinking is a means of assessing the implications of our decisions by considering future consequences. Second-order thinking is a mental model that considers all future possibilities. It encourages individuals to think outside of the box so that they can prepare for every and eventuality. It also discourages the tendency for individuals to default to the most obvious choice.

Lateral Thinking

lateral-thinking
Lateral thinking is a business strategy that involves approaching a problem from a different direction. The strategy attempts to remove traditionally formulaic and routine approaches to problem-solving by advocating creative thinking, therefore finding unconventional ways to solve a known problem. This sort of non-linear approach to problem-solving, can at times, create a big impact.

Bounded Rationality

bounded-rationality
Bounded rationality is a concept attributed to Herbert Simon, an economist and political scientist interested in decision-making and how we make decisions in the real world. In fact, he believed that rather than optimizing (which was the mainstream view in the past decades) humans follow what he called satisficing.

Dunning-Kruger Effect

dunning-kruger-effect
The Dunning-Kruger effect describes a cognitive bias where people with low ability in a task overestimate their ability to perform that task well. Consumers or businesses that do not possess the requisite knowledge make bad decisions. What’s more, knowledge gaps prevent the person or business from seeing their mistakes.

Occam’s Razor

occams-razor
Occam’s Razor states that one should not increase (beyond reason) the number of entities required to explain anything. All things being equal, the simplest solution is often the best one. The principle is attributed to 14th-century English theologian William of Ockham.

Lindy Effect

lindy-effect
The Lindy Effect is a theory about the ageing of non-perishable things, like technology or ideas. Popularized by author Nicholas Nassim Taleb, the Lindy Effect states that non-perishable things like technology age – linearly – in reverse. Therefore, the older an idea or a technology, the same will be its life expectancy.

Antifragility

antifragility
Antifragility was first coined as a term by author, and options trader Nassim Nicholas Taleb. Antifragility is a characteristic of systems that thrive as a result of stressors, volatility, and randomness. Therefore, Antifragile is the opposite of fragile. Where a fragile thing breaks up to volatility; a robust thing resists volatility. An antifragile thing gets stronger from volatility (provided the level of stressors and randomness doesn’t pass a certain threshold).

Ergodicity

ergodicity
Ergodicity is one of the most important concepts in statistics. Ergodicity is a mathematical concept suggesting that a point of a moving system will eventually visit all parts of the space the system moves in. On the opposite side, non-ergodic means that a system doesn’t visit all the possible parts, as there are absorbing barriers

Systems Thinking

systems-thinking
Systems thinking is a holistic means of investigating the factors and interactions that could contribute to a potential outcome. It is about thinking non-linearly, and understanding the second-order consequences of actions and input into the system.

Vertical Thinking

vertical-thinking
Vertical thinking, on the other hand, is a problem-solving approach that favors a selective, analytical, structured, and sequential mindset. The focus of vertical thinking is to arrive at a reasoned, defined solution.

Metaphorical Thinking

metaphorical-thinking
Metaphorical thinking describes a mental process in which comparisons are made between qualities of objects usually considered to be separate classifications.  Metaphorical thinking is a mental process connecting two different universes of meaning and is the result of the mind looking for similarities.

Maslow’s Hammer

einstellung-effect
Maslow’s Hammer, otherwise known as the law of the instrument or the Einstellung effect, is a cognitive bias causing an over-reliance on a familiar tool. This can be expressed as the tendency to overuse a known tool (perhaps a hammer) to solve issues that might require a different tool. This problem is persistent in the business world where perhaps known tools or frameworks might be used in the wrong context (like business plans used as planning tools instead of only investors’ pitches).

Peter Principle

peter-principle
The Peter Principle was first described by Canadian sociologist Lawrence J. Peter in his 1969 book The Peter Principle. The Peter Principle states that people are continually promoted within an organization until they reach their level of incompetence.

Straw Man Fallacy

straw-man-fallacy
The straw man fallacy describes an argument that misrepresents an opponent’s stance to make rebuttal more convenient. The straw man fallacy is a type of informal logical fallacy, defined as a flaw in the structure of an argument that renders it invalid.

Google Effect

google-effect
The Google effect is a tendency for individuals to forget information that is readily available through search engines. During the Google effect – sometimes called digital amnesia – individuals have an excessive reliance on digital information as a form of memory recall.

Streisand Effect

streisand-effect
The Streisand Effect is a paradoxical phenomenon where the act of suppressing information to reduce visibility causes it to become more visible. In 2003, Streisand attempted to suppress aerial photographs of her Californian home by suing photographer Kenneth Adelman for an invasion of privacy. Adelman, who Streisand assumed was paparazzi, was instead taking photographs to document and study coastal erosion. In her quest for more privacy, Streisand’s efforts had the opposite effect.

Compromise Effect

compromise-effect
Single-attribute choices – such as choosing the apartment with the lowest rent – are relatively simple. However, most of the decisions consumers make are based on multiple attributes which complicate the decision-making process. The compromise effect states that a consumer is more likely to choose the middle option of a set of products over more extreme options.

Butterfly Effect

butterfly-effect
In business, the butterfly effect describes the phenomenon where the simplest actions yield the largest rewards. The butterfly effect was coined by meteorologist Edward Lorenz in 1960 and as a result, it is most often associated with weather in pop culture. Lorenz noted that the small action of a butterfly fluttering its wings had the potential to cause progressively larger actions resulting in a typhoon.

IKEA Effect

ikea-effect
The IKEA effect is a cognitive bias that describes consumers’ tendency to value something more if they have made it themselves. That is why brands often use the IKEA effect to have customizations for final products, as they help the consumer relate to it more and therefore appending to it more value.

Ringelmann Effect 

Ringelmann Effect
The Ringelmann effect describes the tendency for individuals within a group to become less productive as the group size increases.

The Overview Effect

overview-effect
The overview effect is a cognitive shift reported by some astronauts when they look back at the Earth from space. The shift occurs because of the impressive visual spectacle of the Earth and tends to be characterized by a state of awe and increased self-transcendence.

House Money Effect

house-money-effect
The house money effect was first described by researchers Richard Thaler and Eric Johnson in a 1990 study entitled Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice. The house money effect is a cognitive bias where investors take higher risks on reinvested capital than they would on an initial investment.

Heuristic

heuristic
As highlighted by German psychologist Gerd Gigerenzer in the paper “Heuristic Decision Making,” the term heuristic is of Greek origin, meaning “serving to find out or discover.” More precisely, a heuristic is a fast and accurate way to make decisions in the real world, which is driven by uncertainty.

Recognition Heuristic

recognition-heuristic
The recognition heuristic is a psychological model of judgment and decision making. It is part of a suite of simple and economical heuristics proposed by psychologists Daniel Goldstein and Gerd Gigerenzer. The recognition heuristic argues that inferences are made about an object based on whether it is recognized or not.

Representativeness Heuristic

representativeness-heuristic
The representativeness heuristic was first described by psychologists Daniel Kahneman and Amos Tversky. The representativeness heuristic judges the probability of an event according to the degree to which that event resembles a broader class. When queried, most will choose the first option because the description of John matches the stereotype we may hold for an archaeologist.

Take-The-Best Heuristic

take-the-best-heuristic
The take-the-best heuristic is a decision-making shortcut that helps an individual choose between several alternatives. The take-the-best (TTB) heuristic decides between two or more alternatives based on a single good attribute, otherwise known as a cue. In the process, less desirable attributes are ignored.

Bundling Bias

bundling-bias
The bundling bias is a cognitive bias in e-commerce where a consumer tends not to use all of the products bought as a group, or bundle. Bundling occurs when individual products or services are sold together as a bundle. Common examples are tickets and experiences. The bundling bias dictates that consumers are less likely to use each item in the bundle. This means that the value of the bundle and indeed the value of each item in the bundle is decreased.

Barnum Effect

barnum-effect
The Barnum Effect is a cognitive bias where individuals believe that generic information – which applies to most people – is specifically tailored for themselves.

Anchoring Effect

anchoring-effect
The anchoring effect describes the human tendency to rely on an initial piece of information (the “anchor”) to make subsequent judgments or decisions. Price anchoring, then, is the process of establishing a price point that customers can reference when making a buying decision.

Decoy Effect

decoy-effect
The decoy effect is a psychological phenomenon where inferior – or decoy – options influence consumer preferences. Businesses use the decoy effect to nudge potential customers toward the desired target product. The decoy effect is staged by placing a competitor product and a decoy product, which is primarily used to nudge the customer toward the target product.

Commitment Bias

commitment-bias
Commitment bias describes the tendency of an individual to remain committed to past behaviors – even if they result in undesirable outcomes. The bias is particularly pronounced when such behaviors are performed publicly. Commitment bias is also known as escalation of commitment.

First-Principles Thinking

first-principles-thinking
First-principles thinking – sometimes called reasoning from first principles – is used to reverse-engineer complex problems and encourage creativity. It involves breaking down problems into basic elements and reassembling them from the ground up. Elon Musk is among the strongest proponents of this way of thinking.

Ladder Of Inference

ladder-of-inference
The ladder of inference is a conscious or subconscious thinking process where an individual moves from a fact to a decision or action. The ladder of inference was created by academic Chris Argyris to illustrate how people form and then use mental models to make decisions.

Goodhart’s Law

goodharts-law
Goodhart’s Law is named after British monetary policy theorist and economist Charles Goodhart. Speaking at a conference in Sydney in 1975, Goodhart said that “any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.” Goodhart’s Law states that when a measure becomes a target, it ceases to be a good measure.

Six Thinking Hats Model

six-thinking-hats-model
The Six Thinking Hats model was created by psychologist Edward de Bono in 1986, who noted that personality type was a key driver of how people approached problem-solving. For example, optimists view situations differently from pessimists. Analytical individuals may generate ideas that a more emotional person would not, and vice versa.

Mandela Effect

mandela-effect
The Mandela effect is a phenomenon where a large group of people remembers an event differently from how it occurred. The Mandela effect was first described in relation to Fiona Broome, who believed that former South African President Nelson Mandela died in prison during the 1980s. While Mandela was released from prison in 1990 and died 23 years later, Broome remembered news coverage of his death in prison and even a speech from his widow. Of course, neither event occurred in reality. But Broome was later to discover that she was not the only one with the same recollection of events.

Crowding-Out Effect

crowding-out-effect
The crowding-out effect occurs when public sector spending reduces spending in the private sector.

Bandwagon Effect

bandwagon-effect
The bandwagon effect tells us that the more a belief or idea has been adopted by more people within a group, the more the individual adoption of that idea might increase within the same group. This is the psychological effect that leads to herd mentality. What in marketing can be associated with social proof.

Moore’s Law

moores-law
Moore’s law states that the number of transistors on a microchip doubles approximately every two years. This observation was made by Intel co-founder Gordon Moore in 1965 and it become a guiding principle for the semiconductor industry and has had far-reaching implications for technology as a whole.

Disruptive Innovation

disruptive-innovation
Disruptive innovation as a term was first described by Clayton M. Christensen, an American academic and business consultant whom The Economist called “the most influential management thinker of his time.” Disruptive innovation describes the process by which a product or service takes hold at the bottom of a market and eventually displaces established competitors, products, firms, or alliances.

Value Migration

value-migration
Value migration was first described by author Adrian Slywotzky in his 1996 book Value Migration – How to Think Several Moves Ahead of the Competition. Value migration is the transferal of value-creating forces from outdated business models to something better able to satisfy consumer demands.

Bye-Now Effect

bye-now-effect
The bye-now effect describes the tendency for consumers to think of the word “buy” when they read the word “bye”. In a study that tracked diners at a name-your-own-price restaurant, each diner was asked to read one of two phrases before ordering their meal. The first phrase, “so long”, resulted in diners paying an average of $32 per meal. But when diners recited the phrase “bye bye” before ordering, the average price per meal rose to $45.

Groupthink

groupthink
Groupthink occurs when well-intentioned individuals make non-optimal or irrational decisions based on a belief that dissent is impossible or on a motivation to conform. Groupthink occurs when members of a group reach a consensus without critical reasoning or evaluation of the alternatives and their consequences.

Stereotyping

stereotyping
A stereotype is a fixed and over-generalized belief about a particular group or class of people. These beliefs are based on the false assumption that certain characteristics are common to every individual residing in that group. Many stereotypes have a long and sometimes controversial history and are a direct consequence of various political, social, or economic events. Stereotyping is the process of making assumptions about a person or group of people based on various attributes, including gender, race, religion, or physical traits.

Murphy’s Law

murphys-law
Murphy’s Law states that if anything can go wrong, it will go wrong. Murphy’s Law was named after aerospace engineer Edward A. Murphy. During his time working at Edwards Air Force Base in 1949, Murphy cursed a technician who had improperly wired an electrical component and said, “If there is any way to do it wrong, he’ll find it.”

Law of Unintended Consequences

law-of-unintended-consequences
The law of unintended consequences was first mentioned by British philosopher John Locke when writing to parliament about the unintended effects of interest rate rises. However, it was popularized in 1936 by American sociologist Robert K. Merton who looked at unexpected, unanticipated, and unintended consequences and their impact on society.

Fundamental Attribution Error

fundamental-attribution-error
Fundamental attribution error is a bias people display when judging the behavior of others. The tendency is to over-emphasize personal characteristics and under-emphasize environmental and situational factors.

Outcome Bias

outcome-bias
Outcome bias describes a tendency to evaluate a decision based on its outcome and not on the process by which the decision was reached. In other words, the quality of a decision is only determined once the outcome is known. Outcome bias occurs when a decision is based on the outcome of previous events without regard for how those events developed.

Hindsight Bias

hindsight-bias
Hindsight bias is the tendency for people to perceive past events as more predictable than they actually were. The result of a presidential election, for example, seems more obvious when the winner is announced. The same can also be said for the avid sports fan who predicted the correct outcome of a match regardless of whether their team won or lost. Hindsight bias, therefore, is the tendency for an individual to convince themselves that they accurately predicted an event before it happened.

Read Next: Biases, Bounded Rationality, Mandela Effect, Dunning-Kruger Effect, Lindy Effect, Crowding Out Effect, Bandwagon Effect.

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