13 Dangerous Psychological Biases

What's up, everyone? This is Alex, the host of Founders Journal. As you may know, I built Morning Brew from my senior year of college until we sold the business in 2020. And now I'm building a variety of businesses in different spaces and different stages. I'm basically averaging 1 to 2 new businesses per year. And because of that, I have had the opportunity to test a ton of different products and services, ultimately landing on a core software stack that serves as my business operating system whenever I start a new company. I have my go-to banking service. I have my go-to formation service. I have my go-to domain hosting service. But probably the most important of them all is my HR service, Gusto. If you're a longtime Founders Journal listener, you know how much I think about people in the context of business. A business is nothing without its people, which means a platform that helps me manage and take care of my people is invaluable. And that means I've tried every HR platform under the sun, always with the same exact goals in mind. First, I want a product that's intuitive and delightful to use. As a non-HR person, I find the intricacies of payroll, benefits, taxes, compliance, and expenses to be painful. So I just want something that makes my life easier. Second, I want it to be affordable.

I'm a bootstrapper at heart.

I started Morning Brew with $0 and I started StoryArc with $0 as well, which means I don't have infinite dollars to drop on SaaS products. And third, I want a platform that acts as my one-stop shop for all things people. I want it to handle payroll, benefits, hiring, onboarding, and taxes, all while integrating with all of the other tools in my business stack, whether it be QuickBooks, Slack, or Google Workspace. Well, Gusto hit the trifecta, which is why I am a customer and use it for every single one of my businesses. Yes, this is a paid sponsorship by the amazing team at Gusto, but I would sing their praises even if I wasn't being paid to do so. So if you're looking for a platform that takes the pain out of payroll benefits and HR, I highly recommend you check out Gusto. And if you sign up at gusto.com/alex, you will get your first 3 Now onto the episode.

What's up, everyone? Welcome back to another episode of Founders Journal, my personal diary made public for the world. I'm Alex Lieberman, co-founder and executive chairman of Morning Brew. On November 28th, 2023, Charlie Munger died at the age of 99. Charlie was Warren Buffett's partner at Berkshire Hathaway for 45 years after the two met years earlier at a diner in Omaha, Nebraska, and they actually worked together as teenagers at Buffett's grandfather's father's grocery store. Beyond being one of the greatest value investors of all time, Charlie Munger was often considered to be the behind-the-scenes voice of reason for his more public counterpart Buffett, and many admired him for his latticework of mental models or human psychological tendencies that he developed through which he looked at the world. If you want to go deep into the mind of Charlie Munger, I highly suggest that you read Poor Charlie's Almanac, which is a 548-page profile of Charlie's life and lessons. And if you want to understand what informed so many of Charlie's views, I would explore the life of Benjamin Franklin, who Charlie considered to be one of his greatest teachers. Today I'm going to focus on one specific text that was written by Munger. In 1995, Charlie gave a speech called The Psychology of Human Misjudgment, which contains 25 psychological tendencies by humans that can lead to bad decision-making and bad outcomes. In 2005, he wrote down a revised version of the speech, which I read this past weekend. This speech is 52 pages of pure gold filled with timeless lessons that can be applied to life, relationships, and business. My goal with this episode is to share my 13 favorite misjudgments and provide examples of how they impact your abilities and success as an entrepreneur. Let's hop into it. I'm going to approach each of my favorite human tendencies in the same way. I'm going to share the tendency, what it refers to, possibly an interesting story or example to illustrate it further. further, and an example of the tendency in a business context. So let's start going down the list. Number 1 of 13. Number 1 is inversion. This is probably the most famous Mungerism. The typical way we as humans approach goals is by defining success and then creating a plan to succeed. But there is a flaw in this way of approaching problems in life because we are bad as humans at understanding the second and third order effects of our decisions. So inversion is a psychological antidote that basically takes the opposite approach. It says that avoiding stupidity is easier than seeking brilliance. And Munger has famously said, all I want to know is where I'm going to die, so I'll never go there. So let me use an example. Instead of me saying I need to do these 3 things to allow StoryArc, my content agency, to get to 100 clients and a $10 million run rate, if I use inversion, it would say I need to figure out what behaviors will, one, avoid clients churning before 6 months, 2, avoid content not being high quality enough. And 3, avoid my CEO spending too much time bogged down in the minutia of the business. So that is inversion. Inversion is a clearer way of getting to a goal where you're not running the risk of not considering second and third order effects. Number 2, incentives. If I had to rank the most important psychological tendency, it would be the stranglehold that incentives have on all of us. The great Munger quote about this concept is, Show me the incentive and I'll show you the outcome. Quick story on the power and potential danger of incentives, and then a thought on how to think about incentives in your company. There are endless stories of perverse incentives, but a recent crazy one is the Wells Fargo account fraud scandal. Here's the TL;DR. Wells Fargo employees faced extreme pressure to meet sales goals with customers. If they hit their sales goals, they were given incentives, and if they didn't, they would face penalties and scrutiny. This incentive structure was brought to Wells Fargo by this guy named Richard, who at his last last company, Norwest, created a campaign that was called Going for Great that implored employees to get customers to buy at least 8 products from the bank. Given the rewards and penalties for hitting or missing sales targets at Wells Fargo, employees were not only engaging in fraud to juice their sales numbers, but they actually were being taught how to engage in fraud to inflate their sales numbers as well. Here are some of the things they were doing. They were creating duplicated client accounts. They were finding out which clients were pre-approved for credit cards and submitting applications without clients knowing. They encouraged a homeless person to open 6 checking and savings accounts. The punchline here is that Wells Fargo had to pay a $3 billion fine to the SEC for the violations. This is just one of countless bad incentive stories, and the reality in business is that creating thoughtful incentive structures is really, really hard, which means if you haven't put a lot of thought into them, you can probably assume that you're improperly incentivizing employees in many parts of your business. Here are the common suspects. Some examples: First, salespeople being incentivized to hit quota, which leads them to discounting in order to close deals, which hurts your brand, or it leads them to overpromising, which hurts your account managers and customer retention. Another example, you making business decisions that reward vanity metrics in order to be able to raise your next funding round instead of making business decisions that are best for your customers. 2 more examples. There are less tangible, probably more dangerous examples in the context of your business. Here's one. If in a senior leadership meeting, you appear defensive when one of your executives is challenging an idea you have, you can assume that you are now incentivizing other leaders to be silent and hold back their opinions. Final example, if 90% of the people that you give promotions to at your company are in-person employees, then you can be sure that remote employees will have feelings of resentment about what's happened. And ultimately, they may feel incentivized to either work in real life at your headquarters, which will create further feelings of resentment because they can't be home, or incentivize them to join a more remote-friendly company. Number 3, Granny's Rule. Granny's Rule is the requirement that children eat their carrots before they get dessert, and the business version requires that executives force themselves daily to first do their unpleasant and necessary tasks before rewarding themselves by proceeding to their pleasant tasks. And I think this is a universally good rule, which is that when you're organizing your to-dos for a day, you should prioritize tasks that have 3 characteristics: they're most urgent, they're most important, and they're most unpleasant. Number 4, Character Multiplication. So this is a combination of 2 of Charlie Munger's 25 psychological misjudgments. The first is the liking-loving bias, which basically says when you like or love someone, you love the things associated with them while having the tendency to turn a blind eye to their faults. The second misjudgment is the dislike-hate bias, which says that when you hate someone, you globalize your hate for them, making it very difficult to see good or redeeming qualities in them. And how I think about this is that we have this shortcut whereby once we form an opinion on someone, we do our best to save time by basically not having to reform an opinion every single time we talk to them. That can be efficient, but it can also be dangerous. And so here's how character multiplication can show up in business. The most obvious example is you become known as a leader who has in-people and out-people. In-people are the leaders you admire at your company, the people who can do no wrong, the people you talk to about the out-leaders. The out-leaders are the people that you don't believe in. Who you believe to be on the outs of the company, who no matter how well they perform or how smart of an idea they present to you, you will never change your perception of them. Character multiplication leads us to blindly following people we love, and it leads to unfairly punishing people we don't love. The best way to combat character multiplication is to force your brain to avoid the character shortcut that I just mentioned and try your best to reassess people at the individual idea level, meaning you treat every new idea they share as a new opportunity to form a view on them. Versus assessing people at the identity level, meaning once they have a certain identity from your perspective, that identity is fixed forever. Number 5, doubt avoidance. We do not like uncertainty or doubt. And as Munger said, it makes total sense. Our ancestors likely wouldn't have benefited from taking a long time to make a decision when they were being hunted down by like a lion or a tiger. Our hardwiring is to reach a decision as quickly as possible to remove any doubt. Sitting with uncertainty puts our brain in a very uncomfortable state, and doubt avoidance is almost our psychological reflex to get back to a place of comfort. On top of that, we live in an age where leaders are considered to be good if they are decisive and bad if they are indecisive. Unfortunately, too many people misunderstand decisiveness for speed. The two are completely different things. So all of this, everything around doubt avoidance, can be a trap. The best way to make good decisions in business is to embrace discomfort, especially for decisions that will have an outsized impact on your business and will be difficult or uncomfortable to undo once you've made the decision. There are, are 2 great antidotes to doubt avoidance. The first is to delay decisions. Oftentimes, emotional excitement leads to quick decision-making because it feels way better than the discomfort of using a lot of brainpower to mull something over. It is easier to do this when you delay your decisions and you let your emotions subside. The second antidote is to have great critics in your life. When making a big decision, ask someone you trust and who you know wants the best for you to argue the opposing side to the decision you're thinking about making. This will will be a painful and emotion-provoking process. You will feel adrenaline pumping, and you'll feel probably defensiveness as someone is being asked to make an argument for why you are wrong. That feeling is completely natural, and you should get comfortable with sitting with it. Number 6, Kantian fairness. Kantian fairness refers to the pursuit of perfect fairness, which leads to horrible problems. The way I understand it is that there is a difference between individual and system fairness. And oftentimes we try to be fair to the individual, which actually means we're being less fair for everyone else. Here is a really good example that Charlie Munger shared. Let's say you are in charge of running a retail store and one of your cashiers, who is an elderly woman, is caught committing a minor embezzlement. Fearing that she might be dismissed, she approaches you to plead forgiveness. She tells you that this is the first time she embezzled money from the company, and she promises that she'll never do it again. She tells you about her sad situation, namely that her husband is very ill and that she was going to use the money to buy medicine for him. She becomes extremely emotional and your heart is melting. What do you do? So there are 4 possible actions that Charlie lays out. First, she is lying and you fire her. If you did that, it means it's a good outcome because it cures the problem and sends the right signals. The second is she's telling the truth and you fire her. This is a bad outcome for her because she was in integrity in what she said, but it's a good outcome for the system because they're seeing that a bad action leads to a bad outcome for that person. The third is she is lying and And you pardon her. That is a good outcome for her because she keeps her job, but it's a bad outcome for system integrity because now people believe that you can embezzle money without being punished. The fourth is she is telling the truth and you pardon her. It is a bad outcome for system integrity because it will send the wrong signal that it's okay to embezzle once, meaning she at least was honest with you, but she still embezzled. You didn't punish her for embezzling, which means now people think it's okay to embezzle once and then have a good reason for it. If you actually weight the probabilities here and consider the signal your decision will have on other employees' incentives and the impact on the overall system, unfortunately, it is clear that the woman should be fired. But that is not likely the decision that most leaders will make. This is an extreme example, but I think what I just described shows up all of the time in business. Think about all of the times that you prolong firing someone because you believe the fair thing to do is to give them ample time to improve and also for you to do all you can to help them. But it's likely unfair at the system level because it decreases other employees' trust in your judgment of talent, and no good employees will enjoy working with subpar employees. So it's bad for the system. Number seven: the extrapolation effect. Charlie calls this influence through association, which basically says that what we associate something or someone with greatly influences how we treat them. You see this with products. I think about how the pricing of Louis Vuitton signals exceptional quality to customers in the. Same way that the Wharton professor who advised the founders of Warby Parker said that they couldn't price their glasses at $49 even if the economics made sense because they would be associated with shitty quality. You also see the extrapolation effect with people. If someone on your team proved themselves really capable in the first 12 months of working at your company, you are way more likely to give them more rope to be autonomous and tell you what they think is best, given the credibility they've built up with you. Extrapolation can be a really helpful shortcut in business, but it can also have detrimental effects. There are 2 major risks I see with the extrapolation effect. The first is global extrapolation, and the second is unexamined extrapolation. Global extrapolation refers to associating your experience with someone or something in one context to a future experience that is in a totally different context. What this looks like is— let's use the example of the employee who crushed it in year one of working with you. Let's say they crush in year one, mostly focusing on helping to build up your sales organization. And let's say in year two, they change their focus to helping you in the product org. The extrapolation effect or global extrapolation would mean you extrapolate your trust in this person doing a great job in the product org, even if they have no experience or built up knowledge in product. And this is where I see so many leaders get burned is when people who did a great job leave their domains. They shouldn't have as much trust, but you keep that trust in them. The second biggest risk. Is unexamined extrapolation, which refers to incorrectly creating association with someone or something. A classic example of this is trusting someone because of previous success, because you perceive that success as skill, even if it was driven by luck. And I would say this is a very common risk of extrapolation today because you have a lot of leaders of companies that succeeded in the last 10 years because we were in a 10-year bull market, and the business they were in succeeded in spite of them, not because of them. Number 8 is the endowment effect. This is a well-documented psychological concept that we have a tendency to oversubscribe value to our qualities and possessions. In business, one big risk of this is having a bias to hire people that are like you. This is something that I absolutely struggle with because my personality is more outspoken. I have an unconscious bias to consider more extroverted candidates better suited for roles, but this can be a huge Sometimes the most extroverted, outspoken people are also the worst employees because they're great interviews but horrible workers, and they get through their career via bullshitting versus actual substance. Another big risk of endowment effect is thinking that you believe you control more of your business's success in the past than you actually did, and continuing to believe that you'll have an outsized impact on your business in the future. I believe that this risk of endowment effect causes far too many CEOs and founders to continue running their companies past their point of incompetence. Number 9, loss reactivity. According to Munger, the quantity of man's pleasure from a $10 gain does not exactly match the quantity of his displeasure from a $10 loss. That is, the loss seems to hurt much more than the gain seems to help. Moreover, if a man almost gets something he greatly wants and has it jerked away from him at the last moment, He will react much as if he had long owned the reward and had it jerked away. The overreaction to loss over gain leads to a lot of potential issues in business. The first issue is missetting expectations, whether it is telling your employees that you have confidence that your business will do $50 million next year, which will mean a big bonus for them if the numbers hit, or if it's you delivering a one-year plan to your investors. Your approach to expectation setting. Should be through the lens of whatever you say is what they believe will end up being true. And so if it ends up not being true, you can expect they will experience high loss reactivity because they feel like their reality was taken away from them. Another big issue in business of loss reactivity is FOMO. Founders will oftentimes make decisions today because they fear losing out on opportunities in the future. The classic manifestation of this is a founder who decides not to sell their company today because they fear missing out on all of the potential gains they could be making by holding out and selling for more 5 years from now. What I can tell you anecdotally is that I have talked to a lot of founders who regret not selling sooner, and I have never talked to a founder that regrets selling too soon. Number 10, social proof tendency, or more commonly called herd mentality. Herd mentality can be really helpful as a shortcut in life. When my wife and I went to the Big Ten Championship in Indianapolis last year, We had never been to that city and had no idea where the stadium was. So we followed thousands of people walking in a certain direction because it was a high signal, low effort way to be confident that we would make it to the game. But obviously herd mentality can be a detrimental shortcut that trades speed for accuracy via blind acceptance. And this blind acceptance gets stronger based on the perceived believability of the group or the potential risk of fighting against social proof. A senior leader is more likely to blindly agree when 7 other senior leaders are in agreement than when 7 junior employees are in agreement. Carly and I were more likely to follow the crowd when 50,000 fans were walking in one direction than if we saw 5 fans walking in one direction. Think about how you see herd mentality in business. Any time you ask someone why they're doing something and you hear them utter the phrases either because that's how it's been done or because that's what so-and-so said or because there's no better way, you are likely bearing witness to herd mentality. When you saw VCs pile in on crypto companies and then Web3 companies and then mental health startups and then AI startups, you were likely watching a lot of herd mentality. Herd mentality is best combated by creating a culture that invites independent thought and radical candor, where the best thinkers are rewarded above all else. Number 11, contrast misreaction. The idea of contrast misreaction is that when something happens, the reference point we're comparing that something to can lead to bad decision-making. Munger gives the example of a guy who bought a completely overpriced $1,000 leather dashboard simply because it felt so low compared to his recent purchase of a $65,000 car. I've experienced this very concept in business after letting go of a senior leader at Morning Brew because they had done a great job but had reached their ceiling. We hired a new senior leader who we thought was an absolute veteran compared to the other employee. But what we learned after a while was the new hire was also a relatively junior person and more junior than we would be able to have last at the company for a long time. They just appeared very senior because their reference point was an even more junior person that we had at the company prior. Here's another way that contrast misreaction takes shape. Munger's example here is the cruel story about how if you put a frog in in boiling water, it will jump out. But if you put that same frog in room temperature water and you heat it to boiling at a very slow rate, the frog will ultimately stay in the pot and die in the pot. In business, I think of this as death by a thousand paper cuts. It is the project that either ended up being delayed by months or the final product was horrible, not because there was a single bad decision or a single major delay, but because there were tons of small errors made along the way that each time seemed insignificant, but when compounded led to a massive issue. Number 12, the bottom apple effect. The idea here is another manifestation of this broad psychological tendency we have to prefer easy and quick as humans. And in the bottom apple effect, we as humans like working with what's easily available to us. We like the low-hanging fruit, non-straining choices. That can look like mishiring an employee because you end up choosing to hire your third-best candidate simply because the first and second candidates dropped out of the process, not necessarily because choice number 3 was actually the right person. Or in the context of marketing ideas or business ideas or content ideas, we all have a tendency to get excited about the first idea we think of. But you can generally assume that if you thought of an idea in 60 seconds, many other people thought of that same exact idea as well. And I would say there is one main way to combat the bottom apple effect. Force yourself to sit with the discomfort of reaching for high-hanging fruit. Fruit. Think of 10 ideas, not one idea. If you're not sure if a candidate is actually great, get a few more into the funnel as a comparison. Overall, create a process that forces you to reach the top of the tree before automatically deciding that the lowest hanging fruit at the bottom of the tree was better, because most of the time it's not. It was just easier to get to. And finally, number 13, reason-respecting tendency. People like understanding why something is being done versus just that it is being done. People like not just hearing about a decision, they want to know why you made the decision. This is a great insight because by preempting people that are going to ultimately ask why you made a decision, you can avoid storymaking and drama in your business. When people don't have answers to things, when people don't have answers to decisions that are made in a business or actions that are taken, they end up creating stories. And when they create stories, you end up having a culture of gossip. By making transparent your and your leader's thought processes, the oxygen for gossip is squeezed out. Now, the downside of reason respecting is that people will sometimes blindly follow a person if they give rationale behind their decision, even if those reasons are meaningless or incorrect. But I would say net-net, it is always a good thing to explain exactly how you arrived at a conclusion. It allows people to understand where you come from and it removes gossip. That is it for today's Founders Journal. As always, thank you so much for listening to the pod and I will catch you next episode. And if you have any questions, you want to say what's up, or you want to recommend a future episode or topic I should talk about, shoot me an email to alex@storyarb.com. That is alex@storyarb.com. Thanks for listening. Catch you next time.