Deprival Super-Reaction Syndrome And Investing. Part four of a short series on Charlie Munger’s Human Misjudgment Revisited.

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In his Human Misjudgment speech, Charlie Munger discussed the deprival super-reaction syndrome, which in plain English is the tendency to be more influenced by minor decrements down than movements in the opposite direction. As Munger explains:

“People are really crazy about minor decrements down…People do not react symmetrically to loss and gain. Well maybe a great bridge player like Zeckhauser does, but that’s a trained response. Ordinary people, subconsciously affected by their inborn tendencies…”

Charlie Munger Deprival Super-Reaction Syndrome And Investing
Image source: YouTube Video Screenshot

Other examples include, as put forward by Munger himself:

  • “A man with $10 million in his brokerage account will often be extremely irritated by the accidental loss of $100 out of the $300 in his wallet.”
  • “Bureaucratic infighting over the threatened loss of dominated territory often cause immense damage to an institution as whole.” Jack Welch’s long fight against bureaucracy is business’s wisest-ever campaigns.
  • DST often protects intense ideological or religious views by triggering hatred toward vocal nonbelievers, and that happens in part because the ideas of the nonbelievers would damage the influence of the believers if they spread.
  • University liberal arts departments, law schools, and businesses all display ideology-based groupthink.
  • Inconsistency-Avoidance Tendency combined with Deprival-Super reaction Syndrome is an especially powerful duo.
  • Antidotes include the deliberate maintenance of extreme courtesy, as on the Supreme Court, the inclusion of “able and articulate disbelievers of groupthink.”
  • Labor negotiations often lead to the death of the company – it is more common for the entire company to die than to get a wage cut.
  • Mis-gambling compulsion also comes into play, as losses create a passion to “just get back to even.” Combined with the multiple “near misses” of some games this can lead to compulsive and ruinous gambling.
  • Good poker skill is a good antidote to throwing good money after bad.

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Deprival Super-Reaction Syndrome And Investing

As Philip Ordway, author of the Human Misjudgment Revisited paper notes, “Prospect theory and loss aversion have a lot to say here. And beyond the idea of losing something owned or almost owned, there is a related deprival factor. Scarcity – real or perceived – is a huge driver of human behavior."

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A sense of scarcity is a real driver of human behavior. All you need to do is consider the buzz and lines at stores when a new limited-edition product is released to see this in effect. Relating these behaviors to the world of finance is easy. A sense of scarcity drives bubbles and euphoria, investors tripping over each other to get in on the action and not miss out on any gains – see the greater fool theory for more. A sense of scarcity drives valuations higher, leads investors to forget their assessment principles and drives portfolio churn as the most sought-after equities are regularly brought and sold.

An example of the deprival super-reaction syndrome is the pensions crisis. Pension systems in developed markets around the world are chronically underfunded, and pensioners will likely have to take huge benefit cuts to balance the books. Doubtless, pensions will feel short changed, even though this is the removal of something almost, but never actually possessed. They will be more concerned about the potential loss rather than the real (albeit lower) returns they’re still in line to receive.

The deprival super-reaction syndrome hugely impacted investors during the 2007 crisis. Investors were scared into liquidating their last assets, right near the bottom, and scared to re-enter the market when stocks hit all-time lows. Over the past decade, the syndrome has prevented a generation of investors from getting back into the market because of the losses others suffered in 2007/08. Even though many investors suffered horrendous losses in 2007/08 on the way back up, the returns have far exceeded anything anyone could have imagined at the time. This hasn’t stopped the naysayers from trying to predict the end. I can’t remember a time in the past decade when there wasn’t at least one high profile analyst predicting the end of the current bull market for one reason or another.