How a loss or a threatened loss can lead us to overreact - often to our own detriment
11-Sep-2015 •Mohammed Ekramul Haque
What is it? This is the human tendency to hugely overreact to a loss or a threatened loss of a loved one, property, friendship, one's territory, status, etc.
The crux of this tendency is misframing of the problem, says Munger. "In displaying the deprival-superreaction tendency, man frequently incurs disadvantage by misframing his problems. He will often compare what is near instead of what really matters. For instance, 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."
Often found in: Auctions, bureaucratic infighting, slot machine players, labour resistance
In Life: Sometimes even neighbours fight over what they perceive as deprival superreaction. One neighbour puts up a large overhead tank that could take up all the water available to other neighbours. Says Munger, "Even a one-degree loss from a 180-degree view will sometime create enough deprival-superreaction tendency to turn a neighbor into an enemy, as I once observed when I bought a house from one of two neighbours locked into hatred by a tiny tree newly installed by one of them."
The compulsion to gamble is a well-known behaviour that has caused financial ruin to many. Now you know it is the deprival-superreaction tendency to blame. "The deprival-superreaction tendency is also a huge contributor to ruin from compulsion to gamble. First, it causes the gambler to have a passion to get even once he has suffered loss, and the passion grows with the loss. Second, the most addictive forms of gambling provide a lot of near misses and each one triggers the deprival-superreaction tendency."
In investing: It is common to find an investor who does not book profits if the stock he owns has turned out to be a multi-bagger in a very short time. The reasoning goes that it could go higher. However, as innumerable stocks have shown, many gains have been nearly completely reversed in the cases where a stock catches the fancy of the stock market and is later dumped. Says Munger of this behaviour, "Many Berkshire Hathaway shareholders I know never sell or give away a single share after immense gains in market value have occurred.. I believe the single strongest irrational explanation is a form of the deprival-superreaction tendency. Many of these shareholders simply can't stand the idea of having their Berkshire Hathaway holdings smaller. Partly they dislike facing what they consider an impairment of identity, but mostly they fear missing out on future gains from stock sold or given away."
The auction system works in a similar way to create a deprival-superreaction behaviour. "What if I lose that item? What if it goes to someone else?" Says Munger, "Deprival-superreaction tendency often does much damage to a man in open-outcry auctions. The "social proof" that we will next consider tends to convince man that the last price from another bidder was reasonable, and then the deprival-superreaction tendency prompts him strongly to top the last bid. The best antidote to being thus triggered into paying foolish prices at open-outcry auctions is the simple Buffett practice: Don't go to such auctions."
In corporations: Even corporations suffer from this tendency. The most visible form of superreaction has been in the instances of trade union disagreements. Many industries have closed down because of inflexible trade unions that sought to extract the maximum benefits for the labour force. It didn't matter to the government of the day or the unions themselves that many industries closed down especially in the militant trade union states of West Bengal or Kerala because of their unrealistic demands. Says Munger, "The deprival-superreaction tendency has ghastly effects in labor relations. Nowadays, we see more occasions when whole companies disappear, as competition requires either takeaways from labor - which it will not consent to - or death of the business. The deprival-superreaction tendency causes much of this labor resistance, often in cases where it would be in labor's interest to make a different decision."
Another form of the deprival-superreaction tendency is seen in business failures. "The deprival-superreaction tendency and the inconsistency-avoidance tendency often join to cause one form of business failure. In this form of ruin, a man gradually uses up all his good assets in a fruitless attempt to rescue a big venture from going bad."
You just read about one of the misjudgements people generally make while investing. Read 25 ways to (Not) make mistakes to get an account of Charlie Munger's twenty-five typical misjudgements, along with our commentary on how they fit into Indian businesses and Indian investments.