Spoiler alert: The conclusion; we need to think for ourselves
I came across an article yesterday from CNBC, titled: Here’s how Buffett partner Charlie Munger applies psychology to economics
It discusses the many different psychological phenomena that Charlie Munger and Warren Buffett have observed over the years. It is a very insightful article, and helps to explain investor psychology and the reasons why most people are not very good when it comes to making financial decisions.
With that said, there are two items, the Bystander effect and the Social Proof tendency that I wish to concentrate on for this article. These two phenomena are the most easily observable and are the causes of so many of the problems people experience with money, finance, and personal choices.
In the large aggregate these two observations are the primary causes of the the boom-bust cycles, as most people just copy what everyone else is doing at the time. Social media reinforces our confirmation bias and we convince ourselves that we are correct, even though, by definition, we are usually incorrect.
If we wonder why so many people go into debt, attend college with tons of borrowed money, complain that they cannot come up with a down payment for a house, buy expensive coffees at Starbucks, continue to bust personal budgets, and repeatedly make poor investment choices then we should first look at the social proof tendency and the Bystander effect as the root causes.
Social proof tendency
The social proof tendency has had the most adverse impact on people’s finances. Of all the psychological phenomena I have observed over the years of investing and studying the human condition, this is the most detrimental predilection.
In his book titled, “Influence: The Psychology of Persuasion,” Robert Cialdini writes…
One means we use to determine what is correct is to find out what other people think is correct. We view a behavior as more correct in a given situation to the degree that we see others performing it.
In ambiguous situations, human beings are more likely to accept the actions (and inaction) of others. It makes our lives easier and our decisions simple. This can be beneficial in many aspects of our lives, and has worked throughout civilization. Indeed, we rely on other people’s expertise and experience to make our own decisions. Unfortunately, as humans, we don’t only imitate good actions, but we also have a tendency to follow wrong actions and inaction of fellow humans.
The Bystander effect is the direct outcome of following such human inactions. According to Wikipedia, the Bystander Effect is a social psychological phenomenon that refers to cases where individuals do not offer any means of help in an emergency situation to the victim when other people are present.
Most of the times, these decisions are good and extremely helpful. In fact, according to James Surowiecki, in his book, The Wisdom of Crowds, he argues that the quality of decisions taken by a group is usually better than the one that a single member of group will make.
But when it comes to investing Munger disagrees. He insists that when it comes to investing, social proof and the bystander effect are costly. I agree. According to the CNBC article, Munger says that the bystander effect and social proof demonstrate that many investors are just a bunch of followers.
Social proof – the undoing of the average debt slave
Unfortunately, when it comes to money and investing the social proof tendency can have detrimental consequences. People tend to just copy the behaviors and decisions of those around them.
Now that we have social media coupled with the modern marketing and advertising of Madison Avenue, the average person is incapable of escaping; there’s a flavor for every idea and impulse.
So, the next time someone blames the US Fed or any political party for the debt woes of the average person, we need to stop and ask ourselves, is there anything that the debt slave could have done to change his circumstances?
Avoiding social proof tendency
So what can we do to save ourselves from these tendencies? As always, the advice is simple to give here but difficult to master.
Thinking and acting independently is imperative but, the day to day interactions with numerous people and constant bombardment of information and various point of views make it an extremely difficult art to master. However, objectivity and independent thinking must be placed front and center, and we must not end up like a lemming running off a cliff.
Bottom line: We need to think for ourselves.