More Than You Know: Influence

In a chapter dedicated to influence and its role in investing, it is no surprise that Michael Mauboussin introduced Robert Cialdini and his landmark book, “Influence: The Psychology of Persuasion.” The author took up Cialdini's ideas in chapter 11 of his book, "More Than You Know: Finding Financial Wisdom in Unconventional Places."

Aptly titled “All I Really Needed to Know I Learned at a Tupperware Party: What Tupperware Parties Teach You About Investing and Life,” the chapter addressed three aspects of investing psychology.

But first, Mauboussin noted that for more than 30 years, Cialdini had focused on what makes humans comply with requests. Specifically, Cialdini identified six tendencies of human behavior that prompt us to positively respond. The six tendencies are:

1. Reciprocation: If someone else does something for you, you feel internal pressure to do something for them. This is the basis of many marketing campaigns.
2. Commitment and consistency: We don’t like to change our views once we’ve made decisions, especially if we publicly affirmed them. Consistency allows us to stop thinking about an issue and allows us to avoid acting.
3. Social validation: If others are doing something one way, we will likely want to do it the same way. In a ground-breaking study, the psychologist Solomon Asch showed that subjects would disbelieve evidence seen with their own eyes when under the influence of group pressure.
4. Liking: Our tendency is to agree with people we like, and to like people who are similar to us.
5. Authority: To support this point, Mauboussin cited the famous experiment by Stanley Milgram, a study in which we learned that people obey authority figures—even against their better judgment.
6. Scarcity: “Buy now, our limited stock is selling out quickly.” We think items that are scarce, or perceived to be scarce, are more attractive.

Each of these tendencies is powerful on its own, but taken together they are even more powerful. Charlie Munger (Trades, Portfolio) refers to a “lollapalooza effect,” which is a combination of bad ideas amplified by the presence of several tendencies at once.

Mauboussin argued that such a lollapalooza effect occurs at Tupperware parties, where four of the six tendencies are used by organizers to increase sales of kitchen containers and related goods:

1. Reciprocity occurs at the beginning of the party when the organizers give away prizes.
2. Commitment is demonstrated when participants are asked to share how they use the products they previously purchased.
3. Social validation occurs when the buying starts, showing that others value the product.
4. Liking happens because the purchase request originates with a friend, not with a stranger. Mauboussin called this “the single most important facet of the Tupperware formula.”

Taken together, these influences make Tupperware parties very powerful sales events.

Investing now gets its turn, with the author reporting that three of the six tendencies are relevant to investing:

1. Consistency and commitment are at the top of the list. He cited a psychological study that found bettors at a racetrack feel more confident about their horses after they place their bets. On the investing front, it means we experience both internal and external pressure to stay true a belief, even if later evidence refutes it. To avoid this trap, he recommended: “One useful technique to mitigate consistency is to think about the world in ranges of values with associated probabilities instead of as a series of single points. Acknowledging multiple scenarios provides psychological shelter to change views when appropriate.”
2. Social validation. According to the author, “Investing is an inherently social activity, and investors periodically act in concert.”
3. Scarcity enters in the sense that many investors simultaneously try to buy the stocks with the hottest recent records. Booms and busts are driven by a sense of scarcity and a lack of scarcity, respectively.

To Mauboussin’s analysis, I would like to briefly explore how value investors might be affected by these ideas. At the heart of the value investor experience is contrarianism, the belief that we should zig when the rest of the market zags.

On the issue of consistency and commitment, value investors do make commitments, and to the longer term, which is usually three years or more. We’re going to make that commitment at a time when the rest of the market is shunning or avoiding our picks because we believe that reversion to the mean or some other factor will pull up the stock prices of companies that are under temporary (not permanent) shadows. Being consistent seems baked in because buying at a discounted price is only the launch of a contrarian strategy. Throughout the period we hold the stock, our strategy involves holding for a longer period, or until it is clearly overvalued.

Regarding social validation, it may be true within the value investing community, but not with the broader consensus of investors. In fact, most value investors would argue that going against social validation is part of their DNA.

Scarcity is an intriguing factor for value investors because we are buying stocks that others no longer want. When a stock becomes abundant because the broader market is no longer interested is the time a value investor considers buying. In contrast, we should be selling when the stock becomes scarce, when the scarcity of available shares pushes up the price of the stock.

There are, of course, many different types of value investors and so my comments above are broad generalizations. Nevertheless, I think that using a value investing strategy should provide most investors with good to excellent resistance to the negative influences discussed by Mauboussin.

Conclusion

In chapter 11 of "More Than You Know: Finding Financial Wisdom in Unconventional Places," Mauboussin has shown us how different aspects of influence can negatively affect our investing.

In particular, he reported that three types of influences are most important and should be addressed: commitment and consistency, social validation and scarcity. Each of these has the potential to affect our thinking, and suboptimize our returns.

I have argued that value investors do have some built-in immunity to these negative tendencies because the inherent “rules” of value investing force us to be more rational than we might otherwise be.

Read more here:

• More Than You Know: Investing and Stress
• More Than You Know: The Management Factor
• More Than You Know: The Myopic Loss Aversion Problem

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