In the 1950s, Solomon Asch developed an experiment to study how individuals yielded to or defied a majority group. A group of 8 students would be shown a card with a reference line on it. The line was a certain length, let’s say 1 inch. The group was then shown three different lines and asked which line best matched the reference. Two of the lines were clearly longer or shorter and one matched perfectly.
The trick was that 7 of the 8 students were confederates, people who were in on the experiment. In the first round, the confederates were all instructed to give the right answer. The test subjects also gave the right answer. But in the third round, the confederates were instructed to give the same wrong answer. The test subjects also gave the same wrong answer.
What happened here? Why did the test subject give a clearly wrong answer just because other people were doing it? This is the subject of today post.
The TL;DR of human nature: we use shortcuts of reasoning that can get us into trouble. Nowhere is this more apparent than with social proof. History is littered with examples – from the crusades, to the Salem witch trials, to economic bubbles, to Time Warner buying AOL, to everyone buying a house they couldn’t afford – we do what others are doing. In fact, much of human progress can be attributed to ignoring social proof and having an original thought (the world isn’t flat argument).
Put simply, social proof is following the crowd instead of thinking for yourself. In his book Seeking Wisdom, Peter Bevelin explains:
We are social animals, influenced by what we see other people doing and believing. We believe that others know more than we do.
We want what others want. Since everybody else wants it, we assume there has to be a reason. We avoid what others avoid. We imitate without thinking. Especially when many or similar people do it, when we are uncertain, in an unfamiliar environment, in a crowd, lack knowledge, or if we suffer from stress or low self-esteem.
This idea was best condensed by Eric Hoffer in The True Believer:
When people are free to do as they please, they usually imitate each other.
Social proof is a double-edged sword. It is extremely useful for a well-functioning society to have some level of conformity. People see that others aren’t rioting and burning down the village, so maybe they shouldn’t either. But as we saw with the opening examples, it can also get us into trouble.
In 1964, Kitty Genovese was on her way home when she was stabbed, sexually assaulted, and murdered in front of multiple witnesses. According to newspaper accounts at the time, the attack lasted for over an hour – during which no one intervened or contacted the police. The newspapers were exaggerating, but the event still serves as the hallmark example of the bystander effect.
The bystander effect is a phenomenon where people do not offer help to a victim when other people are present. The more people who are present, the less likely help will be offered. Using social proof, we look at other people to judge if the situation is an emergency or not. If other people aren’t reacting, we assume we shouldn’t either. We also diffuse responsibility in a crowd. We assume someone else probably already called the police or offered help.
A lot of this boils down to a powerful human desire to not look foolish. People rather be wrong in a group than right by themselves. Experiments have shown that as soon as one person helps, everyone else will join in.
If you’ve ever read YouTube comments, you have a fundamental understanding of crowd psychology. The concept explains why the psychology of a group differs so much from the psychology of the individuals who make up that group. As group size increases, individual responsibility decreases.
Riots are the classic example. Many people, who would not otherwise participate in a solo looting, join in when they see others looting. One person may feel bad booing a theater performance, but they join in when others are.
As it relates to investing
When we see other smart people doing something, we feel less of a need to do our own due diligence. Bernie Madoff built one of the largest Ponzi schemes in history based on this idea. He made sure that only successful people were allowed into the scam. Whenever he needed fresh capital, he would just point to this social proof. If there was anything fishy going on, certainly someone else would have found it.
Enron was a similar example. No one understood how Enron was making money, but no one wanted to be that guy who looked foolish for not getting it. So everyone piled in and gave them a buy rating. John Olson was the lone analyst who said Enron was a sell for over 10 years. His reward was being ostracized by wallstreet over that time. Being right can be lonely.
Bubbles are another hallmark of social proof. Anytime we observe a power law, social proof won’t be far behind. If everyone else is making money in internet stocks or real estate, it must be full proof. Why else would anyone be buying them?
CEO’s often fall victim to social proof. Time Warner bought AOL at the worst possible time with the argument that everyone else was doing it. Similarly, everyone bought their own oil exploration company right before the market crashed in 2014. Just look at Freeport McMoran. Charlie Munger puts it this way:
Big-shot businessmen get into these waves of social proof. Do you remember some years ago when one oil company bought a fertilizer company, and every other major oil company practically ran out and bought a fertilizer company? And there was no more damned reason for all these oil companies to buy fertilizer companies, but they didn’t know exactly what to do, and if Exxon was doing it, it was good enough for Mobil, and vice versa. I think they’re all gone now, but it was a total disaster.
The point is, having others agree with you isn’t the same as being right. Warren Buffett often states:
We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don’t
The only thing that matters is that we form sound judgements based on facts. The rest is just having the courage to act on those judgements, even when everyone else is doing something different.
Ralph Waldo Emerson, an American transcendentalist, once said:
It is easy in the world to live after the world’s opinion; it is easy in solitude to live after our own; but the great man is he who in the midst of crowd keeps with perfect sweetness the independence of solitude.
Social proof is the human tendency to live after the world’s opinion. It is a reasonable shortcut for figuring out what is right and wrong; but when it fails, it fails big. Like Emerson suggests, we should always fall back on the reason of solitude.