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Lessons from Charlie Munger-X

Jan 5, 2012

In the previous article, we had discussed how our tendency to be over-optimistic distorts our view of reality and as a result, we often end up making wrong investment decisions. Today, we shall discuss a very important human tendency which is prevalent in all walks of our social life and has a tremendous influence on how we think and behave. Our aim is to help you understand the workings of your mind better so that you do not let your biases and thinking errors jeopardise your investments.

Social proof tendency

We would like you to contemplate a bit about the below questions before we share our views on them:

  • Have you ever commuted on Mumbai's local trains? If you have, you will most certainly agree about how a harmless looking gentleman can so quickly transform into a savage beast to plough his way into the train and onto a seat.

  • What causes riots? How are terrorists created? What do you think prompts an otherwise normal person to pick up weapons and brutalise unarmed strangers?

  • What was the reason for the success of Anna Hazare's movement against corruption? Why did an otherwise indifferent middle class go all out in support of Team Anna, sometimes even referring to the episode as India's second freedom struggle?

  • Why are Indians cleaner and more disciplined abroad than at home?
Though there may be other reasons as well, but the one important common thread among all these is the social proof tendency. What is social proof tendency? Well, it is an automatic tendency to think and act the way people around you are thinking and acting.

In the first instance, an otherwise gentleman turns rash in a Mumbai local train. Since everyone is doing the same, it seems socially acceptable to him. While he may not display that kind of behaviour in most other places, pushing and suffocating others in a local train appears pardonable to him. At least that is what it seems to him from the behaviour of others. Meaning, there is social proof.

The social proof tendency works in both positive and negative situations. Be it riots and terrorists. Or be it the massive support that came in for Anna Hazare. This tendency most readily occurs in the presence of puzzlement or stress, or both.

Social proof tendency and corruption in India

Charlie Munger points out one interesting aspect of the social proof tendency which very well explains why corruption in India is so deeply rooted. The "Serpico Syndrome" is named in the memory of Frank Serpico who once entered a highly corrupt New York police division. Unlike others, he resisted to be consumed by the contagion of corruption. And for that resistance, he was almost about to lose his life. Isn't this reminiscent of the many Indian films wherein the protagonist is the honest police officer who challenges the corrupt system? In the film, of course, the good cop reigns over his adversaries. In real life, however, that is seldom the case. As it is evident, the evil of corruption continues to persist in our country because of this very Serpico Syndrome, which is created by the social proof tendency and the power of incentives.

Akin to the other spheres of life, social proof tendency is present in overwhelming proportions in the world of business and finance. It dominates how investors behave in stock markets, how company managements do business and so on. We will discuss this is more detail in the next article of this series.

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