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Charlie Munger (Trades, Portfolio) is known as one of the greatest investors who has ever lived. Apart from having a keen sense of valuation and ability to judge the character of management, he has written extensively about the various ways in which the human mind can trick investors into making mistakes. I have written about some of these cognitive biases previously. Munger has reasoned that these biases are most dangerous when they interact with one another, a question that he thinks is unexplored in academic psychology.
Munger's term for the phenomenon wherein different biases layer and interlock with one another is the "Lollapalooza effect." It occurs when multiple different tendencies and mental models combine to act in the same direction. This makes them especially powerful drivers of behavior, and can lead to both positive and negative results. In a 1995 speech at Harvard University titled "The Psychology of Human Misjudgement," Munger used open outcry auctions as an example of the Lollapalooza effect. Participants are pushed to bid by reciprocity ("I should buy because I was invited to the auction"), consistency ("I have been on record saying that I like this so I must buy it"), commitment tendency ("I am already bidding so I must continue"), and social proof ("I know that buying is good because my peers are doing it").
Munger stated that while psychologists have been good at identifying individual biases, they are less good at figuring out how they interact and manifest in the real world, because it is difficult to run controlled experiments in that environment. At the 2017 Daily Journal annual meeting, he said:
"The psychology people couldn't do experiments that were four or five things happening at once because it got too complicated for them and they couldn't publish. So they were ignoring the most important thing in their own profession. And of course the other thing that was important was to synthesize psychology with all else. And the trouble with the psychology profession is that they don't know anything about 'all else.'"
Media creates these effects
Of course, the stock market is one big auction. And while open outcry stock trading is no longer how we buying stocks, the 24-hour business media does a very good job of feeding our impulses and biases. The ability to see prices quoted in real time also incentivizes short-termism in thinking and impulsive buying and selling.
Social media, too, has the power to affect investor behavior. In many ways, it is an even more potent creator of the Lollapalooza effect because of its tendency to create echo chamber communities, where investors can self-select to be surrounded by like-minded peers. In an ideal world, investors would use the internet to reach out to people who will critique their theses. Alas, that is simply not human nature.
It's all well and good to say, "Well, I'm smarter than the crowd, so I won't worry about being swept up by it." But by their very nature, Lollapalooza effects work in the subconscious mind, and are not easily controlled by the conscious brain. For this reason, the best way to escape them is by limiting your exposure to 24-7 media, and understanding that most of it is opinion, not fact. Sometimes the only winning move is not to play.
Disclosure: The author owns no stocks mentioned.
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This article first appeared on GuruFocus.