Charlie Munger (Trades, Portfolio) has often recommended "Influence: The Psychology of Persuasion" by Robert Cialdini as one of the must-read books in order to get a grasp on the most important psychological factors that affect us while making decisions. As I was reading through it, some of the key components of crowd-thinking and investing popped into my mind.

What is Social Proof?

"First, we seem to assume that if a lot of people are doing the same thing, they must know something we don't. Especially when we are uncertain, we are willing to place an enormous amount of trust in the collective knowledge of the crowd. Second, quite frequently the crowd is mistaken because they are not acting on the basis of any superior information but are reacting, themselves, to the principle of social proof."

So, what can we take from this? As Cialdini mentions, we are wired to follow our instinct to follow the crowd in uncertain times. This has helped us survive in the past and continues to do so now. But most importantly, the author describes the main problem with this situation: There is no superior information. Howard Marks (Trades, Portfolio) has described the process of successful investing as thinking differently and being right on that thinking. How can we expect to achieve different results from stock averages if our core portfolio replicates or is concentrated among the same positions?

Charlie Munger (Trades, Portfolio) and Warren Buffett (Trades, Portfolio) also value independent thinking highly, saying that what they do is sit, read and think throughout the day.

“Warren and I do more reading and thinking and less doing than most people in business. We do that because we like that kind of a life. But we’ve turned that quirk into a positive outcome for ourselves. We both insist on a lot of time being available almost every day to just sit and think. That is very uncommon in American business. We read and think.”

After collecting all that data and information, though, what great investors do is get to their own conclusions. We will hardly see great capital allocators skim through target prices from analysts or get caught up with upcoming earnings' estimates.

When we use independent thinking and avoid social proof, we generally feel a bit awkward and fearful. What if I'm wrong? What if the consensus is right? All these things are part of our brain and how it has developed in order to survive. Great investors believe that to achieve success in this task is the ability to be contrarian, not by the sake of it, but after going through a diligent process of collecting information. By acknowledging the biases that affect our decision making, we can identify and suppress our tendencies and achieve better results step by step.

Have you ever been a victim of Social Proof?

About the author:

"I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you." - Charlie Munger