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Friday 2 September 2011

Robert Cialdini and the Weapons of Influence

“Well here, again, Cialdini does a magnificent job at this, and you’re all going to be given a copy of Cialdini’s book. And if you have half as much sense as I think you do, you will immediately order copies for all of your children and several of your friends. You will never make a better investment.”; Charlie Munger on The Psychology of Human Misjudgement.
A World Too Complex

Influence: The Psychology of Persuasion (Collins Business Essentials)One of the recurring themes in behavioral economics is the concept of bounded rationality: the idea that we’re perfectly rational up to the point at which our limited brainpower stops out. Cialdini’s Influence turns this idea on its head, and argues that it’s our brainpower that’s created a world that’s too complex for us to understand: and that the result of this is that we take mental shortcuts, which then open us up to exploitation at the hands of any unscrupulous third-party. Which is pretty much everyone, these days.

We'd argue that these weaknesses are exposed directly in stockmarket investing when we're not so much fooled by other people as dumbfounded by our own brains.  Influence is not about investing, but about psychology: which makes it essential reading for everyone, but especially investors.

Dumb By Design

It’s the complexity of the world we’ve created which is the main problem. Faced with vast amounts of data and a shortage of time we opt for simplicity, and focus on a few salient signals which generally work. This, as Cialdini points out, is exactly the approach taken by smaller brained animals, who use automated stimulus-response mechanisms to avoid the need for complicated decision making systems which are expensive to maintain and difficult to fit into their tiny crania. We don’t have the same space shortage, but instead have increased the number and sophistication of the decisions that we need to make, to achieve the same sort of problem, which we attempt to fix with the same sort of mechanism.

The trouble is that these shortcuts expose us to dangers, where our learned tricks can be exploited by the unscrupulous to persuade us to do things that simply aren’t in our interests. In investing sometimes we fool ourselves by misapplying these simple rules – heuristics, as they’re known – in situations where they look like they apply but where they really don’t.

Weapons of Influence

Influence is really targeted at helping us identify these “weapons of influence”, as Cialdini calls them, with the aim of being able to sidestep them when they’re used on us. He identifies six area of weakness, where we’re open to attack: reciprocation, commitment and consistency, social proof, liking, authority and scarcity. Each of these can be used to persuade people to your point of view and all are a problem for us investors, in a world where everyone is trying to persuade us to part with our hard earned capital.

The lessons of Influence are valuable in their own right, but when we think about how they apply to us as financially literate human beings they open up a whole new set of ideas about why we do what we do and what we should do about it. Take reciprocation, for instance. Economists for a long time took the view that people would accept any offer made to them as long as they were better off, yet many studies have shown that this isn’t true and that people will reject offers they view as unfair. Reciprocity lies at the heart of this, but can easily be misused.

Averaging Down

Reciprocation is the key to the power of “free”: the idea that by giving someone a gift you impose on them an obligation to respond, often with something of much more value than they’ve been given. It’s a facet of our nature as social animals that we feel this obligation, even in circumstances where we’re plainly being gamed: as Cialdini relates, it's the stock in trade of the Hare Krishna.

A typical approach, as described in the book, is the rejection-then-retreat ploy where a higher priced item is offered in the expectation it’ll be rejected, so that a lower priced item is then more likely to be accepted. Of course, if the latter had been offered in the first place that too would have been rejected. It’s a common way of persuading people to buy pretty much anything, financial services included: it’s known as the contrast principle and if you’ve ever averaged down on a dead-loss stock you’ll know exactly how it works on investor psychology.

Danger Everywhere

All of the other methods of persuasion we’ve also seen in one form or another. Commitment, social proof and liking are short-cuts we use to navigate our way through life, which also trigger nasty investment problems. Cialdini identifies all of these as weapons of influence: if we can be made to make a commitment or made to feel as though our peers approve a decision or can simply be made to like a salesman or a product we become open to persuasion.

Applied to investing these short-cuts open us up to behavioral errors of judgement. Commitment bias, for instance, means that we’re more confident about an investment after we’ve made it than we are before. Social proof is the trigger behind market booms and busts, as we take our cues from the people around us rather than the emotionless data we should be analysing. Liking is triggered by those who can form a pact of similarity with us – in investing this may be an incredibly dangerous trait, where we want to associate ourselves with the latest, greatest or most familiar stocks, rather than the investments that will make us the most money.

Deferral to Experts

Authority, of course, is a problem we’ve met with many times: the idea of deferral to experts in any guise is recurring issue in finance, where almost anyone can set themselves up as an expert without ever being held to account for the results of their suggestions. However, it’s scarcity which is perhaps most intriguing. Scarcity can be used to scare people into buying and is best triggered by time limited offers: if you don’t get it now it’ll be gone. It’s a favoured technique of high pressure salesmen, from double glazing to boiler rooms.

Indeed, time-dependent scarcity is one of the triggers behind stock market booms: the fact that we won’t be able to buy stock X at the current price tomorrow acts as self-reinforcing positive feedback to encourage us to buy now, while the ‘sales’ are on. In fact it’s rather startling how each of these “weapons of influence” are brought to bear on us, by ourselves, in the cognitively confusing world of investing.

Not an Investing Handbook

Cialdini doesn't spend his time relating the effects he describes to stock investing, this is something we need to work out for ourselves using the handbook he’s provided. No, he’s more concerned about how these weapons are used upon us by others, unscrupulously attempting to get us to purchase their wares by using our own psychology against us. His view is that we need to recognise that we’re being manipulated and develop a perspective that argues that in such circumstances we’re no longer obligated to reciprocate in any terms.
“The blitz of modern daily life demands that we have faithful short-cuts, sound rules of thumb to handle it all. These are not luxuries any longer, they are out-and-out necessities that figure to become increasingly vital as the pulse of daily life quickens. That is why we should want to retaliate whenever we see someone betraying one of our rules of thumb for profit”.
Of course, if we’re the one exploiting ourselves then retaliation is difficult: but recognising that we’re demonstrating behavioral short-cuts triggered by specific situations is something we need to cultivate. Cialdini’s book is anyway an important part of any investor’s toolkit, but it’s actually essential to everyone flummoxed by the information overload of the modern world.

You can take Cialdini’s Influence Quiz here, to see how good an influencer you are.

Influence: The Psychology of Persuasion (Collins Business Essentials)

See more from the Psy-Fi Blog's Book Review page or the Psy-Fi Blog on the Weapons of Influence:

On Reciprocity: When a Dollar's Not Just a Dollar
On Committment and consistancy: Disposed to Lose Money
On Social proof: The Proper Etiquette for Market Panics
On Liking: Puke: Don't Invest in the Familar and Love Your Kids, Not Your Stocks
On Authority: Euphemisms for Morally Disengaged Managers
On Scarcity: Stocks Aren't Snakes

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