Module 2 | Lesson 14
“Follow an expert.”
~ Virgil (Ancient Roman poet, 70-19 BC)
“In questions of science, the authority of a thousand is not worth
the humble reasoning of a single individual.”
~ Galileo Galilei (Italian astronomer and physicist, 1564-1642)
All of us have obeyed to authorities at some points in our life. We all have done that to our parents, teachers and policemen. Obedience to authority is definitely needed.
Our parents taught us how to be disciplined and respectful to others. Teachers taught us to read and write. Policemen provide us safety. So obeying authorities is a way to show respect to what they do.
But blindly following an “authority” can result in serious problems, like the following examples suggest.
Jim Cramer and Bear Stearns
Jim Cramer is a former hedge fund manager in the US and a famous host for the TV show ‘Mad Money’. In the show, he offers stock recommendations, and there are a lot of people who buy stocks based on his recommendations.
…like they followed his recommendation on the US investment bank Bear Stearns on 11th March 2008, when he advised them this – “Bear Stearns is fine. Do not take your money out of the stock!” The stock was then selling around $63 a share.
Five days after his recommendation, on March 16th, JP Morgan agreed to acquire Bear Stearns via a share exchange for the equivalent of $2 per share.
Here, watch this video…
From Bear Stearns to Suzlon
Watch these two videos on what an “authority” has to say on India’s leading wind power company, Suzlon.
The first video was shot three years back when Suzlon was at Rs 78, and the second one year back when the stock was at Rs 28.
The stock is now under Rs 10!
Now that Suzlon has crashed over these years is not the big idea here. The big idea is that I have seen several investors buying the stock just because an “expert” or “authority” had recommended it on CNBC.
The More You Don’t Understand…
…the more you would believe the authority.
Here is what Charlie Munger said in his speech on “The Psychology of Human Misjudgment”…
Experts are sometimes more convincing when we don’t understand them. Sometimes we are too impressed by something that sounds clever. For example, some people buy into investments just because they don’t understand them. They assume it must be something unique. As Warren Buffett says, “Techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising ‘Take two aspirins’?
Like, look at this video that was shot at the time of SKS Microfinance’s IPO. Given the anchor’s authoritative looks, voice, clothes, and words, it was easy for any gullible investor to fall prey to the stupid things (in terms of sensible investing) he was talking about. And many did!
Give special attention to words like “expensive but justifiable”, and “will forever trade expensive”…and you will see the authoritativeness surround you from all sides.
It’s another matter that SKS is down almost 90% since its IPO three years back.
Pilots and Co-Pilots
Charlie Munger, in his speech on ‘The Psychology of Human Misjudgment’, gave the following example of authority bias…
You get a pilot and a co-pilot. The pilot is the authority figure. They don’t do this in airplanes, but they’ve done it in simulators. They have the pilot do something where the co-pilot, who’s been trained in simulators a long time — he knows he’s not to allow the plane to crash — they have the pilot to do something where an idiot co-pilot would know the plane was going to crash, but the pilot’s doing it, and the co-pilot is sitting there, and the pilot is the authority figure. 25% of the time the plane crashes.
Remember Madoff?
The Ponzi scheme orchestrated by Bernard L. Madoff was the largest fraud by anyone in American history, involving $65 billion and damaging the finances of thousands over a 20 year period. Victims were mainly individuals and charities.
Madoff was once a leading figure in the US financial markets, and among the highest paid people on Wall Street. He went on to become the Chairman of Nasdaq.
Madoff’s Ponzi scheme came to light in 2008 as investors started pulling out funds due to financial crisis. The money went out faster than Madoff can pull money in from new investors, and subsequently he disclosed the fraud to his sons. He told that the business was a big lie and it was indeed a giant Ponzi scheme.
Madoff was arrested in December 2008, but thousands of individuals had already lost their life’s savings. They believed Madoff to be an authority figure in investing and blindly trusted him. In fact, one top French government official committed suicide after the fraud came to light because he had invested US$ 1.4 billion of his own and his clients’ money with Madoff.
Madoff has been sentenced to 150 years in prison, but his authority has already caused devastation to the financial lives of 13,500 people who trusted him and thus invested with him.
India’s Own Madoffs
Ponzi schemes aren’t a western world phenomenon. We in India have had a history of Madoffs appearing at regular intervals, duping people of millions, and then getting caught.
The only difference here is that these fraudsters in India remain unpunished for years, which motivates many others like them to perpetrate similar crimes.
Take the case of Ketan Parikh, Harshad Mehta, or Citibank’s Shivraj Puri – all have defrauded people for crores of rupees.
All these people were considered authorities in their own light, and this helped them make fools out of investors for a long-long time, before they were caught.
Ketan Parikh, for instance, was described as the Pied Piper of Dalal Street. He was a Chartered Accountant by profession, and came from a family of brokers. In late 1990s, he formed a network of brokers and identified 10 stocks that got popularized as “K-10 stocks”.
He manipulated the prices of these stocks, and people thought the gains were for real and would continue till eternity. This was also the time of the dotcom bubble, which compounded money for people in a very short time. So a lot of people borrowed money to speculate in stocks, especially those from the K-10 group.
In 2000, after the dotcom bubble burst and the stock market crashed, the K-10 stocks also went down. Ketan Parikh faced liquidity problems and the brokers started pressuring him for payment. He got behind the bars, but only after causing thousands of Indian investors to lose their savings.
“All my lifetime’s savings are gone. I don’t know how to feed my family,” rued a small investor hit by the Ketan Parikh scam.
Milgram’s “Shocking” Experiment
Authority is so powerful that we may cause pain to other people to comply.
The British novelist and scientist Charles Percy Snow said in “The Two Cultures and the Scientific Revolution”…
When you think of the long and gloomy history of man, you will find more hideous crimes have been committed in the name of obedience than have ever been committed in the name of rebellion.
In one experiment at Yale University, Psychology Professor Stanley Milgram tricked people by posing as an authority and caused normal people to impose what they had every reason to believe was intense pain to other people.
The participants in the experiment were instructed to shock another person if they answered a question wrong. No real pain was delivered during the experiment. But it showed that when we are given orders from what we believe to be a legitimate authority, we obey even if the result is that we end up hurting others.
Milgram said in “Obedience to Authority” – “It is psychologically easy to ignore responsibility when one is only an immediate link in a chain of evil action.”
To Milgram’s mind, evidence of a chilling phenomenon emerges repeatedly from his research study – “It is the extreme willingness of adults to go to almost any lengths on the command of an authority that constitutes the chief finding of the study.”
Here are three videos that show the Milgram experiment…
Learning from Feynman
In the book The Pleasures of Finding Things Out, Richard Feynman writes…
We get experts on everything that sound like they’re sort of scientific experts. They’re not scientific, they sit at a typewriter and they make up something like, oh, food grown with fertilizer that’s organic is better for your than food grown with fertilizer that’s inorganic – may be true, may be not true, but it hasn’t been demonstrated one way or the other. But they’ll sit there on the typewriter and make up all this stuff as if it’s science and then become expert on foods, organic foods and so on. There’s all kinds of myths and pseudoscience all over the place.
Keep in Mind
The “Is this authority truly an expert?” question can be very valuable in helping you avoid getting over-influenced by someone who looks like an authority but isn’t.
The question would impel you to distinguish between relevant authorities and irrelevant authorities. And this is a distinction that is easy to forget when the push of authority pressure is combined with the rush of modern life.
In the busy-ness of our daily lives, we often forget to look at the incentives of people who pose as authorities, because we simply go by how they look and what they talk…like what we see on business channels.
But it’s important to doubt the experts, and especially when they are offering you stock advice.
Do not buy or sell stocks just because an “authority” figure suggested on CNBC or any other business channel or other media.
Also, note that if someone is an authority in one field, it does not mean that he is an authority in every field. It is better to avoid Halo effects.
Finally, always remember what Nassim Taleb said…
In some disciplines, ‘expert’ is the closest thing to a fraud performing no better than a computer using a simple algorithm.
- I must not blindly trust someone, especially when that person appears to be an authority in his/her field. Instead, the first question I must ask when I encounter such a person is – “Is this authority truly an expert?”
- I must always check the incentives of people who pose as authorities.
- I must not buy or sell stocks just because an “authority” figure suggested on CNBC or any other business channel or other media.
- I must remember that if someone is an authority in one field, it does not mean that he is an authority in every field. It is better to avoid Halo effects.
Exercise #2: Visit the Mastermind Forum via this link and share your experience of being fooled by an authority into buying a dud stock, or taking a bad decision in your life. I am sure you would have many experiences to share. 🙂
References and Further Reading
- The Psychology of Human Misjudgment by Charlie Munger
- Aspects of Investor Psychology
- Predictably Irrational: The Hidden Forces that Shape Our Decisions – Dan Ariely
- Your Money and Your Brain – Jason Zweig
- Seeking Wisdom-From Darwin to Munger – Peter Bevelin
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