Social Proof (The Herd)

The classic cliché regarding individual investors, but also a part of the institutional investment scene to a greater extent than they would like to admit. Relative performance can make “smart people look stupid” as they feel compelled to own a stock because it is a large component of their benchmark, or stated another way – because it is owned by their peers. It has always been easier to do stupid things while part of a crowd rather than doing it alone. The scientific name for this principle is “social proof’ and is best expressed by Dr. Robert B. Cialdini, Professor of Psychology at Arizona State University, who has studied this concept as it applies to cult recruitment and conversion.

“One means we use to determine what is correct is to find out what other people think is correct. We view a behavior as more correct in a given situation to the degree that we see others performing it. Social proof is most influential under two conditions:

“Uncertainty - when people are unsure, when the situation is ambiguous, they are more likely to attend to the actions of others and to accept those actions as correct.”

“Similarity - people are more inclined to follow the lead of similar others.”