Financial Freedom

The Psychology of “Influence” in Investing

Robert Cialdini is no ivory tower academic.

Most psychology professors conduct research on college students. But Cialdini bases his work on experiments in the real world of business.

Cialdini spent three undercover years working at used car dealerships, fundraising organizations and telemarketing firms to observe real-life examples of persuasion.

The result was Influence: The Psychology of Persuasion. The book established Cialdini as one of the most influential social psychologists in the world.

You’ll recognize the footprints of Cialdini’s research in almost every sales pitch you come across.

No wonder thousands of salespeople across the world consider Influence their bible.

I consider it among the top 20 most influential books I’ve ever read.

So what do Cialdini’s insights in Influence have to do with investing?

Well, quite a bit, as it turns out.

None other than Charlie Munger – Warren Buffett’s elder and smarter sidekick – credits Cialdini with some of his most critical psychological insights on investing.

Munger cited Cialdini’s book as a profound influence on his thinking in a speech at Harvard back in 1995.

Overcoming your psychological biases is hard work.

But identifying them is crucial for improving the quality of your investment decisions.

So here are six “weapons of influence” to be aware of…

Cialdini’s Six Weapons of Influence

1. Scarcity

If you believe something is scarce, you will suddenly want more of it. That’s why offers are available for a “limited time only.”

In the world of investing, an initial public offering of a stock is often “oversubscribed.”

If investors can’t invest as much as they want, they overvalue the stock. They buy more once the stock is listed, even if it is at a higher price.

The lesson?

Don’t chase the price of a stock irrationally. Chances are good you will get a second swing at the ball at a more reasonable price.

2. Commitment and Consistency

If you commit to an idea orally or in writing, you are more likely to honor that commitment.

This commitment explains why you will stick with an investment longer if you’ve told your friends about it.

Analysts at top investment firms suffer from the same bias. Having put their reputations on the line by recommending a stock, they will stick with it longer than they should.

The lesson?

Don’t “marry a stock.” Look at your investment portfolio every day with fresh eyes.

3. Liking

People are more likely to buy if they like the person selling to them.

That’s why salespeople try to be your new best friend.

In his book, Cialdini cites the marketing of Tupperware. If you make a friend at a Tupperware party, you are much more likely to buy the products. Also, the more attractive you find someone, the more likely you are to buy from him or her.

The lesson?

Be careful of overly friendly salespeople. Don’t part with your hard-earned money just because you’re both Chicago Cubs fans.

4. Reciprocity

If someone gives you something, you feel you need to return the favor.

Hare Krishnas used to pass out flowers at airports in the 1970s. If you accept an unsolicited gift, you are more likely to donate. That’s why brokers overwhelm you with mouse pads, golf balls and tickets to sporting events.

When I was a fund manager, brokers regularly took us to high-profile events. It’s how I first went to a Wimbledon tennis match. Consciously or unconsciously, I felt obliged to place my trades through these brokers.

The lesson?

“Free stuff” is never free. You end up paying one way or another.

5. Social Proof

We all look to others to confirm our decisions. To see others making the same choice makes us feel comfortable about our own.

Cialdini had one of his associates on the street look up into the sky. Bystanders then looked up into the sky to see what the associate was seeing.

The lesson?

Novice investors buy companies on the cover of Fortune magazine or what they hear from their friends. Don’t do that. Experienced investors are doing the opposite.

6. Authority

We tend to obey authority figures, even when their orders make no sense or are objectionable.

Cialdini cites the famous experiments by Stanley Milgram in the early 1960s. Most of Milgram’s subjects were persuaded to give electric shocks to Milgram’s associates because an authority in a white lab coat told them to do so.

Investors will often justify buying a stock by citing Goldman Sachs’ “Buy” recommendation. Jim Cramer recently said that “there is no ceiling on Tesla stock.”

The lesson?

Do your own thinking. Question authority.

How “Weapons of Influence” Apply to Investing

Cialdini did not have investors in mind when he developed his “weapons of influence.”

Yet the psychology behind each can impact your investment decisions in far more ways than you can imagine.

How does Cialdini manage his own money, given his insights?

In turns out that Cialdini has invested the bulk of his assets in Berkshire Hathaway (NYSE: BRK-B) for decades.

He entrusts his investment portfolio to two investors – Warren Buffett and Charlie Munger – who Cialdini knows have read and understood Influence‘s lessons.

So if you want to improve your investment decision making, I recommend you read and study Influence: The Psychology of Persuasion.

It will be one of the most influential books you’ve ever read.

Good investing,

Nicholas

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About

An accomplished investment advisor and widely recognized expert on quantitative investing, global investing and exchange-traded funds, Nicholas has been a regular commentator on CNN International and Fox Business Network. He has also been cited in The Wall Street JournalFinancial TimesNewsweek, Fox Business News, CBS, MarketWatch, Yahoo Finance and MSN Money Central. Nicholas holds a bachelor’s and a master’s from Stanford University and a J.D. from Harvard Law School. It’s no wonder his groundbreaking content is published regularly in the free daily e-letter Liberty Through Wealth.

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