CHAPTER 4

Social Finance

Once we've disentangled the complex interaction between situation and disposition we will be ready to face the next set of challenges. Situation is one aspect of our environment, but there is another one, one that we're so immersed in we hardly recognize it at all.

Humans are social creatures, we rely on our social relationships and social networks to function properly, and we're so embedded in these that we react to the behavior of other people in entirely unconscious ways. And, of course, these ways are generally not going to make us wealthier than we already are.

Our tour, folks, is entering the land of social finance, where what your neighbor, your friend—even your unmet Facebook friend—and your family does is far more important to your investing decision making than anything you analyze in your own head.

CONFORM—OR DIE

The British Prime Minister Margaret Thatcher once opined that there was “no such thing as society,” but we can be fairly sure that she was wrong. We are totally and utterly immersed in our societies, to an extent that's astonishing once you start trying to unpick it. Our behaviors are conditioned by the expectations of the people around us, and we respond to those expectations by, largely, seeking to conform.

As we saw in Chapter 3, the idea of the wisdom of crowds doesn't tend to apply to investing situations because people's decision-making processes are often linked, sometimes in surprisingly obscure ways. But you'll also find people all making the same decision for another reason—in order to conform to their peer group's expectations. This was famously shown by Solomon Asch, whose conformity test is still a staple of college psychology courses.¹

Asch had a group of stooges and a single valid participant compare the lengths of lines in a test in which the correct result was always obvious. He had the real participant answer last and his stooges deliberately got 75 percent of the answers wrong, but such that they were all in agreement with each other. Remembering that the correct answer was obviously the correct answer, regardless of the decisions of the stooges, the results showed the power of conformity—three quarters of the participants conformed at least once rather than trusting the evidence of their own eyes.

Why people do this isn't hard to understand. Faced with concerted agreement by a group of peers, there aren't many of us who are prepared to go our own way, and if we are we're likely to end up on the outside looking in. In our modern age that may not be the worst thing that can happen, but a few thousand years ago it was likely a death sentence. Our inclination to conform to social pressure exerted on us by our peers is a very powerful drive indeed. Unfortunately, groupthink is not a good basis for investing decision making.

GROUPTHINK

The idea that we tend to conform to the beliefs of the majority is usually known as groupthink, a striving for what its original discoverer, Irving Janis,² described as “concurrence seeking.” And the more in tune with the rest of the group we are the less likely we are to engage in thought processes of our own, which all too often leads to poor outcomes.

One spectacular, and tragic, example of this occurred on January 28, 1986, when the Space Shuttle Challenger broke up after takeoff. In a famous piece of independent analysis, aided and abetted by insider information, the Nobel Prize–winning physicist Richard Feynman uncovered the technical problem, caused by the failure of a single component known as an O-ring, responsible for sealing joints between separate parts of the spacecraft.

Feynman³ estimated, given the complexity of the Shuttle, that one in every hundred flights would fail, compared to the management estimate of one in a hundred thousand. It was not that any specific component failed—although given the O-ring design weaknesses were known and apparently ignored (STET?) was a problem in itself—it was that the entire process of risk management was flawed. When, 17 years later, the Space Shuttle Columbia failed it became evident that lessons hadn't been learned and that many of the management issues identified by Feynman were still at work and, as Claire Ferraris and Rodney Carveth have pointed out, groupthink figured high among them.⁴ The NASA management team was operating in a way that made it almost impossible for information that didn't meet their desired outcome to even be discussed, let alone acted upon.

In everyday life, groupthink is powerful because of our addiction to group conformity. You shouldn't be at all surprised to be told that it's an equally powerful force in investment. Unlike the kind of herding processes we discussed in the previous chapter this has nothing to do with people reacting to similar external signals, but is entirely about them reacting to each other. Roland Bénabou⁵ suggests that the effect of group conformity and groupthink is that it frames how people use new information. What he calls a “Mutually Assured Delusion principle” leads to investors ignoring bad news, either because the overconfidence of their peer group is providing them with (temporarily) positive returns or because their losses drive them into denial, which is itself contagious.

Perhaps even worse than groupthink-led collective denial is that the same effect leads to willful ignorance. This is the same behavior we see in people avoiding health checkups that might save their lives because they'd rather not know the truth, because the outcome might not be pleasant. In all of these processes, our decision making is distorted by a nastily contagious form of motivated reasoning.

MOTIVATED REASONING

The idea behind motivated reasoning is quite simple: we feel before we think. This is the affect heuristic again, that faint whisper of emotion that guides our decision making processes and colors our choices. The problem is, largely, that we have to believe something before we can understand it and that gives us a bit of an issue, because it means that if we want to analyze two contradictory positions we somehow have to believe both of them simultaneously, and that's taking keeping an open mind a step or two too far.

The basic idea goes back to a philosopher named Baruch Spinoza,⁶ who argued that if an idea is abhorrent to you then at best you'll ignore it and at worst you'll attempt to twist it to conform with your own beliefs. This is often seen in the backfire effect, where people will take evidence that proves the opposite of what they believe and use it to propose exactly the opposite. The point being is that we can't simply think that evidence that disproves the dominant theories of the group will actually have the expected effect—it may simply serve to drive the collective delusion to a new peak.

Harvard's Daniel Gilbert⁷ has analyzed the issue in depth and has come to the conclusion that Spinoza's ideas are roughly correct. We first have to believe an idea before we can analyze it and then we have to unbelieve it in order to get to the correct position, assuming it's wrong. And if you think the idea of unbelieving something sounds hard you're dead right—Gilbert has also shown that it's relatively easy to interrupt the unbelieving process, by putting people under time pressure or forcing them to multitask. This is yet another aspect of information overload.

The broad conclusion we can draw from these findings are that we need to avoid becoming part of a larger investment group, we need to minimize the number of decisions we need in order to make decisions and, as far as possible, we need to make the process as mechanical as it's possible to achieve. Above all, we need to do all of this without subjecting ourselves or being subjected to unnecessary time pressure or while making other difficult decisions. We can't take away the whisper of emotion, but we can at least relegate it to a backseat somewhere. Of course, if it were that simple to avoid social biases then it wouldn't be hard at all to avoid some terrible investing mistakes. But, as it turns out, groupthink is only the beginning of a very twisted tale.

POLARIZED

If you take a random group of people, put them in a room together and ask them to come to a decision over some matter on which everyone has an opinion, what do you think will happen? Well, for a long time the belief was that the group view would tend to the average and that the more extreme views would be filtered out and watered down. Eventually, James Arthur Finch Stoner of MIT thought it might be worth testing this idea out and discovered, rather to his surprise, that this is not the case, not at all.⁸ In fact, the group will usually move toward a more extreme position than that of the average group member. The effect is known as group polarization and, when added to groupthink, it forms a potent and dangerous cocktail for investors.

The move towards an extreme position is known as a risky shift, and while that may sound like a daring item of ladies underwear it's actually a thoroughly scary type of behavior, because groups of people tend to advocate more risky behavior than they would have as individuals. It's almost as though the presence of other people emboldens the group to embrace danger. None of us will walk the tightrope over the canyon on our own, but as a group we might just manage to egg each other on to do exactly that.

Harvard Law Professor Cass Sunstein's analysis of risky shifts shows that they're more likely to happen in some situations than others.⁹ Where the group members are relatively diverse and randomly selected—a jury for instance—then the effect is less powerful, but where there are shared interests, prior beliefs, and some form of shared social identity—political groups, terrorist cells, or investment clubs, for instance—then a shift to risk is more likely and likely to be more pronounced.

Associated with this is an effect we've seen before, our tendency to outsource our thinking when someone expresses a strong view with great force and precision: a particularly strong-minded individual can often sway the whole group. On the other hand, even if the group is minded to take a particularly strong position then a single person with a strongly held opposing view can ameliorate this effect.

Steven Utkas, who runs the Vanguard Center for Retirement Research, has proposed a four-stage model of stock market bubble formation that draws on group polarization and other effects.¹⁰ Firstly, he suggests that the representative heuristic, where we form opinions on whatever we can easily bring to mind (Linda the feminist again), lures us into chasing short-term success stories. Secondly, he thinks that overconfidence then kicks in and causes unrealistic extrapolation of short-term trends into the distant future. Thirdly, large groups of like-minded investors then undergo a risky shift caused by groupthink and group polarization effects and then, finally, when the bubble bursts then everyone shifts to a risk averse position and sells all their stocks.

This is a fascinating model because it builds on sensory issues—the representative effect—followed by issues of self-awareness into social effects. And there's good reason to suggest that situation in the form of modern technology may be increasing the problem. Eli Pariser has argued that Internet search technology is creating a bubble of experience for likeminded individuals based on their web profiles, where only information that fits that profile is served to us.¹¹ If we all start with a similar viewpoint and all receive similar feedback we're more likely to be polarized into a more extreme position to start with.

In short, we need to be very, very wary of investing opinions formed by groups. Any type of shared investment forum brings with it a combination of issues. Of course, they may give us access to information and investing opportunities we might otherwise not have found but they also bring us group opinions that we may not be able to ignore. More information is good, up to a point, but outsourcing our critical thinking is not. And don't just trust a single Internet search engine when you're doing your research, because it's quite likely to show you what it thinks you want to see—and it may well be right, even if it isn't in your best interests.

A PERSONAL MISSION STATEMENT: SOCIAL IDENTITY AND BEYOND

As you can see, the possible effects of social groups can be very powerful. However, there's a strong argument that states we are only really influenced by people with whom we identify with. If you're a dyed-in-the-wool Democrat you're highly unlikely to be influenced by someone with strong Republican views. Indeed, the evidence of group polarization suggests quite strongly that our group or social identity is heavily implicated in how we make decisions.

Roughly, social identity is a concept about how we anchor our identities by linking them to social groups: political parties, football teams, racial groups, etc. It's also bound up with how we interact with our employers and colleagues. Rachel Kranton and George Akerloff have shown that how an employee relates to his or her fellow workers and managers is far more important than simple incentives when it comes to motivated performance.¹² Of course, this runs completely counter to the modern approach to employee management where people are treated as resources, are hired and fired at will, and it's assumed they can be incentivized to do things regardless of whether they believe in them or not.

The truth, as usual, is more complex, more nuanced, and far, far more interesting. While it's possible to incentivize people to do very specific things there are consequences in doing so, because if you direct peoples' focus on to one specific area of interest then they'll spend a lot of time attempting to ensure that they achieve that specific goal, and will quite often miss or even deliberately bypass the bigger picture. So, for instance, when the headmaster of a private school was given a bonus for every new fee-paying child he recruited the numbers of new starters suddenly soared. It was only later that the school governors discovered that he'd been heavily discounting the fees in order to boost numbers. Consider the contract offered to Ken O'Brien, a football quarterback, which stipulated a penalty every time he threw the ball to the opposition.¹³ In consequence, he rarely got intercepted, but that was largely because he rarely threw the ball at all, not a great quality in a quarterback. Be careful what you wish for.

The same is true of investing, although the incentives are often far more difficult to discern. Although we may start out investing because we want to become rich, we often get diverted by other issues along the way. As we've seen we may do it for reasons of self-esteem, or because we're fooled by our situation or, as it turns out, because we want to be at one with our social group: these are all real incentives for humans and it's important that we recognize this and take account of it. Kranton and Akerloff's employment based research points the way—they argue that you have to make people identify with their employers rather than simply incentivize them, because by doing this you align the goals of the individuals with the goals of the organizations.

So, we need to start out with a manifesto that states what our organization's goals are. It's a personal investing mission statement that will provide us with the structure to socially identify with our own lives, and to provide us with a benchmark against which to measure our own behavior. You have to create your own, based on your own interests and approach to investing; there is no single way of doing this. Here's mine:

This statement contains a whole bunch of difficult to untangle concepts that we'll need to analyze further: What, for instance do “high quality” or “market” or “over-valued” mean? But the general point is easily understood and provides a basis for evaluating any particular investment both before and after a purchase. Moreover, it provides a quick and dirty checkpoint for whenever I get carried away with some awesome new investing idea offered by someone whose ideas I value from within my investing cohort. I seek to actively construct my social identity as an investor, I don't just leave it to random chance to form it.

One other thing, though. This definition is not absolute. Those “relative” terms are important, because they provide an element of flexibility. Remember that markets are reflexive, an investing style that works today will probably not work in ten years' time, and getting drawn into a single method of analysis that's set in stone will guarantee that you fall off a cliff at some point. So don't do it.

GAMING THE SYSTEM

The process by which people manipulate incentives to their own financial advantage is known as gaming the system—basically, we manipulate the rules, staying within them technically but betraying the spirit of the game. Closed groups with a cohesive social identity can often lose sight of the bigger picture, and fail to remember that their little world is actually part of a bigger one in which there are other rules, ones enforceable by law.

The UK had such an example in 2010, when it became clear that their politicians were gaming their expenses system by claiming for things that they weren't actually purchasing and then pocketing the difference. Some of the claims were simply bizarre, one parliamentarian claimed for a duck house, another for horse manure (no, seriously, I am not joking), and another to have the moat of their castle cleaned (only in England!). Some claims were simply illegal and, eventually, a few representatives ended up going to prison, but throughout the whole episode, the entire body of politicians seemed to be unable to accept that their game was illegal within the context of laws that they themselves had enacted. They could see nothing wrong in acting in a way that saw other citizens imprisoned for fraud.

There have been many similar examples in an investing context, where managements simply ended up out of touch with the real world, operating to their own code of conduct, seemingly unaware of the wider context of their actions. The infamous failures at Enron and Worldcom seem, in part, to be due to this kind of group issue.

This type of willful blindness is not confined to politicians and corporate executives. In fact, Dan Airely argues that it's the type of behavior we all might be guilty of given half a chance.¹⁴ His research suggests that the more removed from actual money our fraud is the more likely we will be to try and get away with it, and we will try to find ways of rationalizing our behavior to ourselves to avoid admitting our guilt. This process was dubbed moral disengagement by Albert Bandura, and is a particular issue in corporate fraud as Anand, Ashforth, and Joshi have shown—white collar criminals will tend to acknowledge their behavior but simply deny that it's criminal.

You're probably thinking “so what?” Well, if you think about private investors as a group with a shared social identity—and let's face it, most of us share the same basic beliefs about capitalism and democracy—then it's not hard to see how we can easily end up being polarized in our thinking and subject to groupthink. Moral disengagement is part of the very fabric of shareholder democracy, because we expect our corporations to aim to maximize their returns on investments while staying on the right side of the law.

The problem with this is that the incentives to maximize return on investment can often cause unintended consequences: corporations who have too much of a focus on the short-term and who have overly incentivized their managements to meet these aims tend to underperform in the longer term. CEOs tend to operate to maximize their own returns and, given that the lifespan of a CEO is often comparable to that of a mayfly in a frog farm, that may not be in our best interests as shareholders.

So we shouldn't be surprised that when Daniel Bergstresser and Thomas Philippon examined CEO compensation they discovered that the more heavily biased incentives were towards earnings related elements like stock options the greater the probability there was of earnings manipulation.¹⁵ Of course, it's an unworthy thought that CEO remuneration packages may induce them to direct our great corporations to maximize their own personal compensation but CEOs are nothing if not good at playing the game.

Remember, again, that in the short-term we are likely to be outcompeted by investment institutions. Focusing on corporations with longer-term aspirations will provide us with better returns, even if they take longer to realize. Our moral disengagement may lead to executives gaming the system, something that's not in our interests. We need to frame our investment approach to suit our personal goals, not those of the wider group or faceless corporations.

YOU'VE BEEN FRAMED

And so we come to the odd, but infinitely powerful topic of framing. If you still have any faint residue of hope that you're an independent individual capable of insightfully overcoming your biases then ready yourself to abandon them now. Framing is how politicians bend us to their wills, how lovers overcome our objections, and how children get their way. We don't lose our jobs anymore; we experience career upgrading or are right sized. At other times we're redeployed, reorganized, displaced, or, startlingly, experience career upgrading. We're being framed, to fit with a general approach towards moral disengagement.

The idea of framing comes out of the work of the twentieth century sociologist Erving Goffman, who used the metaphor of a stage and drama for our various roles: as a parent, a partner, a child, an employee, an employer … the roles we play are infinite, while we are not.¹⁶ The way we present ourselves depends upon the situation and the situation frames us through our interaction with others. And this isn't something we can avoid doing because we have to frame situations in order to give ourselves the social context within which we operate; all of that unconscious processing that goes on below the surface that we're rarely aware of but without which life becomes nearly impossible.

The way we look at things colors our perceptions.

The idea of framing has been popularized by the cognitive linguist George Lakoff, mainly in relation to politics.¹⁷ He's studied the way in which politicians frame situations to create an environment that's conducive to their own ambitions and ideologies. They manipulate frames in order to change our perspective—remember that the U.S. Army wasn't engaged in a long-term occupation of Iraq but was involved in a short-term “surge.”

In particular, Lakoff proposes that Wall Street frames itself in a particular way: self-interest is always right, we are individually responsible for our actions but not for their social consequences, and success defines moral authority—by definition if you're successful you must be doing something right—and these principles are ones we should live with in daily life, not just in our financial dealings.¹⁸ Of course, this is not the only way of framing yourself, but it is one that is commonly propounded. And, of course, from this comes the mantra of short-term earnings maximization and the moral disengagement of shareholders, with all the problems that this brings.

In terms of actual investing there's striking evidence that framing has deep consequences for individuals.¹⁹ Think about this:

A: You've found the calculator you want in a local store. It costs $15. However, a bit of judicious Internet surfing shows that you can purchase the same calculator for $10 in a store that's a 15-minute drive away. Would you get in your car or buy locally?

B: You've found the tablet PC you want in a local store. It costs $125. However, a bit of judicious Internet surfing shows that you can purchase the same table PC for $120 in a store that's a 15-minute drive away. Would you get in your car or buy locally?

When Amos Tversky and Daniel Kaheneman investigated this problem they found that in A the majority of people would drive to get the cheaper calculator, but in B most people would buy locally. Yet the saving ($5) and the effort (15-minute drive) was identical in both cases. What's different is the frame, which is constructed on the value of the item under consideration.

In fact, Tversky and Kaheneman were able to show reversals of preferences in a wide variety of situations simply by manipulating the frame. Traditionally, economists didn't expect this, because they assumed our behavior was consistent across time. But it isn't, so it wasn't surprising that when Alok Kumar and Sonya Lim looked at the effect of framing on stock investment choices they discovered that framing has a massive impact on the way people make investing decisions.²⁰ The more narrow the frame, the more likely they were to invest badly.

In this sense a “narrow” frame means one that's constructed in a very focused fashion—maybe on one particular stock or a single investing decision. Wider frames based on portfolios or overall wealth tend to be better diversified. If we think about how the disposition effect works—our behavior changes whether we are dealing with a gain or a loss—then this isn't especially surprising. If you narrowly frame based on every single investment then you'll be letting the disposition effect run rampant on every single stock. If you widely frame based on your entire portfolio then the effect will only really work at the overall portfolio level and you're less likely to be triggered into short term fight or flight reactions.

BEHAVIORAL PORTFOLIOS

One of the lessons of framing should be to ensure we manage our money as a whole, not as separate and different sets of accounts. As we saw with the concept of mental accounting we tend to assign money to different buckets and then manage those buckets separately, even though it's all the same pot of money in the end. We often do this quite consciously to ensure we save money for specific purposes such as holidays or Thanksgiving, but we often also do it unconsciously on a much broader scale.

It has long been noted that people will buy both lottery tickets and insurance. We're simultaneously both risk seekers and risk averse. Most of us probably can't see any issues with that but it's puzzled economists who recognize that this is inconsistent. You may be getting the idea that economists have a lot of trouble with the real behavior of people, and you would be right.

As individuals we have no trouble differentiating between the pleasure of a small gamble and the safety of a small outlay for large downside protection. Meir Statman²¹ has pointed out, however, that our love of gambling can cause problems for investors—because investors confuse the negative sum game of stock trading for the positive sum game of stock holding. In particular, stock trading exposes us to a raft of costs that stock holding doesn't but with every decision comes trailing behavioral consequences which are hard to manage.

Even so, this doesn't explain all of this lottery-insurance behavior. The people who can least afford to gamble on the lottery are the people who are most likely to buy tickets. The people who can most afford the losses they're insuring against are the people who are most likely to purchase insurance. Harry Markowitz,²² the economist who almost single-handedly invented the Efficient Market Hypothesis, suggested a simple reason for this—we're very, very concerned about our social status relative to our peers. We aspire to move up the social ladder and we struggle to avoid moving down it. The keeping up with the Jones' effect is very powerful indeed.

The idea is that our dominant frame, one caused by our society's focus on financial rewards, is that financial status is equivalent to social status and this is all that's needed to trigger this sort of risky behavior. After all, if you're at the bottom of the heap with no way out then a lottery ticket may be a rational, if very low probability, option for seeking a way up and out.

Hersh Shefrin and Meir Statman²³ have proposed that this strange risk seeking/risk avoidance behavior lies behind the way that people build their investment portfolios. Traditional economic theory says that we worry about diversification within our portfolio, and there's a bit of a myth based on this that 15 stocks are all you need to get sufficient diversity to avoid most foreseeable risks. Behavioral economics says that this may (or may not) be true but it's not what real people actually do. Instead they create a downside protection (insurance) portfolio and an upside opportunity (lottery) portfolio and then they manage them separately, as the theory of mental accounting suggests they should.

Into the insurance portfolio people will pour cash, bonds, mutual funds, maybe even some blue chip stocks or whatever meets their particular definition, while in the lottery portfolio you may find higher risk stocks and a range of weird and wonderful derivatives. And people react differently to different events in these portfolios—unexpected losses are okay in a lottery but anathema in insurance, while unexpected gains are bizarre in insurance but quite likely to be gambled away in a lottery. These different reactions are guided by framing, of course.

The older we are the more likely we are to favor insurance over the lottery, unless we suddenly realize we don't have enough to retire on, whereupon we may start gambling. As you can tell, the whole framing thing is fraught with difficulty, but anchoring against what your peers do seems to be a major part of the problem. Nothing makes us more unhappy than seeing the brother-in-law or the neighbors become richer than us, and the temptation to try and keep up can sometimes be overwhelming. Social effects often trump every other type of bias.

However, investment shouldn't be treated as a relative thing. We need to measure against sensible benchmarks, not ones we can't test against. And we especially need to test against ones the hoard of behaviorally compromised investors in the market can't directly impact. Something like a dividend, maybe?

DIVIDEND DILEMMAS

One of the odder bits of framing, suggest Hersh Shefrin and Meir Statman,²⁴ has to do with how we treat dividends from stocks. People tend to get very, very angry at dividend cuts, even though these are often in their best interests, because sometimes retaining funds that would otherwise be paid out to shareholders is the best way for a corporation to raise money to invest in new ideas. The researchers propose that although stocks are treated by most people as belonging to the lottery portfolio, the same people tend to treat dividends as belonging to the insurance portfolio—which is peculiar, but no more so than a range of other behaviors we've seen.

In fact, dividends may offer an interesting route out of some of our more damaging psychogical traits. Shinichi Hirota and Shyam Sunder²⁵ have shown that the difference between vaguely rational investors and very irrational ones can be explained by the way in which they use dividends to anchor their expectations. Investors who use dividends as a starting point for valuation analysis are basing it upon something they can't affect, and this provides a basis for rational analysis of future earnings. The alternative seems to be to base valuation analysis on share price and this leads to the nasty issue of market reflexivity we discussed earlier: share prices can be a self-fulfilling prophecy under certain circumstances.

Further evidence supporting this idea shows that where there is unusual uncertainty about the future trajectory of dividends it's quite likely that the share price of the stock will get out of whack with its fundamental valuation. Basically, the anchor of the dividend is no longer reliable, and no longer a basis for rational analysis. Of course, stocks that don't pay a dividend will also be harder to value: as many of these are high growth or speculative corporations to start with it's easy to see that the valuations of these can often disappear on a tangent of their own, regardless of reality, whatever that may be.

Given this type of extrapolation from dividends to future earnings it's not hard to see why people get a bit upset at dividend cuts, as they cut across rational analysis. Nonetheless, valuation methods that include dividends are far less susceptible to social pressures than those merely based on share price. A dividend is generally not determined by how much investors want it to be, but a share price may be.

THE LANGUAGE OF LUCRE

Of course, the main way in which social interaction is conducted by humans is through language. We frame things through language and we communicate through language. So it's not surprising that a lot of the social biases we're concerned about have their roots in the way we speak to each other and in the stories we tell. In fact we seem to be designed to tell each other stories—narratives—and then to act on those stories. The psychologist Dan McAdams²⁶ actually suggests that we construct our social identities out of narratives, and then follow these narratives to their logical conclusions.

Language has many affects on investors but one of the most common is the way in which it allows memes to be transmitted from brain to brain. A meme is an idea coined by the biologist Richard Dawkins²⁷ by analogy with a gene, it's an idea that propagates from brain to brain through social interaction, and like a gene it has a life of its own.

Investors seem peculiarly prone to accepting these socially propagated ideas without subjecting them to anything like proper scrutiny. In fact, the market is generally full of memes that no one ever really analyzes. To take one, there was the fantastic idea back in the go-go nineties, during the dotcom boom, that you should always “buy on the dips.” The idea was that the market would carry on going up forever, so if it took a dip it would be temporary and that was the time to fill your boots (another meme, by the way). In truth, this meme was, at best, only valid during the temporary insanity of the age and when the market decided to take a decade long dip it took some people quite a long time to come to terms with this. Years, in fact, and some people probably still haven't quite accepted that it doesn't work.

Building on this, the economist Robert Shiller, who famously predicted the great stock market crash of 2000 when most experts were sagely expecting the continuation of the greatest bubble since, well, the last one, has proposed that markets sometimes change behavior for reasons that have nothing to do with economics and everything to do with peoples' shared perceptions of the world.²⁸ He suggests that the way in which prices of all sorts of assets shot up in the 1990s was due to the lowering of nominal interest rates, the idea being that people feel that they can afford to borrow more to invest. However, as Shiller points out, this is actually a meme that's based on a fallacy caused by people framing their ideas based on nominal rather than real interest rates; it's the base rate fallacy in another form. However, the power of the idea is that it's shared, sitting in the heads of all those like-minded investors out there.

These shared ideas form the core of our ideas about how we invest and are incredibly powerful because they're virtually unconscious, they're simply part of the fabric of how we go about doing our investing business. Yet when they're wrong they can drive whole cohorts of investors into major error, often for a generation or more. To counter this we need to construct our own memes, and to develop approaches that aren't easily influenced by fashion and fads. We need to be logical investors, not trendy ones.

EMBEDDED INVESTING

The idea that we invest in a world based on shared ideas mediated by social relationships, and the biases they bring with them, has a specific name—it's called embededness. Embededness argues that the way we deal with economic transactions isn't simply about making money but is very powerfully governed by our relationships with other people. At a simple level this is easy to understand—we will trust people who have previously demonstrated that they're honest and we will avoid dealing with people who've cheated us in the past.

In fact this idea is so obvious that it's largely been ignored by most of economics but is well known in the not-obviously related discipline of sociology, where Mark Granovetter has outlined the basic principles of the concept.²⁹ The idea is that the economic relationships between people and companies are embedded in social networks, but that these networks simply aren't part of any normal kind of economic analysis, and certainly aren't considered by investors.

Because we're all embedded in complex sets of social relationships we can't avoid being influenced by them. And this influence will sometimes lead us into error, when we trust someone who trusts someone else who trusts another person who happens to be wrong. We often cross-check our own behavior by looking at what other people in our social network are doing—we're being consciously reflexive but in so doing we usually don't recognize that our peers are doing exactly the same to us.

An extreme example of this, and one that demonstrates that even the most advanced computer modelling technology can't stop people being people, was identified by Daniel Beunza and David Stark, who analyzed what happened when groups of professional traders who try to make money by exploiting takeover situations got things badly wrong.³⁰ In 2001, the European Commission blocked a merger between GE and Honeywell, a decision which collectively cost the traders about $3 billion.

What's really odd about this particular massive cock-up is that these traders are specifically aware of their own weaknesses and go out of their way to continually question their own beliefs: they're an active, ongoing demonstration of the benefits of reflexivity. However, what the researchers suspected was that reflexivity on its own isn't enough, because the only way that anyone can check their beliefs is by reference to someone else, and if everyone is embedded in the same network of social interactions then the net result will sometimes be disaster.

This is exactly what happened in this case. These reflexive traders were carefully checking each other's views but because they were all working on the same set of assumptions everyone lost, big time. Organizational management experts Daniel Beunz and David Stark question whether simple reflexivity is enough to prevent the kinds of major errors that we frequently see: it's not that people are blindly making errors, it's that we're so embedded in social interactions that we are cognitively interdependent.³¹

In normal life, this is a good thing, because the alternative is pretty scary, but in investing life this can lead to wildly unfortunate outcomes.

FINANCIAL THEORY OF MIND

We know at least one alternative to being socially interconnected, and it's a common symptom of autism. Autistic people suffer from a variety of problems, which manifest themselves as an inability to interact with others. There are lots of ideas about why this might be, but the overarching problem seems to be that autists suffer from a lack of theory of mind.

The psychologist Simon Baron-Cohen has proposed that we are all, in a limited sense, mind-readers.³² It's our ability to know what someone else is thinking, and to know that they know that we know this, that allows us to effectively interact. As it turns out, a lot of human social behavior isn't directly mediated by language, which sometimes causes unusual problems such as the wild nineteenth century belief in animal telepathy, caused by the apparent mind-reading abilities of a horse called Clever Hans.³³

Clever Hans could seemingly provide the answers to simple mathematical sums by tapping his hoof the correct number of times. His owner made a living demonstrating this and Clever Hans became the subject of a bewildering array of scientific theories. When it was shown that the horse could answer questions when someone other than his owner was asking the questions, thus proving it wasn't some kind of signaling trick, the speculation exploded into a fever, with many otherwise serious scientists suggesting that this was evidence of animal telepathy.

Eventually, however, someone had the idea of getting someone who didn't know the answer to the questions to ask them, at which point Clever Hans stopped being clever. It turned out that the horse was just unusually good at reading the body language of the questioner, which told him when to stop tapping.

We all perform this kind of trick unconsciously and naturally and, along with a whole array of other natural skills such as joint attention, they allow us to form common beliefs and to act upon them. We are very, very good at figuring out what other people are thinking and it's this ability that allows us to operate in the complex social networks that form human society. And this is also the way we like to try and invest, as John Maynard Keynes³⁴ demonstrated back in the 1930s.

Keynes is primarily famous for being the economist who argued that in recessionary times governments should man the pumps of financial priming and push loads of cheap money into the markets. This is partly behind the idea of quantitative easing that central banks have been pursuing for the past few years. As such, Keynes' name is enough to send half the world's financial experts into apoplexy.

But when he wasn't coming up with entirely original ways of thinking about economics he was also a highly successful investor,³⁵ and one who spent a lot of time thinking about how people actually went about investing. To this end he came up with the metaphor of a newspaper beauty contest, in which the winner is the person whose choices correspond to the preferences of the competitors as a whole. So to win you need to pick the contestants you think other people will pick, not those you personally find most attractive.

By analogy with investing Keynes suggested that this was how most people go about investing: they pick the shares that they think other people will pick, rather than the ones they themselves would choose. In essence they're relying on theory of mind to figure out what stocks people will buy rather than simply relying on fundamental analysis. As theory of mind is the basis of most human social interaction we can easily imagine that it is very, very difficult to turn off, even in a world such as investing where you're more likely to be rewarded for independent thought, rather than Clever Hans-like attempts to read the minds of others.

In fact, Keynes, who started out as a beauty contest style investor, gradually adopted his style to become much more focused on fundamentals. Unsurprisingly his returns improved dramatically, as will yours, once you stop worrying about what other people are going to do.

TRUST ME, RECIPROCALLY …

A theory of mind is great for figuring out what other people are thinking but it's also very useful for another purpose—deceit. The psychologist Paul Ekman, who's the prototype for the protagonist in the TV series Lie to Me, has made a career out of analyzing liars and their filthy lying ways, which, unfortunately, tends to mean most of us. In fact, one of the theories about why we have such large brains relative to our size is that we're engaged in an escalating war of deception in which the person with the biggest brain wins. Certainly Richard Byrne and Nadia Corp³⁶ have done some convincing experiments with primates, which suggests the larger the brain and the more complex the social group the more scope there is for deception.

Unfortunately, detecting liars isn't as simple as checking out their hat size. Most of us can't figure out when someone is lying. In fact, as Ekman and Maureen O'Sullivan³⁷ have shown, most experts can't detect someone who's lying, which shouldn't really come as a surprise after everything else we've seen. Because of this, it's likely that our evolutionary response to detecting deception was to exclude the liars from the social group—a punishment that would often have been a death sentence.

However, the evolutionary benefits of deception are significant, because anything that allowed our ancestors to freeload on their peer groups was a way of ensuring survival and more breeding opportunities. If you make a daily diary and truthfully record every partial truth and piece of downright dissembling that you do you'll be astonished by how often you don't really speak the truth.

The issue of trust looms large in human social relations, and never more so than in the area of finance, where we all too often have to trust others to invest our money for us. In a world in which liars abound trust is difficult to achieve and we have evolved techniques for managing this asymmetry of information. Here's a little test.

Imagine you're playing a game with a stranger. You're given $100 and are told that you have to offer the stranger some of this money. If he accepts, he gets to keep the money you offered and you get to keep the rest. If he rejects your offer, neither of you get a penny.

How much do you offer?

Well, the standard answer in economics is that you should offer 1 cent. The reasoning is that as far as the stranger is concerned they're getting a cent for nothing, and are better off, and as far as you're concerned then you should be seeking to maximize the amount you make. And as the stranger realizes this, he should accept.

In real life, of course, as Armin Falk, Ernst Fehr, and Urs Fischbacher³⁸ discovered, when they carried out the above experiment, anyone offering one cent will probably be told to take a hike and may well get a punch on the nose in the bargain. A low-ball offer will offend the stranger's sense of fairness and they'll reject it—we expect people to demonstrate reciprocity, we are highly attuned to concepts of social justice, and will tend to rage against perceived injustice. It's likely that this sense of fairness comes out of our need to create and maintain social networks and our rejection of unfair offers is probably based on our innate reaction to being given something: we'll feel obliged to reciprocate and we calculate that what's being offered doesn't make that worthwhile.

Of course, this is a framing effect: we're deciding to reject the offer on the grounds of unfairness rather than that of an overall increase in wealth. So, startlingly, it seems that there's more to money and investment than simply becoming wealthy: we expect people to be fair in their dealings with us as well. Yet the unvarnished truth is that investing is only about making money, and when we get ourselves confused by moral and social issues the only damage we do is to our own finances.

Don't misunderstand me, I absolutely believe that we should live moral lives according to an ethical code of conduct. I believe equally as strongly that the managements of the corporations I invest in should also—I absolutely hate executives who preach one thing, do another, and then disclaim all responsibility when some underling is caught breaking the rules. Responsibility for ethical behavior starts at the top.

However, when it comes to our money we cannot afford to get confused by social biases that are irrelevant to the entirely unsocial world of stock market investment. Reciprocate all you want in the rest of your life, but when it comes to investing, stick to the point, take the low-ball offer, and move on. We're here to make money, not friends.

AKERLOF'S LEMONS

Unfortunately there are financial situations where fairness is important and you do need to be able to detect liars and charlatans. Financial advisers, lawyers, bankers, insurance salespeople—there are lots of situations in which the ability to figure out whether we can trust someone is critical. In these situations we're faced with an issue of trust due to the asymmetry of information in the marketplace: the problems of lying and reciprocity give us immediate problems when we're dealing with experts who may know more than us or may be simply very good liars and are pretending that they know more than us. This type of situation is very common, even outside of finance when we're faced with an expert who knows lots and we're like tourists abroad. Take used cars, for instance, an area renowned for being populated with charlatans and worse.

George Akerlof famously won the Nobel Prize for Economics for his work on this particular problem.³⁹ Normally we'd expect that the price of something like a used car would be set by supply and demand: the more cars on offer the lower the price, and so forth. In the case of used cars, however, this turns out not to be the case because they're all cheap regardless of availability. Supply-demand pricing works whenever we get situations where there is clear and transparent information. Unfortunately, when it comes to used cars most of us are less able to judge the actual state of a particular car than the smooth talking salesman pitching to us, and simply don't know when we're being sold a lemon. So we discount the price of all used cars and end up with what's known as a market failure—market forces simply fail to deliver clear and transparent pricing.

The overall effect on the used car market is chilling, because owners of good used cars can't get a fair price for them, and therefore the only cars on the market are lemons. This type of asymmetry in risk isn't as rare as you might think—for instance, the only older people who want health insurance tend to be the ones who know they have something wrong with them, because the price of health insurance increases rapidly with age. Of course, one of the reasons it increases rapidly with age is because only sick people want the insurance, while all the healthy people decide it's too expensive….

This particular issue is known as adverse selection, and means that those elderly people who aren't ill and simply want to protect themselves are unfairly penalized. It's actually a problem in all sorts of situations: many corporations find themselves with a similar problem of how to distinguish themselves from inferior competitors, and their solution is one based in the psychology of humans. Robert Cialdini, in his book Persuasion,⁴⁰ provides an anecdote that illustrates the principle—a gift shop owner accidentally doubled the price of some hard-to-sell items instead of putting them on a half-price sale and was amazed to find that they were all snapped up in short order. The purchasers were relying on a very simple heuristic—expensive means quality.

This type of external flag is known as a signal, which are often used by corporations to establish the unobservable quality of their goods. Amna Kirmani and Akshay Rao⁴¹ have come up with a range of such signals, but make the point that signaling only works when the gains for the high-quality firm are higher than for other strategies, while low-quality firms get a better payoff by not signaling—otherwise, the lower quality company can compete on signaling. So think of branding as a signaling mechanism—spending large amounts of money on advertising may not be about the messages supplied but the overt signal that the corporation can afford to splash out in this way.

Our use of these types of signals can reach over into investment activities. People will often buy stocks because the share price has gone up or sell them because it's gone down, a practice often labelled “momentum investing.” Whatever you call it, however, if it's being practiced simply based on the signals emanating from the share price itself it's simply stupid investing and should be avoided.

More pertinently, the issue of information asymmetries is one faced by investors every day. Managements, advisers, mutual fund managers; they all know more than we do. Although technically trading on inside information is illegal there's no doubt that it does happen, and it disadvantages the private investor. Again this is why we often see speculation about what movements in share prices mean—because although they're often random sometimes they are signaling that something is going down.

Unfortunately, share price movements unaccompanied by public disclosure of information are not safe signals upon which to base trades. We operate in a social world of murky behavior and uncertain outcomes, where our lie detecting capability often leads us astray, but we need to be clear about what information we can trust and what we can't. If you trade regularly on the signals given off by share prices you will lose money. Occasionally it will work, but don't fall for the occasional reinforcement of a bad idea. Just focus on learning how to spot the lemons in the first place—because even in a market full of them there'll still be the odd peach, if you're smart enough to find it.

THE PEACOCK'S TAIL

The idea that our mechanisms for social trust fail in certain market situations and lead us into other ways of attempting to establish the quality, or otherwise, of goods or stocks arises from an unexpected source: evolutionary biology. In particular, it comes out of some very counterintuitive analysis about the point of some of the most stupidly extravagant displays in nature. Take, for instance, the peacock's tail.

However you look at it, carrying around an enormous set of tail feathers so that you can impress the lady peacocks must carry some kind of handicap: it's a burden in every way and it's not going to help you run away or fight when a fox comes calling. So the idea is that the handicap must be worth the burden—otherwise peacocks with extravagant tails would get eaten and the rather less showy male birds would get their pick of the females. And, in the thinking of Amotz Zahavi,⁴² the handicap is itself a signal.

The idea is that the ridiculous plumage of the handsome male peacocks is actually making a statement that they're so darned fit that they can survive regardless of the handicap that nature has conferred on them. The females aren't being wooed by the display but are using it as a proxy—a signal—for overall fitness of the individual. Not only that, potential predators and competitors are making the same calculation—a bird with that amount of baggage has got to be a pretty tricky customer, so better go find a less fit one. It's a maddeningly perverse idea, but it seems to be correct.

The same idea appears to apply to corporations who use advertising for signaling purposes. Back in 1961, George Stigler⁴³ pointed out that it can be actually quite difficult for people to figure out the correct market price for things, and that advertising may be a practical way for producers to reduce consumer search costs. Richard Nelson⁴⁴ then showed that people don't just use advertising to find the best price but also to establish what he called “experience qualities.” It's not that advertising carries any useful information, it's that it is the useful information. It's a handicap and we respond to it.

The use of handicaps and advertising as a short-cut to doing any actual research is a common problem for private investors. It's far easier to latch onto some popular meme about an investing trend or some powerful signal from a well-known corporation than it is to do the hard work of analyzing stocks. The odd thing is that this trait is actually caused by our underlying mechanisms for trying to establish the truth or otherwise of information we're being presented with in situations where we really don't want to be fooled by others. And yet again we find our evolutionary mechanisms betraying us as they're exploited to trick us into deploying our money in the wrong way.

The layering of different biases on top of each other—salience, availability, social trust failures—compound the issues that we're faced with. It's not sufficient to defend ourselves against specific individual issues, but we need to arm ourselves more broadly against the world.

FACEBOOKED

If you wanted an example of a corporation that marketed itself using a gigantic plume of feathers you need look no further than Facebook, the social networking company. So spectacular was its marketing that investors were prepared to pay almost any price for the stock when it launched on the market and almost inevitably suffered short-term disappointment. It was a classic example of Keynesian beauty contest investing, and went badly wrong for a whole variety of reasons.

But Facebook itself is a prime example of another social trend, because the sheer interconnectedness of social media offers widely separated groups of people ways of interacting in near real-time, which have not been possible until now. And given our propensity for overlaying our evolutionary heritage on top of modern inventions you won't be surprised to know that this seems to be quite a dangerous thing for us to do.

As we've seen, the idea is that financial memes can spread through social networks in what one commentator has called “a sort of social epidemic.” We come with inbuilt social intelligence, ready-made for social interaction, and we'll use this every chance we get. David Hirshliefer's idea that we disproportionately prefer to discuss our triumphs over our disasters—a feature known as self-enhancing transmission bias—leads to the suggestion that the more actively interconnected we are the more we will hear about the investing successes of our peers and the more inclined we will be to become active investors.⁴⁵

When Randy Heimer and David Simon⁴⁶ investigated a Facebook-like social network this is precisely what they found. Successful short-term traders were more likely to start broadcasting their results, and the more successful they were the more likely people were to start copying them. However, because this type of investor normally tends to take significant risks and outlier positions a few of them, purely by chance, will become disproportionately successful. And this group will demonstrate disproportionate influence in a social network.

What's really interesting about this is that it suggests that more efficient forms of communication can actually lead to less efficient investing. The challenge is to separate out the lucky from the skillful and the self-aware from the high risk gambler. The next time you're inclined to follow the teachings of some networked-up guru ask them what their last complete disaster was, and what they learned from it. Investing in stocks involves a great deal of luck as well as skill. We need to distinguish the purely lucky from the genuinely skillful, because skill works for a long time and luck will always run out.

BE KIND TO AN OLD PERSON

Let's end this journey through social biases with a really odd one, our social interactions with our future selves. One of the many interesting facets of our social interconnectedness is that most of us are imbued with a sense of social responsibility. We are inclined, all things being equal, to help people in need when we can.

This doesn't always play out the way you'd want. Famously, Kitty Genovese was repeatedly attacked in New York within earshot of lots of people who could have helped her but didn't.⁴⁷ The theory was that everyone left it to someone else to do something about it, the so-called bystander effect. In fact, there's quite a lot of doubt as to what really happened, sufficient to cast doubt on the whole theory, but there's absolutely no doubt at all about what you should do if you ever find yourself in trouble in a crowd and need help: you need to focus on one person and appeal directly to them. If one person comes to your aid others will follow, but otherwise everyone may leave it to someone else.

More generally it seems that we're naturally imbued with an instinct to connect with others. There are lots of studies about the connection between happiness and money, the general idea being that buying lots of consumer goods doesn't promote any lasting improvement in general well-being but that investing in experiences does. Supplementary to this Elizabeth Dunn, Lara Aknin and Micheal Norton⁴⁸ suggest that spending money on other people makes us more happy than spending it on ourselves—and follow-up research indicates that spending that money on people with whom we have strong social ties makes us happier still.⁴⁹

Coming from a world in which social links are everything, it's not hard to imagine that this type of behavior is generally beneficial in strengthening the social bonds. So the closer we feel connected to someone the more likely we are to act on their financial behalf (and in lots of other ways too, but we'll stick to the knitting on this one). This leads to a puzzling observation—that we often fail to act in our own financial interests because we don't seem to relate very well to our future selves.

The observation comes out of the evidence that we don't save enough for our retirement—in fact, we're generally very unwilling to make short-term sacrifices for ourselves in order to reap long-term benefits.⁵⁰ In addition, we tend to procrastinate over difficult decisions and avoid making any choice at all, and as Ted O'Donoghue and Matthew Rabin have shown the more choices and the more important the decision the less likely we are to make any choice at all.⁵¹

However, a slightly different theory posits a different reason for our procrastination over retirement savings; that we simply don't feel any psychological connectedness to that strange, old person who we will become one day. Christopher Bryan and Hal Hersfield⁵² have suggested that this lack of connectedness means we don't feel any social responsibility to our future selves, which means that when we save for retirement it feels like we're giving money away—to a stranger.

Odd though this is—and it is undeniably strange—it really looks like there's something to this idea. If you appeal to someone's sense of social responsibility about their future self—if you pick yourself out in the crowd and appeal directly to yourself for help—many people respond. It's a framing issue: frame the future you as a stranger and you won't bother helping them, frame them as a friend and you just might. And, to be honest, we'd all be better off helping an old person, especially when that old person is ourselves.

THE SEVEN KEY TAKEAWAYS

This chapter has introduced how social interaction is a critical and unconscious influencer of our investment decisions. We are hopelessly embedded in an intricate network of social relationships; we are social creatures by definition, and we can't avoid the impact of this, however undesirable it might be. Mostly it's not desirable at all, but when we are investing sometimes it pays to be a little self-absorbed.

To finish, let's draw together a few key ideas from this chapter before we move on. The main takeaways are:

1. We take our cues from other people. We like to conform. Never stop asking awkward questions—and if the other people don't like it, then tough.
2. Beware of investment groups, they'll tend to experience a risky shift due to group polarization. Use them by all means, but don't be afraid of being the one opposing the group's preferred view. You'll be doing everyone else a favor as well as yourself.
3. Framing is something we all do, unconsciously. We need to make a specific effort to frame our portfolios widely and to avoid unnecessary mental accounts. It's one big pool of capital, treat it all with equal respect.
4. Basing our investing decisions on second-guessing what other people would like—Keynes' beauty contest style of investing—is very common and not very successful. Keynes himself lost lots of money this way and learned this lesson the hard way: make it easier on yourself.
5. Our normal ways of detecting honesty and cheats and distinguishing between them won't always work in the world of finance. We can't rely on signals for fitness because they are deliberately contrived, not an evolutionary statement. Getting confused between the two can be very expensive.
6. Social interactions can lead us into behavior that seems sensible but leads to negative results. Comparing our decisions to those of others, and relying on the positive spin from other people about their successes, can lead us into profoundly dangerous investments.
7. Try to relate to yourself as an older person, to perceive your future self as a friend you need to try to support. The better you can relate to the future you the more you're likely to take care of your investing needs.

Social biases brings us to the end of our brief trawl through the Outer Limits of psychological bias in investment. Mostly you'll have picked up the idea that we're all somewhat open to unexpected influences, but you may not have recognized that this is a general problem. The normal solution to this kind of difficulty is to call in the experts, but as we are about to see, that isn't as much of a solution as you might hope.

NOTES

  1. Solomon E. Asch, “Effects of Group Pressure upon the Modification and Distortion of Judgments,” Groups, Leadership, and Men, S (1951): 222–236.

  2. Irving L. Janis, Victims of Groupthink: A Psychological Study of Foreign-Policy Decisions and Fiascoes (Boston: Houghton-Mifflin, 1972).

  3. Richard P. Feynman, “Personal Observations on the Reliability of the Shuttle,” Report of the Presidential Commission on the Space Shuttle Challenger Accident 2 (1986): 1–5.

  4. Claire Ferraris and Rodney Carveth, “NASA and the Columbia Disaster: Decision-Making by Groupthink?” Proceedings of the 2003 Association for Business Communication Annual Convention (2003).

  5. Roland Bénabou, “Groupthink: Collective Delusions in Organizations and Markets,” The Review of Economic Studies 80, no. 2 (2013): 429–462.

  6. Benedictus de Spinoza, The Ethics and Selected Letters, ed. Seymour Feldman, tr. Samuel Shirley (Indianapolis: Hackett, 1982).

  7. Daniel T. Gilbert, Romin W. Tafarodi, and Patrick S. Malone, “You Can't Not Believe Everything You Read,” Journal of Personality and Social Psychology 65, no. 2 (1993): 221.

  8. James Arthur Finch Stoner, “A Comparison of Individual and Group Decisions Involving Risk” (diss., Massachusetts Institute of Technology, 1961).

  9. Cass R. Sunstein, “Deliberative Trouble? Why Groups Go to Extremes,” Yale Law Journal 110, no. 1 (2000): 71–119.

10. Stephen P. Utkus, “Market Bubbles and Investor Psychology,” Vanguard Research, Vanguard (2011).

11. Eli Pariser, The Filter Bubble: What the Internet Is Hiding from You (London: Penguin, 2011).

12. George A. Akerlof and Rachel E. Kranton, “Identity and the Economics of Organizations.” Journal of Economic Perspectives 19, no. 1 (2005): 9–32.

13. Canice Prendergast, “The Provision of Incentives in Firms,” Journal of Economic Literature 37, no. 1 (1999): 7–63.

14. Dan Ariely, Predictably Irrational: The Hidden Forces That Shape Our Decisions, revised and expanded edition (New York: HarperCollins, 2009).

15. Daniel Bergstresser and Thomas Philippon, “CEO Incentives and Earnings Management,” Journal of Financial Economics 80, no. 3 (2006): 511–529.

16. Erving Goffman, The Presentation of Self in Everyday Life (New York: Anchor, 1959).

17. George Lakoff and Mark Johnson, Metaphors We Live By (University of Chicago Press, 2008).

18. http://georgelakoff.com/2011/12/11/how-to-frame-yourself-a-framing-memo-for-occupy-wall-street/.

19. Amos Tversky and Daniel Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211, no. 4481 (1981): 453–458.

20. Alok Kumar and Sonya Seongyeon Lim, “How Do Decision Frames Influence the Stock Investment Choices of Individual Investors?” Management Science 54, no. 6 (2008): 1052–1064.

21. Meir Statman, “Lottery Players/Stock Traders,” Financial Analysts Journal 58 (2002): 14–21.

22. Harry Markowitz, “The Utility of Wealth,” Journal of Political Economy 60, no. 2 (1952): 151–158.

23. Hersh Shefrin and Meir Statman. “Behavioral Portfolio Theory,” Journal of Financial and Quantitative Analysis 35, no. 2 (2000): 127–151.

24. Ibid.

25. Shinichi Hirota and Shyam Sunder, “Price Bubbles sans Dividend Anchors: Evidence from Laboratory Stock Markets,” Journal of Economic dynamics and Control 31, no. 6 (2007): 1875–1909.

26. Dan P. McAdams, “What Do We Know when We Know a Person?,” Journal of Personality 63, no. 3 (1995): 365–396.

27. Richard Dawkins, The Selfish Gene (New York: Oxford University Press, 2006).

28. Robert J. Shiller, “Low Interest Rates and High Asset Prices: An Interpretation in Terms of Changing Popular Economic Models,” NBER Working Paper No. 13558. National Bureau of Economic Research, 2007.

29. Mark Granovetter, “Economic Action and Social Structure: The Problem of Embeddedness,” American Journal of Sociology (1985): 481–510.

30. Daniel Beunza and David Stark, “Models, Reflexivity and Systemic Risk: A Critique of Behavioral Finance.” Available at SSRN 1285054 (2010).

31. Ibid.

32. Simon Baron-Cohen, Mindblindness: An Essay on Autism and Theory of Mind (Cambridge, MA: MIT Press, 1997).

33. Oskar Pfungst, Clever Hans(the Horse of Mr. Von Osten): A Contribution to Experimental Animal and Human Psychology (New York: Holt, 1911).

34. John Maynard Keynes, The General Theory of Employment, Interest, and Money (New Delhi: Atlantic Books, 2006).

35. David Chambers and Elroy Dimson, “Keynes the Stock Market Investor.” Available at SSRN 2023011 (2012).

36. Richard W. Byrne and Nadia Corp, “Neocortex Size Predicts Deception Rate in Primates.” Proceedings: Biological Sciences (2004): 1693–1699.

37. Paul Ekman and Maureen O'Sullivan, “Who Can Catch a Liar?” American Psychologist 46, no. 9 (1991): 913.

38. Armin Falk, Ernst Fehr, and Urs Fischbacher. “On the Nature of Fair Behavior,”Economic Inquiry 41, no. 1 (2003): 20–26.

39. George A. Akerlof, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism,” Quarterly Journal of Economics 84 (1970): 488–500.

40. Robert B. Cialdini, Robert Influence: The New Psychology of Modern Persuasion (New York: Morrow, 1984).

41. Amna Kirmani and Akshay R. Rao, “No Pain, No Gain: A Critical Review of the Literature on Signaling Unobservable Product Quality,” Journal of Marketing (2000): 66–79.

42. Amotz Zahavi, “Mate Selection—A Selection for a Handicap.” Journal of Theoretical Biology 53, no. 1 (1975): 205–214.

43. George J. Stigler, “The Economics of Information,” Journal of Political Economy 69, no. 3 (1961): 213–225.

44. Phillip Nelson, “Advertising as Information,” Journal of Political Economy 82, no. 4 (1974): 729–754.

45. David Hirshleifer, “Self-Enhancing Transmission Bias and Active Investing” (unpublished working paper, 2010).

46. David Simon, and Rawley Heimer. “Facebook Finance: How Social Interaction Propagates Active Investing,” AFA 2013 San Diego Meetings Paper (2012).

47. Rachel Manning, Racel, Mark Levine, and Alan Collins, “The Kitty Genovese Murder and the Social Psychology of Helping: The Parable of the 38 Witnesses,” American Psychologist 62, no. 6 (2007): 555–562.

48. Elizabeth W. Dunn, Lara B. Aknin, and Michael I. Norton, “Spending Money on Others Promotes Happiness,” Science 319, no. 5870 (2008): 1687–1688.

49. Lara B. Aknin, et al., “It's the Recipient That Counts: Spending Money on Strong Social Ties Leads to Greater Happiness than Spending on Weak Social Ties,” PloS ONE 6, no. 2 (2011): e17018.

50. Shane Frederick, George Loewenstein, and Ted O'Donoghue. “Time Discounting and Time Preference: A Critical Review,” Journal of Economic Literature 40, no. 2 (2002): 351–401.

51. Ted O'Donoghue and Matthew Rabin, “Choice and Procrastination,” Quarterly Journal of Economics 116, no. 1 (2001): 121–160.

52. Christopher J. Bryan and Hal E. Hershfield, “You Owe It to Yourself: Boosting Retirement Saving with a Responsibility-Based Appeal,” Journal of Experimental Psychology: General 141, no. 3 (2012): 429.