The Lollapalooza effect
It refers to the fact that many biases intertwine and thus multiply the simple sum of the initial biases. These inherent tendencies can influence our behavior both ways. Although the Lollapalooza effect is often portrayed in a bad light, it can have both positive and negative consequences. This cumulative effect amplifies the basic emotional response and sometimes leads investors to make poor portfolio decisions.
But getting rid of our judgments is not easy because they help us simplify our decisions. It is a particularly powerful engine of human behavior. Charlie Munger often mentions it in his speeches. Let’s see how this effect works and how to avoid it to make better investment decisions.
1 + 1 = 11
The formula is quite clear. The Lollapalooza effect expresses the fact that compound returns also exist in terms of cognitive biases. Adding these biases together is like multiplying the resulting behavioral influence. Kind of like stacking cubes.
If we add a cube in width, one in height and one in depth, we do not obtain four cubes (an addition) but eight cubes (the double). The same happens with prejudices and stereotypes when combined.
The sustainable competitive advantage of a company can be built on the Lollapalooza effect
Charlie Munger cited The Coca-Cola Company’s global dominance in the soft drink market in 1996 as the perfect example of the Lollapalooza effect applied to a business. The ease with which Coca-Cola is now available in most stores (network effect), its advantage in terms of production costs (scale effect), its strong brand synonymous with happiness to be shared (brand effect, bias availability), the social influence that stems from her well-oiled communication, and the fact that she has a large number of clients (social proof) or the famous secret recipe (which is not really a secret, but it creates a sense of superior quality and scarcity) have combined to create a real divide (translating into sustainable competitive advantage) for Coca-Cola. Together, these effects increase the company’s competitive bulwark and even create a virtuous circle that is self-reinforcing. This makes it virtually impossible for a new entrant to the soft drink market to replace Cola-Cola, even with tens of billions of dollars in their pockets.
This is a Lollapalooza effect applied to an economic model. But this effect also affects investors in their day-to-day decisions.
The Lollapalooza effect can be applied to investing, causing millions of investors to buy one industry, sell another, or act like real sheep. In this environment, several cognitive biases converge, leading investors to act in a stupid way and sometimes even contrary to their initial will, if they were alone and independent.
This psychological phenomenon known as “social proof” causes people to mimic the actions of others in order to reflect seemingly appropriate behavior. Social proof is one way to deal with uncertainty. When we are in doubt, we often make decisions by imitating what others are doing. For example, during a stock market panic, investors want to sell their assets at any price, not because they think company fundamentals have deteriorated or their stocks are overvalued, but because they concluded that other investors could also sell at the current price.
This herd mentality is any investor’s worst enemy. Blending into conformism leads to mediocrity. After all, if you are selling while everyone else is selling, you are likely to suffer a huge loss. If you do the opposite and buy when everyone else is selling, you are likely to get good prices for your stocks. So, before making an investment, it is wise to think about the various psychological factors that can cause an irrational reaction in the market.
Too much information kills information
Information has never been so widely disseminated through the media and easily accessible by the population. With a single click, we can find out what’s going on halfway around the world. However, this perpetual flow of data, reinforced by the presence of streaming news channels and social networks, obscures our minds and can even make us impulsive in our decision-making.
First, this FOMO (Fear of Missing Out) prompts us to devour the debilitating continuous flow. This disorderly overflow blurs the meaning of events and deprives them of perspective.
Second, this instantaneous media acts as an echo chamber. When we speak, the chamber echoes back to us exactly what we said. Algorithms (Youtube and Facebook to name a few) favor content that matches our preferences. Google always has a search result that matches our beliefs. And our confirmation bias is taking over. We consume content that we like, with which we are “comfortable”, because it reassures us in our choices. That’s why it’s so hard to change your mind.
Faced with this flood of information and prejudices that are reinforced by confirmation, it is better to sit down and think. Reduce the flow that reaches us, focus on feature articles, compare different opinions, analyze the consequences of the most important events, those which are long term and may impact our investments.
The more articles (or shows) you read about current affairs (especially alarmists), and the more you look at your portfolio and the daily movements of your stocks, the more you will be tempted to place frequent trades.
The Lollapalooza effect has been responsible for the success of large companies as well as the most irrational crowds in the markets.
Faced with our biases and prejudices, it might be wise to accept that we don’t know, not everything, not all the time. Charlie Munger said that “knowing what you don’t know is often much more useful than being brilliant.”
Be aware of your cognitive biases, the limits of your area of knowledge, the influence that others have on you. Relativize your assumptions, define several investment scenarios, weigh the risk / reward ratio of each position and think for yourself.
Even if “it is as difficult to see yourself as it is to look back without looking back” (Henry David Thoreau), taking the time to analyze your behavior and your emotions in the face of events that happen to us is already taking care of yourself. better decisions.
I would like to end by quoting Friedrich Nietzsche: “You still have to carry chaos within yourself to be able to give birth to a dancing star. […]. In a humanity as advanced as ours, every man by nature has access to many talents. Everyone has an innate talent, but few have the tenacity, endurance and energy to become a talent, that is, to become who they are. “
Our prejudices are our chaos. Our willingness to overcome them is the key to making better investment decisions. Learning a little more about day-to-day market behavior also means learning a little more about your psychology and developing, and even overcoming, self-control.