Monday, October 22, 2007

The Asch Conformity Experiment, the Milgram Obedience Studies and value investing

Have you heard of this world famous experiments? They're featured in every Sociology 101 textbook. The first experiment deals with the powerful influence of group pressure. Solomon Asch presented showed a group of five students the following figures. Next, he asked a simple question. Which line(A,B,or C) on the right is equal to line S on the left? How could anyone fail this test? After all, the line lengths are clear and unambiguous.
Unknown to the fifth student, the first four students were in league with the Asch. They purposely gave wrong answers. Asch wanted to see, if their wrong answers would influence the fifth student. Well, it did. In 33% of the cases, the fifth student gave the wrong answer at least half of the time. 40% gave "some" wrong answers. Only 25% of the students consistently gave the correct answer.
The Milgram Obedience Studies deal with the tension between authority and conscience. In this series of experiments, test subjects were told that they would act as a teacher and present test questions to another person who was a student. Whenever the person, gave a wrong answer they were to administer an electric shock, one that would increase by 15 volts with each successive wrong answer. As was the case in the Asch Conformity Experiment, the test was simple.
The shock machine bore clearly visible labels that said Slight Shock, Moderate Shock, Strong Shock, Very Strong Shock, Intense Shock, Extreme Intensity Shock, Danger: Severe Shock, and finally, XXX at 450 volts. As the voltage rose, the "student" responded with squirming, groans, and then screams. If the subject wanted to quit, he would be told to continue with the experiment. As was the case with the Asch Conformity Experiment, the test was rigged; the "student" was working with Dr. Milgram.
Before conducting the experiment, Milgram asked psychiatrists, psychologist, philosophers, and sociologists how many subjects they thought would go to 450 bolts. The experts said about one in a thousand. What did Milgram find? He found that 65% of subjects were willing to administer a lethal shock. He later repeated this experiment several times, changing the venue from a science lab to a dingy basement so as to counteract the tendency of some people to defer to a scientist conducting a scientific study. Still, about one half of the subjects were willing to administer a lethal shock. He tried the experiment with women as the teachers. In subsequent experiments, he found that class, race, and ethnicity made no difference.
So how does this relate to value investing? One should be leery of following the herd. How many times have you bought a stock because of a tip, or an article in Forbes, or because some "guru" likes it. There's nothing wrong with taking advice from sources that you respect and trust. You just have to make sure that you're making the decision based on your situation, your financial goals, your risk tolerance, the investment approach that works best for you. The financial press(I am guilty of this as well) is very fond of setting up someone as an unimpeachable authority and then claiming their endorsement. Please remember to do your own due diligence, no matter how trusted the source is. If you lose money, and you will if you invest long enough, let it be by your own actions at least.

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