Isaac Newton was a genius. Yet, even revolutionary thinkers make stupid mistakes. They are human after all. Just like you.
Newton came up with the laws of gravity, calculus, and enhanced our understanding of light, but he also invested in something called the South Sea Company. At the time, England was facing a huge public debt, and didn’t have much money to even pay its army. So in order to take care of this problem, some individuals came up with incredibly “creative” solutions.
One of these was the setting up of the South Sea Company, which among other things would consolidate the government debt. In order to help with its mission, it was granted a monopoly on trade with the “South Seas”, aka South America.
The problem with this act of the London government was the fact the continent was controlled by Spain and Portugal. Turns out, the company didn’t really do much trading with its supposed monopoly area.
Instead, the company turned into a get rich quick scheme. Hype around the firm grew to epic proportions, and investors quickly piled in. The stock price skyrocketed. As the price got higher and higher, more and more people started to jump in on the bandwagon. One of these was the famed scientist, Isaac Newton.
According to historical sources, he lost a lot of money on the scheme. In fact, there is a quote attributed to him that says: “I can calculate the motions of the heavenly bodies, but not the madness of people.” Even now in the 21st Century, the British government is still repaying the debts it racked up in that era. That’s 300 years later!
How to explain the madness of the crowds, and your own
In 1995, billionaire investor and Warren Buffett sidekick Charlie Munger made a speech at Harvard. In it, he listed a number of ways the mind can fail when taking a decision. It was a brilliant analysis of human misjudgment.
Twelve years later, the Financial Crisis of 2007–2008 exposed these mental failures for everyone to see. It was evident that the classic image of people being rational maximizers of self-interest doesn’t really conform to reality. Instead, the economic meltdown showed how irrational humans can be.
Decision-making is usually not really an objective analysis of the evidence. People fall for cognitive biases. Charlie Munger observed that the outcome that arises is the result of not just one, but several of these psychological tendencies working at the same time. He called it the Lollapalooza effect.
This happens when several different biases combine to sway a person to pursue a particular course of action. For example, you might have some preconceived notions about a subject. Then you find a story that confirms this. Your brain acts in a way to only pay attention to the evidence that you like, and discards all the rest.
In his speech at Harvard, Charlie Munger listed several tendencies that often lead to human misjudgment. These include behavior based on misplaced incentives, liking and loving a certain person or thing, or a tendency to avoid doubt.
One powerful factor is what he calls “social proof”, or imitating the things that other people around you are doing. When you add one or several of these tendencies to your inherent biases, then you are in for a bad ride.
“Social-Proof Tendency is about as strong a factor as one could imagine. “Monkey-see, monkey-do” is the old phrase that reminds one of how strongly John will often wish to do something, or have something, just because Joe does or has it.” — Charlie Munger
When things like lazy assumptions, confirmation bias, and social proof combine, your brain can turn into a mush as Charlie likes to say. The resulting negative effect is greatly amplified in comparison to what it would have been otherwise.
Let’s illustrate this with a nice little math equation. In normal circumstances, the result of 1+1 would have been 2. However, when the Lollapalooza effect comes into play, 1+1 = 11 or even 33. With multiple biases in action, things don’t happen in a linear fashion. Instead, it’s exponential.
You can enter into vicious circles, which pile on top of each other. This is the reason why otherwise smart people like Isaac Newton can make really dumb decisions. The Lollapalooza effect also explains why little initial misjudgments or assumptions can turn into disastrous consequences.
What to keep in mind
The definition that Charlie Munger gives of the Lollapalooza effect is:
“Confluence of psychological tendencies in favor of a particular outcome.”
The keyword here is confluence. Several mental biases come together to strongly steer your mind towards a particular course of action. One of these biases alone wouldn’t be able to do that, but a combination of them will have an effect greater than the sum of its parts.
Lollapalooza effect is behind some of the worst disasters in history, but it is also the reason for many of your own personal calamities. So the question arises. What do you need to do to stay ahead of the curve?
Here are some tips:
- Always be aware of the initial assumptions you are making.
- Before making a decision, go through a mental checklist of the potential cognitive biases that might be swaying your decision.
- Don’t follow the crowds, but instead think for yourself.
- Don’t make decisions while angry.
- Keep in mind that there are a lot of things you don’t know.
“Knowing what you don’t know is more useful than being brilliant.” — Charlie Munger
An earlier version of this article was originally published on “Medium” here.