Bad influence

There was a lot of noise on social media over the past few days after a crypto platform recommended by some influencers suspended withdrawals. I don’t want to delve into the issue, a lot has already been said and written publicly. But the whole episode highlights just how influential these influencers have become.    

Monkey see, monkey do

At first thought, it might sound surprising that people invest serious money based on the opinions of random people just because they are famous or have a large following on social media. But if you think about it for a second, we do this all the time. As much as we like to believe that we make rational decisions based on careful consideration of all the available information, that’s not true. If the last 4-5 decades of behavioral science have shown us anything, it’s that we are far more irrational than we like to admit. In fact, if we knew the real reasons behind your decisions, we’d be embarrassed half the time. 

Think about this for a minute. Do you think the choice of the music people listen to can impact the stock market performance? The question itself sounds downright stupid. But as it turns out, the type of music we listen to is indeed correlated to stock market performance and also mutual flows. In a study, Adrian Fernandez-Perez and Ivan Indriawan found that when people in a given country listened to positive music, the markets in that country had positive gains and mutual fund flows. Consider this case. Do you think the color in which financial information is presented impacts how you invest? Again, as silly as it sounds, there’s evidence that the color in which numbers are shown can influence how you invest. Bazley et al. found that when people saw losses in red compared to black took significantly lesser risks. Similarly, people who view historical stock data in red compared to black expected considerably lower returns in the future.

I get that these things sound ridiculous, but as much as we’d like to think that we do something because we want to, that’s another lie we tell ourselves. Every decision we make is influenced by our surroundings, our peers, what we eat, culture, social norms, etc. The word “influence” can often have a negative connotation, but we’re constantly influenced. Every time you ask a friend about a restaurant or rely on reviews to buy something or ask others for career advice, you are getting influenced, but probably in a positive way. 

It’s the same with money. Other people disproportionately shape our attitudes and beliefs about money. One big reason why most Indians invest in fixed deposits and gold is because that’s what their parents and friends do—social conformity.   

We’re also hardwired to avoid regret when making decisions. One way we try to minimize regret is to look for safety in numbers or follow the herd. There was a hilarious, yet brilliant experiment on the show Brain Games by National Geographic. There’s a waiting room filled with actors who are all in on the act except one woman. The actors are told in advance to stand up whenever there’s a beep in the room, and they start doing that. At first, the woman is puzzled and has no idea what’s happening and doesn’t get up. But after a few beeps, she starts following the other actors, even though she has no idea why. She continues standing up, even after the actors leave the room. She continues to stand up at every beep even when new people who aren’t clued in enter the room. Soon, the new people in the room start following her. This is a beautiful demonstration of the power of social settings and norms on our behavior. 

The human brain might be a small part of the body, but it consumes 20% of the energy and it’s hardwired to conserve energy. One way the brain conserves energy is to take as many mental shortcuts as possible. This is why we make decisions on what we remember last, ignore our own biases, avoid negative information, and anchor to some number or information when making decisions, among other things. Another such shortcut is automatically assuming that someone who speaks about investing confidently knows something. 

Sitting and learning about investing is hard, and our brains naturally push us to take shortcuts. Listening to “influencers” that your brain thinks they know something is one such shortcut. So when we see people on YouTube and if we think that they know something, we are more likely to follow their advice without thinking twice. There’s also a subtle element of blame avoidance at play. People typically don’t like taking responsibility for their actions and prefer being told what to do. The fact that they can always blame an “expert” or an “influencer” if things go wrong makes acting on their recommendations easy. 

Perhaps, the other issue with investing, especially for younger investors, is that it feels intimidating at first. They aren’t wrong. The investment industry is notorious for making things complicated. This is one reason we have about ~3.5 crore unique investors in India. I was talking to a few 22-23-year-old kids who had started investing early. They said that they learned about investing basics by following influencers because there weren’t good sources that make finance easy for young people like them. They also said it was pretty much the same across most Gen Z kids. There’s anecdotal evidence. Here’s a stunning statistic from a survey by the Australian Securities and Investments Commission (ASIC): 

In 2021, the ASIC young people and money survey found that 33% of 18-21 year olds follow at least one financial influencer on social media. The survey found a further 64% of young people reported changing at least one of their financial behaviours as a result of following a financial influencer.

Nothing new

Influencers in finance are nothing new. Long before social media influencers, the stock tipsters on business news channels were the original influencers. Before the tipsters, star investors and fund managers like Ray Dalio, Warren Buffett, Prashant Jain, etc were influencers of a different kind. In the ’70s and 80s, there were 100s of influential stock newsletters on Wall Street, and the writers were the influencers of that era.  

Over the last century, radio, TV, outdoor, and magazines were largely the go-to mediums for advertising. Brands piggybacked on the star power and credibility of movie stars and other well-known personalities. But with the internet, things changed and this also coincided with a generational change in attitudes. The younger generations no longer found movie stars authentic. At the same time, thanks to platforms like YouTube, Instagram, and TikTok, anyone could broadcast their thoughts to the entire world.  Suddenly, you had millions of micro-influencers with small but loyal followings. As more people interacted with these influencers, the more they started trusting them—the pandemic lockdowns supercharged this trend. With people being cooped up at home, they had extra time on their hands, and when they turned to YouTube for tips, advice, or just to pass the time, they found these influencers, and the trend just exploded.

There’s also another behavioral explanation for why people trust influencers. In 1956 Donald Horton and Richard Wohl coined the term “parasocial relationships” to describe the tendency of people to develop feelings of friendship and intimacy toward media personalities. When people follow celebrities and other well-known people for a long time, over a period of time they start considering them as friends and trust what they say. This is the long-winded explanation to the question: how the hell can people invest based on the recommendations of random people? 

Selling snake oil

With a large following comes great responsibility. For every sensible influencer, ten others are spreading dangerous nonsense. These influencers have monetized their followings to promote various financial products and services. There’s nothing wrong with that as long as the risks and commercial arrangements are disclosed transparently with generous usage of common sense. But what’s happening today is that many of these influencers will say anything and promote anything to make a quick buck. This isn’t just crypto, this is across stocks, F&O, insurance, etc. There are countless channels whose sole purpose is to induce people to trade even more. 

Over the last few years, I’ve lost count of the stories of people losing money in stocks, F&O, and crypto by blindly following these people. It’s so easy to start a YouTube channel and start giving financial advice without having to be a Research Analyst (RA) or a Registered Investment Adviser (RIA). Since there are no regulations governing finance influencers or influencers, they can get away with anything. No wonder the Australian Securities and Investments Commission (ASIC) threatened a jail term of 5 years for Australian influencers promoting financial products or giving advice without a license.

It’s very easy to say that greed is why people lose money listening to these influencers. Of course, that’s true. If some loudmouth claims a risk-free way to make 20%, some people are bound to fall for it. But on the other hand, there’s also the fact that schools and colleges don’t teach basic financial concepts. So when people reach a stage in life where they can start saving, they’ll start Googling how to save and invest, and they’ll find these people. 

Let me be clear once again, I am not saying all influencers are bad. There are perfectly sensible people doing a commendable job in promoting financial literacy. We need thousands of such people if the market participation has to grow. But at the same time, there are some moral and ethical lines that you just don’t cross. I hope SEBI brings in some regulations soon to change this. 

The more things change, the more they remain the same

What surprises me with these episodes is just how unoriginal all this is. Investing has to be the only activity where a new generation keeps learning the same old lessons over and over again. When has trading and investing based on random tips and advice ever worked well? Thousands of Ponzi’s, pump and dumps, and greed-driven investment fiascos, and people still keep making the same old mistakes. 

It reminds me of a wonderful quote from Jim O’Shaughnessy: 

Arbitraging human nature is the last sustainable edge. 

Keepsakes

1. Taking investing and trading advice from random people is a recipe for disaster. “Shortcuts usually grease the rails to disappointing outcomes.” John Neff
2. As someone once said, all of the investing can essentially be boiled down to spending less, saving more, having a diversified portfolio, and not doing anything silly. But yet, people continue to search for get-rich schemes when there are none. If something is too good to be true, it almost always is. If someone is promoting ridiculous claims and get-rich schemes, run. 
3. The only way you can avoid following the wrong advice is to have an understanding of the basics of personal finance. 
4. Learning about investing need not be a nightmare. Once you get the basics right, you can figure things out for yourself. We’ve even created short videos about investing on Varsity.
5. I get that figuring out how to save, what stock or fund to invest in, and what insurance policy to buy can be super scary, but it need not be. Here’s a quick personal finance guide if you are about to save and invest for the first time. If you just stuck to this guide and avoided listening to random loudmouths, you’d be better than 80% of other investors.   

From our conversations with investors, one thing most of them struggle with is insurance. This is something we’ve been thinking about for a long time and We’ve partnered with ditto to make insurance simple and transparent for Indians. We are working on integrating insurance on Coin, but in the meanwhile, if you need help, you can request a call here.