Investors: Beware of the HerdSubmitted by Compass Wealth Management LLC on July 20th, 2015
If you’ve ever seen it, it’s one of those things you’ll never forget – the mass migration of hundreds of thousands of wildebeest moving across the plains of Africa in search of a fresh feeding area. It’s magnificent to watch. Of course, we know why mammals herd together – it’s because there’s safety in numbers. If a wildebeest traipses off by itself, it is more likely to be picked off by a predator. But, when traveling with thousands of its mates, there’s less of a chance that will happen. But, what works well for the wildebeest doesn’t necessarily work well for humans. True, there still may be safety in numbers, but have you ever seen a herd stampeded off a cliff? Unfortunately, that what happens to investors when they join the herd.
Humans naturally want to belong to a community – a group of people with shared cultured and socio-economic norms. But, in doing so, we still prize our individuality and sense of responsibility for our own welfare. Why is it that, in investing, humans are induced into following the herd – whether it is at the top of a market rally or over the cliff in a market crash? The answer may lie in the natural human tendency to fear being left alone; or perhaps the fear of missing out; or it could just come down to the raw, but very powerful, emotions of fear, greed and envy that drive people to irrational states of mind.
Human Herds and Market Bubbles
All of the more infamous bubbles, going back Tulipmania in 1637 on through to the Tech Bubble of 1999 and, more recently the housing bubble and subsequent market crash of 2008, arose from a herd mentality that started as a “buzz” and quickly escalated into a race to the top as asset prices spiked. In each case, investors were drawn into price movements without regard to the asset’s intrinsic value. And, as the paper net worth of friends, neighbors and colleagues continued to grow, greed ultimately trumped fear and investors leveraged up in order to capitalize on a “once in a lifetime” opportunity. And, along the way, dealers, salespeople, stockbrokers and mortgage brokers drove the frenzy without concern for the inherent risk of the investments. Such are the lessons of bubbles past and present, and while the world has most definitely changed in the five centuries of bubbles, it seem as though human nature hasn’t.
Stay Away from the Herd
Herd behavior may seem natural, even rational for humans. But, generally speaking, it has the potential to be disastrous for the herd. While we are all meant to be a part of a community, being a part of a herd can actually hold us back, or, as in the case of the “bubble” drive us over a cliff. Herds are slow to respond in crises, but when they do it’s often in the form of a panic.
It’s natural to feel isolated and vulnerable when you see the masses moving off into different direction leaving you to your own doubts about the validity of your direction. Would you feel any different if you knew they were heading towards a cliff in the dark of night? While that is not necessarily a certainty, it can be said that an overreliance on the hyperbolic media, the latest trends and market performance can lull investors into a blinding complacency that will impede their ability to change direction before they reach the edge.
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