Fear of Missing Out: Investment Herd Mentality
In many ways, human beings are herd animals. In judgement and in opinion-forming, we tend to conform to the norm—as defined by the herd around us. But as an individual investor you need to be wary of the dangers of investment herd mentality and not let it influence your investment strategy: what is herd mentality, how can you identify it, and how can you avoid it?
What is Herd Mentality for Investors?
Herd mentality in investing is investors’ tendency to follow and copy what others are doing. This is most often a result of performance “peer pressure” and wanting to take advantage of hot investment opportunities without understanding the investments themselves but rather relying on information spread by the herd—information that is often unreliable or inaccurate.
Extreme market fluctuations are often a result of herd-created volatility. One prime example of herd investing could be seen in the London stock market after the UK’s vote to leave the EU.
On Friday June 24, 2016 (the day after the Brexit referendum results became clear), investors in London couldn’t unload their stocks fast enough. On Monday, the sell-off continued and the British market (as measured by the FTSE 100 index) had fallen almost 6% in just two business days. Then what happened? When British investors realized that their world hadn’t collapsed, they poured back into the market, pushing it up 9.1% in the following week. Clearly, by standing firm, an investor who did not follow the herd would have gained more than 3% in just over a week.
Responding to herds, more often than not, is not investing, but speculation—a high-risk activity with returns that could be anywhere on the wide spectrum of gains and losses.
The Wisdom of Crowds?
Herding is what happens when we follow the crowd, and we follow the crowd because we are afraid of missing opportunities. It is hard for most people to resist the lure of a crowd. In a herding environment, the typical buyer’s decision is influenced by the actions of the investing crowd—led by the populous voice and the media. If everybody else is investing in a particular stock, then the tendency to do the same increases.
A sure indication that herd mentality has motivated investors is when they proclaim that traditional investment research procedures and modelling no longer apply to their investment decisions—but they are unable to justify those decisions with hard data. History has repeatedly shown what happens when today’s hot stock becomes tomorrow’s bubble. It is almost always the case that most people invest just before the bubble bursts.
The tech-bubble of the late-1990s was like a bursting balloon. An investment bubble is like a balloon that becomes increasingly filled with hot air (unsupported investment claims) until it bursts, and its shattered remnants float back to earth along with all the investors’ unrealized gains—not to mention their self-esteem. In 1996, everybody you asked owned Bre-X; today, you would be hard-pressed to find anybody who would admit to having been a Bre-X shareholder.
Many boom-and-bust cycles are alike. Over-exuberance causes investors to ignore the true value of an investment and buy it at an inflated price because they adopt a herd mentality. As Warren Buffett said, “If everyone is thinking alike, then somebody isn’t thinking.”
Leaders of the Pack
Stop to consider who is at the front of the herd. What may have been initiated as a justifiable and profitable investment driven by the fundamental research of professional institutional investors can quickly result in hype, as early gains focus research and media attention on the investment. At this point herding may develop, but before you jump in you need to consider who is already at the front of the herd—and where they are going next.
As recently as the 1960s, not more than 10% of stock market investments were made by what were then considered institutional investors with the other 90% conducted by individuals. Today, well over 90% of trading is done by institutional investors. Since the 1960s, what has happened to these “professionals”? They have obtained more and more specialized education and experience, and they are able to utilize the latest technology and investment algorithms. As an individual investor, how can you avoid being at the back of the herd, grazing on leftovers, as these professionals lead the pack?
Don’t Let Herd Mentality Lead Your Investment Strategy
Fighting against the herding response isn’t always easy but separating from the group is often necessary. Warren Buffett also said, “Be fearful when others are greedy and be greedy when others are fearful.”
5 Disciplines to Keep You Out of The Herd
Understanding the herd mentality will keep you from chasing investment bubbles and my even help you develop a sound strategy to profit from the herd. Five disciplines to keep you out of the herd are:
- Be contrarian at times: because herding behaviour almost always reverses itself, you may be positioned to benefit from the reversal.
- Understand your decision making: invest based on your own knowledge and research.
- Be disciplined: don’t be distracted by the crowd noise and media.
- Be a leader: have the confidence and conviction to stick to your own decision, even if it goes against the crowd.
- Remain focused: don’t let the crowd sway you from your long-term investment strategy. Only make adjustments as your own research supports them.
Prudence and patience is key. You must be aware of the pitfalls that can erase all of your diligent investing efforts as well as the wealth that you’ve accumulated. By examining why herd investing takes place and avoiding it by sticking to your long-term strategy, you will be in a much better position to avoid herd-created investment marketbubbles.
Invest Long-Term and Let the Herd Pass You By
There is a saying: “Don’t just do something, Stand there.” When you observe the mainstream pouring into an investment, and you cannot independently see any fundamental reason justifying your participation, then stand aside and let the herd pass you by. As with the “Brexit Vote” example mentioned above, this “inaction” often provides you with the more favourable outcome, especially when you are already committed to a long-term investment strategy.
Preserve and Build Your Wealth with Bloom
As an independent investment management firm with decades of experience in the field, Bloom Investment Counsel, Inc. is among the professionals leading the pack. Our clients can be assured that we continue to stand firm against herd mentality as a result of our own independent, in-house fundamental research and disciplined decision-making process.
At Bloom Investment Counsel, we manage prudently focused and efficiently diversified equity portfolios aligned to each client’s long-term financial needs, objectives and legacy goals to help our clients preserve and grow wealth. We always maintain our focus on fulfilling our clients’ long-term goals rather than chasing short-term market movements. This investment approach has helped provide our clients with the confidence to invest in the stock market and entrust their wealth with us.
This content is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this content should consult with his or her financial partner or advisor.