Herd Behavior or Herding or Lazy Thinking

Mostly, our herd conformity is a good thing and it’s one of the reasons that societies are able to function (legal system, driving, etc).  Nevertheless, watch out for what you step into when you follow the herd.

Herd behavior occurs when investors follow the behavior of a larger group, even in situations which may be difficult to rationally justify the decisions of the group.

A classic example of herd behavior occurred in the late 1990s.  Investors poured huge assets into stocks of young fresh Internet companies, even though many of them didn’t have any profit and were unlikely to generate significant revenues in the foreseeable future.

Don't follow the herdAs this example is so long past and our memories so short, herds did the same in 2007/2008.  Who knows, perhaps the herds are at it again right now.

There are many adverse consequences of herd behavior.  They include high transaction costs which happen when everyone tries to keep pace with the latest trends.  Focusing on the conduct of the herd in the stock market—instead of on fundamentals that might have more relevant considerations—will likely result in disappointing returns.

Investment ideas, like yawns, are contagious.  Merely being part of a group makes us less inclined to ask the relevant questions. Yes, being part of the herd is fun while it lasts, but it’s seldom lucrative for very long, and it’s impossible to predict when the herd will change its ’emotional mind.’

Masses are always breeding grounds of psychic epidemics fueled by fear, greed, overconfidence and the confirmation bias. It is the masses that drive the markets and not the markets that drive the masses.

stand aside

Don’t get swept away by them.

Stand aside.

If you want to make more money than other people, you can’t invest like other people.

If you want to be excellent in anything, because by definition, excellence is sticking out from the herd. It’s excelling ahead of everyone else.

It’s always what you do after you have bought a stock/ETF that makes a much bigger difference than finding the right entry (still people do spend so much time on this single – not decisive – aspect of investing).

Don’t be lazy!  Start up your trustful brain, understand what the masses are doing and then do your own thinking.

Sometimes, people make mistakes because they behave like sheep and sometimes they err because they behave like mules.

 

“If 50 million people say something foolish, it is still foolish.” – W. Sommerset Maughan

2 Comments

  1. Andy,

    I have a naughty thought!

    I wonder how many of those johnny-come-lately who jumped on the passive indexing bandwagon recently have made the decision themselves with eyes open?

    I suspect some are practicing monkey see, monkey do 😉

    • Jared, your naughty thought is preposterous. All of us ETF-investors are always fully informed, totally rational, and go through life with our eyes wide open (unless we do sleep). ha ha ha

      Actually, you may be right there.

      But at least they are not passive. They managed to get up from the couch and invest in the stock market. That’s a bit ‘active’, isn’t it? Certainly compared to the myriad of people (especially young ones) who give the “risky” stock market a miss and prefer losing money safely every single day by holding mainly cash and watching it shrivel away in the hot tropical sun (aka inflation).

      Learning by doing is still better than not doing anything.

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