The New York Times Sketch Guy columnist, Carl Richards, recently wrote a column on July 17th, 2017 titled “When Following the Flock is Not a Winning Strategy.” He wrote that “we have been taught that there is safety in numbers and sometimes that is true. But, just because there are many people doing something that doesn’t make it safe. Sometimes it makes it more dangerous.” This was his picture:
Safety in numbers comes from the Herding Mentality. The idea of herding has a long history in philosophy and crowd psychology. Herd behavior describes how individuals in a group can act together without planned direction. The term pertains to the behavior of animals in herds and to human conduct during activities such as stock market bubbles and crashes, sporting events, and everyday decision-making.
Stock market trends often begin and end with periods of frenzied buying (bubbles) or selling (crashes) – when market prices seem to temporarily disconnect from underlying fundamentals. Many observers cite these episodes as clear examples of herding behavior that is irrational and driven by emotion—greed in the bubbles, fear in the crashes. Individual investors join the crowd of others in a rush to get in or out of the market.
Herd behavior is just one type of mental shortcut used to help us make the thousands of decisions we must make every day. According to Duke University researchers, we usually make most of these thousands of daily decisions with almost no thought, using what psychologists call “heuristics” – rules of thumb that enable us to navigate our lives. Without these mental shortcuts, we would be paralyzed by the multitude of daily choices. But in certain circumstances, these shortcuts can result in bias that may lead us to make errors of judgment.
The CFA Institute Financial NewsBrief administered a survey in August, 2015 asking readers to select the behavioral bias that most affects investment decision making. As shown in the graph below, herding garnered 34% of the votes and stood out as the topmost bias affecting investment decision making in the eyes of poll participants.
Poll: Which of the following behavioral biases affects investment decision making the most?
With the current U.S. stock market expansion now one of the longest in history, above average valuations, and record cash inflows to U.S. equity based ETFs, elements of herding are quite possibly at play. As is usually the case, we won’t know for sure until we have the benefit of hindsight.
We must remember, though, that history suggests that investors who remain committed to their long-term strategy are more likely to achieve their investment goals when compared to those who allow behavioral biases to cloud their decision making. Legendary investor Benjamin Graham may have said it best when he said that “by developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.”
So, if and when you find yourself needing some help with your investments in the discipline and courage department – as we all do from time to time – remember it is only human nature. And, know that we are just a phone call, email, or click away.