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The folly of following the crowd People are better off as investors when they ignore the herd instinct and stick with their own plans
Carl Richards
In February 2012, a group of experienced skiers headed into the backcountry near the Stevens Pass resort in Washington State to look for untracked powder. It was a beautiful day, and everyone expected to have a great time skiing the popular Tunnel Creek section.
Minutes after the first skiers began heading down the hill, the snow cracked, setting off an avalanche which killed three.
In an article that one of the survivors, Ms Megan Michelson, wrote for Outside magazine, she noted that "all of the warning signs had been there, glaring and obvious: heaps of new snow, terrain that would funnel a slide into a gully, a large and confident group with a herd mentality, and a forecast that warned of dangerous avalanche conditions".
So what happened?
It was a combination of what researchers call the human factors, the article said, things like "familiarity, social pressures and the expert halo".
On this particular day, these skiers "relied on familiarity with the terrain and the snowpack". There was also the false security of being in a group, combined with the unwillingness of individuals to question the group's actions as a whole. Essentially, they thought they would be safe because, in part, they were acting as a group.
Removed from the emotion and excitement of the day, it is easy to say we wouldn't make the same decision or the same mistake. But if we are honest, we know we are all susceptible to this human flaw of going along with the group.
Scientists at the University of Leeds found "that it takes a minority of just 5 per cent to influence a crowd's direction - and that the other 95 per cent follow without realising it". So it's not uncommon to be lulled into assuming we are safer when we do what everyone around us is doing.
Seeking the safety of being in a group traces back to how we survived as a species. In many situations, we feel safer (and often are) if what we are doing aligns with what everyone else is doing. After all, when you stick with the herd, you rarely get eaten (or at least when you do, you have plenty of company).
But, as is often the case, this instinct can work against us when we want to become good investors.
The economist John Maynard Keynes highlighted this issue many years ago in his book The General Theory Of Employment, Interest And Money. According to Keynes, the "long-term investor" is not particularly interested in going against market trends (or the group). Being contrary, even when right, seems too risky.
Keynes noted: "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally."
Maybe a little stroll through history will help illustrate what I'm describing.
Remember what things felt like in 2009? The markets were down a lot from 2007 highs, and no one wanted to buy. In fact, I imagine almost everyone you knew was scared. The news was full of terrifying stories about the markets. Getting out and staying out felt like the safest thing because that was what everyone else seemed to be doing.
Now fast-forward to late 2013. Things had changed. The sun was shining again. Your neighbours were buying, and the news was mostly positive. Investing felt safe again - because lots of people were doing it.
While we do not know where the market will go, we do know that we were wrong about the market's being risky in 2009. I know that might cause some raised eyebrows, but stop for a minute and put aside the emotional response you might have to that statement. Does it really make sense to think of the market as less risky now that it's close to 200 per cent higher?
No matter what your gut or your neighbours say, of course it was less risky back in 2009. But that was not how it felt or how it looked.
A major reason it felt so scary was that everyone around you was scared, too. It's a rare investor who is wired not only to think differently, but also to put his money where his mouth is and stay disciplined even when the group says it is crazy.
It's one of the things that make Mr Warren Buffett so special and willing to follow his own investing advice to "be fearful when others are greedy, and be greedy when others are fearful".
Once we understand why we are attracted to the crowd, it becomes easier to separate what the group is doing from what we should be doing, such as selling high and buying low.
With that understanding, we can put barriers between ourselves and the peer pressure that makes us think we should make money decisions that match our peers' actions instead of our goals.
I suggest starting with a simple question we probably heard from our parents more than once:
"If your friends jumped off a cliff, does that mean you should, too?" Yes, it still sounds over the top, but the point is no less relevant.
Breaking from the group requires acknowledging that we don't have to follow them in the first place. Then, we need to remember that no one will care more about our goals than us, and when it comes to investing, it's our goals and not the group that matters most.
It will not be easy. I know how hard it is to break away, and there may even be a relapse or two. But even if it means being on our own for a while, we will be better off as investors when we walk away from the group and stick with our own plans. New York Times
Carl Richards
In February 2012, a group of experienced skiers headed into the backcountry near the Stevens Pass resort in Washington State to look for untracked powder. It was a beautiful day, and everyone expected to have a great time skiing the popular Tunnel Creek section.
Minutes after the first skiers began heading down the hill, the snow cracked, setting off an avalanche which killed three.
In an article that one of the survivors, Ms Megan Michelson, wrote for Outside magazine, she noted that "all of the warning signs had been there, glaring and obvious: heaps of new snow, terrain that would funnel a slide into a gully, a large and confident group with a herd mentality, and a forecast that warned of dangerous avalanche conditions".
So what happened?
It was a combination of what researchers call the human factors, the article said, things like "familiarity, social pressures and the expert halo".
On this particular day, these skiers "relied on familiarity with the terrain and the snowpack". There was also the false security of being in a group, combined with the unwillingness of individuals to question the group's actions as a whole. Essentially, they thought they would be safe because, in part, they were acting as a group.
Removed from the emotion and excitement of the day, it is easy to say we wouldn't make the same decision or the same mistake. But if we are honest, we know we are all susceptible to this human flaw of going along with the group.
Scientists at the University of Leeds found "that it takes a minority of just 5 per cent to influence a crowd's direction - and that the other 95 per cent follow without realising it". So it's not uncommon to be lulled into assuming we are safer when we do what everyone around us is doing.
Seeking the safety of being in a group traces back to how we survived as a species. In many situations, we feel safer (and often are) if what we are doing aligns with what everyone else is doing. After all, when you stick with the herd, you rarely get eaten (or at least when you do, you have plenty of company).
But, as is often the case, this instinct can work against us when we want to become good investors.
The economist John Maynard Keynes highlighted this issue many years ago in his book The General Theory Of Employment, Interest And Money. According to Keynes, the "long-term investor" is not particularly interested in going against market trends (or the group). Being contrary, even when right, seems too risky.
Keynes noted: "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally."
Maybe a little stroll through history will help illustrate what I'm describing.
Remember what things felt like in 2009? The markets were down a lot from 2007 highs, and no one wanted to buy. In fact, I imagine almost everyone you knew was scared. The news was full of terrifying stories about the markets. Getting out and staying out felt like the safest thing because that was what everyone else seemed to be doing.
Now fast-forward to late 2013. Things had changed. The sun was shining again. Your neighbours were buying, and the news was mostly positive. Investing felt safe again - because lots of people were doing it.
While we do not know where the market will go, we do know that we were wrong about the market's being risky in 2009. I know that might cause some raised eyebrows, but stop for a minute and put aside the emotional response you might have to that statement. Does it really make sense to think of the market as less risky now that it's close to 200 per cent higher?
No matter what your gut or your neighbours say, of course it was less risky back in 2009. But that was not how it felt or how it looked.
A major reason it felt so scary was that everyone around you was scared, too. It's a rare investor who is wired not only to think differently, but also to put his money where his mouth is and stay disciplined even when the group says it is crazy.
It's one of the things that make Mr Warren Buffett so special and willing to follow his own investing advice to "be fearful when others are greedy, and be greedy when others are fearful".
Once we understand why we are attracted to the crowd, it becomes easier to separate what the group is doing from what we should be doing, such as selling high and buying low.
With that understanding, we can put barriers between ourselves and the peer pressure that makes us think we should make money decisions that match our peers' actions instead of our goals.
I suggest starting with a simple question we probably heard from our parents more than once:
"If your friends jumped off a cliff, does that mean you should, too?" Yes, it still sounds over the top, but the point is no less relevant.
Breaking from the group requires acknowledging that we don't have to follow them in the first place. Then, we need to remember that no one will care more about our goals than us, and when it comes to investing, it's our goals and not the group that matters most.
It will not be easy. I know how hard it is to break away, and there may even be a relapse or two. But even if it means being on our own for a while, we will be better off as investors when we walk away from the group and stick with our own plans. New York Times
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