For many of us, being within a crowd is a safe place to be. We’ve all surely uttered ‘I don’t know, go with the crowd’ at some point or another.
There is something comforting about safety in numbers. You usually are in familiar company when amongst a crowd. You are ‘all in the same boat’.
Investing with the Crowd
When it comes to investing, going with the crowd is generally not the best strategy. You may feel more confident in your stock choices, and satisfied knowing that, when returns are up, you are not missing out, and when they are down, you can console yourself that you are in the company of others who have also lost.
There is rarely exceptional value to be found in crowd favourites, however. Going against the crowd can result in better returns, if not a more uncertain emotional ride as you question your decision.
The Nature of Crowds
What is it in the nature of the crowd: the way in which a collection of usually calm, rational individuals can end up making irrational decisions when they perceive their peers to be behaving in a certain, common manner?
Extraordinary Popular Delusions and the Madness of Crowds1 by Charles Mackay2, originally published in 1841, is an early study of crowd psychology which is still applicable today.
Herd Mentality
A trademark of crowd behaviour is our tendency to look to the majority for guidance and follow the actions of others rather than form their own analysis. Those who hold the attention of the crowd and appear confident and knowledgeable are attractive to us during times of uncertainty, and we follow them.
Herd instinct has a history of starting large, such as unfounded market rallies and sell-offs that are often based on a lack of fundamental support to justify either.
Fear of Missing Out
Fear of missing out (FOMO) contributes to following the crowd. Behavioural studies have found that an opportunity for profits is a more enduring motivator than the fear of losing one’s life savings. This fear of being left out or failing when your friends, relatives and neighbours seem to be making money is what drives the power of the crowd.
FOMO can heavily influence an individual’s major financial decisions, such as whether or not to set up a self-managed super fund (SMSF) or purchase cryptocurrency.
The Wisdom of Crowds
Sometimes, a better-informed decision can be reached as a group, rather than an individual. This occurs when diversity of opinion, independence of thought from those around you, specialisation of knowledge from different areas, and the opportunity to discuss unique opinions can work to the group’s advantage.
However, this is hard to apply, and it requires deliberate organisation. In an investment bubble, conformity takes over and there is no system in place for collective diverse thinking and decision making.
Case Study: Lithium Stocks
It was only a year ago that people were asking me about Lithium and which stocks should they buy.
Some of the comments made to me were akin to “the electric car is coming, demand for lithium batteries will explode and we have got to get onto this.”
My advice at the time was a bubble in lithium shares is occurring. Looking rationally at the facts, Lithium is not as rare as it is being made out to be, with numerous mining projects in development. If it is exposure to batteries you are after, I would recommend buying a solid cheap business producing nickel or cobalt, which also go into batteries. Lithium stocks have typically since fallen dramatically in price over the last year.
If you are looking to build your wealth or discuss your investment options, please contact Allan at [email protected] or on 07 3398 4888 for a complimentary consultation.
- This book discusses the madness of crowds, and the belief that if everyone else is doing it, it can’t be wrong or that bad.
- Mackay was an accomplished teller of stories, though he wrote in a journalistic and somewhat sensational style. In this book, he covered economic bubbles such as the South Sea company, the Mississippi Company and the Dutch Tulip mania, along with the Crusades and witch mania.