Steadfast FinancesInvestor Psychology: Your Brain is Hardwired to 'Follow the Herd'

Investor Psychology: Your Brain is Hardwired to ‘Follow the Herd’

Filed in Investing 101 , Investor Psychology 39 comments

Not following the herd. Going against the grain, being an iconoclast.

If you’ve ever wondered why it’s so difficult to ignore peer pressure and why you feel anxiety when expressing a differing opinion from the herd, you might want to blame Ardi and the rest of your human ancestors.

Like most animals on the planet, humans come pre-programmed to notice the behavior of our species and copy it. This has probably helped humanity countless times: avoiding predators, finding the best watering hole, passing on beneficial learned behaviors, etc.

If you disagree, just think about it for a second.

How many times have you walked out of a building and noticed everyone is staring into the sky? For whatever reason, did you feel the need to stand there and stare like everyone else? If only for a few seconds, you felt that you needed to follow along. Right?

Why wouldn’t you? You’re human, you want to see what’s going on like everyone else.

This is because herding behavior is a result of not being in the know in any given situation. If you don’t know what’s going on, you begin to rely upon those around you who do. After all, there has to be someone out there who does, so why not follow along with him or her? If they screw up, then you can say it was their dumb idea and you’re not the only sucker who got fooled. Once again, you’re anxiety free since you’re back within the safety of the group a second time.

So it’s fairly commonplace to witness the old adage “there is safety in numbers” rule most daily of our lives. While this may be a good rule of thumb since crowdsourcing is usually a very efficient and productive way of getting something done with minimal effort, it may not be the best policy when it comes to your finances.

Following the Herd via PBS Your Mind and Your Money

[RSS readers please click to site for video]

Behavioral Finance Lessons with Dr. Gregory Berns (best video in my opinion)

Extended Interview with Dr. Gregory Berns

As the first video describes, a large percentage of people will knowingly give the wrong answer in an group Q&A session if the majority of this group has openly stated the incorrect answer. In essence, they just want to follow the herd.

Of course, scientists (psychiatrists) like Dr. Berns have artificially engineered these types of behavioral psychology studies where group members are coached to give the wrong answer to identify how many uncoached members (e.g. the test subjects) will knowingly go along with the group by giving an incorrect answer even when they know their original answer was correct. Had the test subjects been given a silent ballet vote, a voting booth to give their answer in private, or had the option of giving their answer prior to listening to the coached answers, their answers might not have been as heavily influenced by peer pressure and the herd mentality.

In other words, following the herd has the potential to override your common sense, your rational thinking, and maybe even the way you would normally conduct your business.

Now that you know this, how many times can you relate this herding behavior or decentralized decision making to your financial faux pas?

Maybe you bought an investment property in 2005 just because everyone else was doing it? Did you buy stock in oil companies when oil was at $140 per barrel to get in on the emerging market demand? Maybe you bought into the new economy paradigm when tech stocks didn’t have to worry about basic fundamental analysis metrics like P/E ratios?

The psychology of bubbles is an incredibly difficult temptation to ignore, so you might want to think twice the next time you follow along with with what the business section of your newspaper is telling you. These days, with so much financial porn trying to sucker you into the “greater fool” investing game, the safest play is probably to avoid those investments altogether.

Photo by mysza831

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Posted by CJ   @   30 November 2009 39 comments
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Nov 30, 2009
5:11 pm
#1 Guzzo :

Thanks for the video links. They were interesting, but I’m going to have to go against the herd. ;-)

In my opinion the word “iconoclast” is a very poor definition for those aren’t afraid to go against the crowd. The word “contrarian” is a better definition.

But, I may be biased in my opinion.
.-= Guzzo´s last blog ..SIGTARP Transparencies =-.

Nov 30, 2009
5:27 pm
#2 Matt SF :

@ Guzzo,

I think I might have to partially agree with you. The iconoclastic personality trait translates fairly well, but not 100%.

Considering the forum and the audience to which those videos were speaking, I suppose the using the term iconoclast was more appropriate than contrarian.

The destroyers of icons and challengers of authority sounds more impressive than short sellers and black sheep! ;)

Nov 30, 2009
6:51 pm
#3 TJ :

So true Matt. The herd instinct has led to many historical disasters of group think origin and the words frequently used to shut down the guy who looks up from the watering hole and senses impending doom before the others are very familiar, like: “alarmist” “heretic” or the ever popular “naysayer,” even “rogue.”

Nov 30, 2009
7:32 pm
#4 Matt SF :

Well said TJ. I’m kinda partial to blasphemer myself.

Dec 1, 2009
1:03 pm

You’re right Matt, there is safety in numbers.

Couple things, if you bought property at the beginning of 2005, you’re doing well and about 10-15% above water, at least here in SF. If you bought at the END of 2005, well, you’re probably even since 2005 was a banner year.

Finally, if everybody really did follow the herd to make money, they would have studied hard in High School, got straight A’s, attend the best universities, and get the most lucrative job and stop complaining why they have debt problems or why they don’t make enough!

Alas, not everybody follows the heard :)
.-= Financial Samurai´s last blog ..Tuition Hike For The Poor Is Like A Tax Hike For The Rich =-.

Dec 2, 2009
12:43 pm
#6 Matt SF :

@ FS

San Francisco is a scary real estate market. As I posted a few months ago, SF had one of the highest speculative real estate bubbles in terms of home price appreciation versus median income. So in relation to your comment, timing the market can really pay off, or really bite you in the arse.

Dec 3, 2009
10:22 pm
#7 Len Penzo :

I guess my brain’s wiring is broken. LOL

I am a contrarian by nature, and that definitely saved me from taking a bath when the stock market tanked in 2008.

Nice post, Matt!

Len Penzo dot Com

Dec 3, 2009
11:20 pm
#8 Matt SF :

Thanks Len! I’m right there with ya… I’ve always had a few shorted out wires.

Guess it’s helped me see through the fog of “investing BS” more than normal. Would have liked to moved some index funds around a little better, but really glad I sold my investment property in 2005. Probably underwater big time!

Dec 5, 2009
4:39 am
#9 Monevator :

Something to keep in mind, to play devil’s advocate, is that politicians are more interested in the herd than in us weirdo contrarians looking down at the water hole from the mountains. They therefore design policy to suit them.

E.g. Here in the UK herd overpaid for houses for years and ran up big debts, and they’ve been bailed out by super-low interest rates and other measures to support home owners.
.-= Monevator´s last blog ..Facing mortality when you have a family =-.

Dec 5, 2009
10:51 am
#10 Matt SF :

I couldn’t agree more Monevator! Here in the U.S., we see the same exact same thing where the politicians only care about the majority and go with along with them no matter the cost. After all, that’s where the votes are, so why fight the math.

The U.S. got into it’s big troubles partially because of governmental tomfoolery by keeping mortgage rates extremely low, and now, we’re doing it again to stimulate home purchases and clear the glut of foreclosures. Strange how the same (spiked) Kool-Aid that made us sick is supposed to make us well again.

Ex) A 30 year mortgage dipped into the 4.875% range just last week. The lowest national average in 38 years! I wouldn’t be surprised to see a 15 year mortgage at 4.0% within a few weeks.

Too bad weirdo contrarians like us don’t have the power to dis-invent things… I’d have to dis-invent politics.

Dec 5, 2009
10:01 pm

I read a Wall Street saying in college, I believe in a popular book called “A Random Walk Down Wall Street”, that said “Better to be wrong WITH the herd than to be right standing alone”.

While I think that verse applies to all of life, it seems to explain behavior in the financial markets, including booms and busts. Few people will sell at the top, just as few will buy at the bottom. Buy low/sell high is so simple a concept, but so difficult in the execution, all because of the emotion (fear and greed).

We’d be richer for overcoming this affliction before playing the market.
.-= Kevin@OutOfYourRut´s last blog ..Finding Work by Working for Free =-.

Dec 5, 2009
10:18 pm
#12 Matt SF :

@ Kevin,

That’s a great quote, and just as great explanation for why many of the market experts and mutual fund managers can’t outperform the Plain Jane index funds.

As for overcoming the fear and greed affliction…

I’m guessing that’s why the psychiatrist in the videos mentioned he invests primarily in index funds because he doesn’t trust another human being to ignore their emotions or manage their fear sufficiently to beat the market over the long term.

Dec 7, 2009
5:46 pm

How many people do things just because they heard it or read it somewhere? Unfortunately, it’s taken as the best way to do things just because someone told you. People don’t spend the time to research and dig a little deeper to determine if it’s best for them. The herd mentality plays into everyone being in the same situation. Unfortunately with finances none of our situations are exactly the same, especially when hopes, dreams and emotions come into play.
.-= Evolution Of Wealth´s last blog ..Sundy Link Rodeo 11 =-.

Dec 11, 2009
11:44 am

Great post! Thinking outside of the box and NOT with the herd is part of investment success. Group think has caused many issues in our society (not just finance).

Our brains, while to help with previous generations, makes us hardwired to fail with investing.
.-= Investor Junkie´s last blog ..Why Buying a Timeshare is a Bad Idea =-.

Dec 11, 2009
2:18 pm
#15 Matt SF :

Absolutely. Reminds me of that old phrase…

If your friends jumped off a bridge, would you do it jump to?

Dec 11, 2009
2:29 pm
#16 Matt SF :

I like to think of it like sheep sitting on a hill “talking” about how the grass is always greener on the neighboring hill.

If you know the sheep (or sheeple) are always looking for something new, why not buy what they want before they know they need/want it when it’s cheap, outdated, looks like crap, etc.

As long as you know the sheep will be back in force, it’s just matter of time before you can sell at or near the top.

It’s weird, but the more I trade the more I want to be a value investor!

Dec 11, 2009
3:56 pm
#17 Investor Junkie :

If you are a value investor, you trade less, not more. ;-)

IMHO, other than indexing, value investing is the only way to go.

But I agree with what you mean.

Dec 12, 2009
3:07 pm
#18 Matt SF :

Absolutely. Value trading is about spotting the buy on the dips bargains when no one on the planet — other than a few savvy value investors (or vulture investors) want to swoop in and pick up a sweet deal.

Dec 17, 2009
8:06 pm

I would go against the herd because I believe that persons need to made their own decisions. Yes sometimes one will go with the herd and be successful but that would be like 5/10. Thanks for a wonderful article.

Dec 17, 2009
8:15 pm
#20 Matt SF :

No problem, thank you for commenting and your kind words.

Your comment reminded me of a quote I read recently…

A wise man makes his own decisions, an ignorant man follows public opinion. — Chinese Proverb

Can’t find better advice that that!

Aug 10, 2011
12:04 pm
#21 NickOoi :

Disagree, if we all follow along what others have been doing, we woudn’t have techonology breakthru…we will be still living in jungle.

Aug 10, 2011
12:08 pm
#22 Matt SF :

Oh I agree, there is a subset of people who are the iconoclastic personalities. They compose a very small percentage of the population. They innovate, become history book legends… Einstein, Tesla, Ford, Gates, etc.

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