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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Aug 10, 2011
12:04 pm
#1 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
#2 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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