Human Beings are very Social Animals
After a decade of almost uninterrupted stock market growth throughout the world, 2018 saw significant declines in most markets around the world. The volatility has continued in the first week of 2019. Indeed, in its annual report issued in January, the World Bank is forecasting a significant slowdown in the world’s economy. Faced with this scenario, how should a prudent investor react?
Behavioural scientists tell us that humans are not very good decision-makers and I wish to concentrate on one of these “frailties”.
Human beings are very social animals.
We like to feel part of a community, and we fear being alone or missing out. So we tend to pay close attention to what others are doing and often like to mimic their actions. Behavioural scientists refer to this tendency as herd behaviour, or herd mentality.
Simply put, rather than making decisions for yourself, we will look around and try to find somebody who appears to know what they’re doing and we’ll follow them.
Herd behaviour is very common among investors.
The financial markets are intrinsically risky but we take comfort from copying what others are doing — particularly people like us. Unfortunately, because we, as humans, are such poor decision-makers - following other people is rarely a recipe for success. We have to actually step away from the herd. Try to find a way of looking in the other direction. Be the contrarian. Be the person who’s willing to swim upstream.
Another reason why herding is so prevalent is that it seems intuitively right. It can even feel foolhardy not to follow the crowd.
The trouble with herd mentality with investing is that the herd is following the herd. So, when a stock market boom gets started and people start getting in on the trend and more and more people get excited about that trend, the herd is travelling in one direction.
Then, as soon as that direction tips and the bubble breaks, the herd leaves. If we follow the herd, then we’re always behind. We’re always going to be buying high and selling low.
It’s particularly in the run-up to, and the aftermath of, market bubbles that herding behaviour tends to manifest itself.
Herding was also greatly in evidence in 2009 after global markets had fallen sharply as a result of the financial crisis.
If there was ever a time to get into the markets, it was then. And yet, every morning you opened the newspaper, there were scare stories about how “it’s all going to get worse…” and of course, it made everyone else scared. So no-one was acting, no-one was getting involved.
There were a few people who bought shares at that point, but most people — even the ones who thought ‘this has got to be a great time to invest’ — said ‘I’ll just wait a little’. And then they did, and they waited a little longer and a little longer.
So it was really where every rational, dispassionate rule of investing said ‘this is the time to put your wealth to work’, very few people did.
Herding, in short, is part of our make-up.
Resisting the temptation to join the stampede takes discipline and self-control but, if we can resist, we’ll be far more likely to achieve our long-term investment goals. Stick to your financial plan.