30
May
2016

The dangers of following the crowd

‘The herd instinct’

There are a number of human behaviours that have helped us evolve and thrive as a species, but hurt terribly when it comes to investing! Perhaps the most dangerous is human natures desire to conform, the behaviour known as ‘Herding’ or ‘The herd instinct’.

The herd instinct is simply thinking and acting the same as those around them, with little thoughtfulness, in investment markets it is a group of investors gravitating to or away from similar or the same investments based solely on the fact that others are doing the same thing, generally the fear of missing out on a good investment is the driving force.

It is this behaviour that sees man rallies and sell offs based seemingly on little fundamental evidence, this behaviour leads to the bubbles and crashes we see in all investment markets regularly.

The most bizarre and extreme example of this occurred in Holland in the 1630’s where Tulip bulbs became the first known speculative investment, the price of a Tulip bulb increased 200 fold, and at its peak traded for roughly 10 times the annual salary of a skilled craftsman, and of course crashed back to where it all started. This event led to the term “Tulip Mania” which gets used to this day when investors go crazy for an investment type and even led to a few books and movies warning about the risks of following the market.

In more recent times we have seen investors go crazy for speculative “Dot Com” investments, investors were valuing companies at many hundreds of millions of dollars despite many of them having yet to find a way to generate income from their product, My Space sold for a billion dollars and had very limited income streams.

Most of us have heard the old age mantra made famous by Warren Buffett, “buy low and sell high”, Buffett has actually said he’d prefer not to sell at all! The herding mentality makes this virtually impossible. If we buy when everyone else is buying, then we will always be buying high, we are following the market. We are also likely to then sell when everyone is selling and sell low. The herd instinct makes us do the exact opposite of what we know we should be doing.

In the 20 year period from 1994-2014, Blackrock investment studied investor performance, and the results indicate the average investor is rubbish! Over that period the average investor returned 2.5%.  This is lower than every single asset class. So essentially the average investor could have literally picked any investment and left it there for 20 years and be better off then what they actually did.

So what did the average investor do? Well based on inflows and associated data they chased returns, made emotive decisions and were victims of the herd instinct.

In the both the 98-2000 period and 2005-2008 many investors entered the share market, well after a lot of the gains had been made, depending how early they entered the market some of these investors would have seen initial gains, and this made great BBQ talk, seeing many others join the herd.

We all remember that in both 2000 and 2008 we saw sharp market falls, most investors were prepared to ride the fall for a little while. But as markets continued to fall we saw more and more Mum’s and Dad’s exiting the market, again following the herd. 

This crystalized their loss, many of these same investors than re-entered the share market once the market started to grow again. Not surprisingly, again missing much of the gains. Had they have just stayed strong, not altered their investment strategy, they would have been significantly better off.

 

The secret to success in the market is to simply select a long time investment strategy and stick to it! Avoid emotive investment decisions and following the herd.

Author; Alex McKenzie Categories: Future Financial Services Blog

About the Author

Alex McKenzie

Alex McKenzie

Owner at Future Financial Services

Past:

  • Paraplanner at Zammit Partners Investments
  • Unit Trust Administrator at Colonial First State

Education

  • University of Western Sydney
  • Penrith High

About

As a Financial Planner I help people to achieve what they would like in life. This involves helping you to identify the things in life they would like , developing plans to help achieve them and strategies to protect what you already have. We do this by providing Financial Advice to guide you through your life stages.

The financial planning process involves determining a clients current situation and financial objectives and tailoring strategies to assist in best achieving those objectives.

I am an expert in superannuation, investments and insurance, these are tools we use to help you achieve your goals.

I aim to use my knowledge of superannuation, taxation and Centrelink to efficiently use your assets and income to achieve your financial goals.

Retirement and pre-retirement planning, wealth creation, asset protection, insurance planning and estate planning are all areas of advice that I provide.

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