In our last post on confirmation bias, we left you with the homework of teaching your cat to sing, “I Did It My Way.” In fact, it’s a good sentiment for investors to learn too, to help them avoid another bad habit that can run roughshod over their returns: herd mentality, or the tendency to react to public sentiment by buying high when a holding is wildly popular or panic-selling when the herd is running scared. Tempting investors to buy high or sell low–and incur unnecessary costs through hyperactive trading–the results of herd mentality run the opposite of optimal investing.
One of our favorite illustrations of herd mentality came from Intelligent Investor Jason Zweig’s Wall Street Journal column. In October 2008 at the depth of the Great Recession, Zweig presciently reminded readers to “Take a Deep Breath, Turn Off the TV, Calm Yourself.” In short, avoid herd panic: “When fear leaps from one person to another, it turns into panic,” he said. “You can catch other people’s emotions as easily as you can catch a cold.”
Herd mentality is just as applicable in bull markets, as early experience taught me well. Remember the tech stock bubble of the 1990s? As an engineer at Dell in the “second Silicon Valley” of Austin, Texas, I happened to be in hotbed of all the madness then, a young buck, surrounded by my fellow tech-loving herd, feeling close to invincible.
Not surprisingly, everyone around me was buying tech. It was hard to go into work without someone mentioning how much they’d made by buying tech stocks or a tech fund that seemed to go nowhere but up. With projections of permanent 25% annualized returns, my gleeful colleagues were buying boats and second homes, and planning to retire at age 35.
Thankfully, I didn’t get quite that caught up. I had a little more financial experience, having been investing since I was 12 (the results of a lucrative paper route). But still, I had more to learn then. Even I couldn’t resist the allure of generously tilting my portfolio toward “dot.coms” and high-tech mutual funds. In addition to herd mentality, my community and I were challenged by another well-known behavioral bias, “familiarity bias.” Confusing “familiar” with “safe,” we assumed that because we were technology experts in our careers, we knew what we were doing in the markets by investing in technology stock.
I probably don’t need to tell you how the story ended. Many of my friends lost their heady purchases and most are still working hard today. The silver lining for me was that I learned valuable lessons that I have put to good use in my current career as a financial planner. I’m now able to remind myself how critical it is to keep my head about me during market runs (bear or bull), which better positions me to help those around me do the same. What I hope for you is that, next time you’re tempted to run with the herd, you remember the Pathway and stay the course, instead of learning the hard way what so often happens in the middle of a stampede.
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