Herd Mentality: The Investor’s Version of Peer Pressure
As a person, we all love to fit in. Being a part of the community and doing what everyone else is doing makes us feel safe. Or, is it? What if it was just danger wearing a mask.
For most of us doing what others are doing makes us feel comfortable and at ease with our decision. Not everyone can be all wrong at the same time. Right? Well, they may not be right.
Herd mentality is the behaviour that has to do with what others are doing. We don’t have to go looking for herd mentality as it is very obvious in everyday life. Imagine you are in a street that is doted by food stalls. Which stall will you pick? Majority of us will go for the stall that is highly crowded as we assume that they must be the most popular one.
Let's imagine you are attending a seminar and the trainer has asked a question. You have the option to select option 1 or option 2. If we are not 100% sure of the answer, most of us are going to raise the hand for the option where a maximum number of hands are on air.
These two scenarios are nothing but examples of herd mentality.
Investors are also prone to herd mentality. In the case of investment, herd mentality is the investors’ tendency to do what other investors are doing. Here, investors’ analytical and technical skills take a back seat and their decisions are governed by emotions.
This is how most investors get it wrong. It is almost always better to avoid the herd. After all, Warren Buffet can’t be wrong when he said, “Be fearful when others are greedy, and be greedy when others are fearful!"
What causes the Herd Mentality?
Studies have shown that going against the crowd may be emotionally or psychologically taxing for investors. Taking a contrarian approach strikes fear in the minds of the investors. They assume that they are doing something wrong and they do not want to look foolish in front of others.
Peer pressure is another driving force of the herd mentality. From our school days to our adult life, peer pressure continues to have an impact over us. Getting left out is painful and no one wants to go through that.
As the majority of investors are taking a particular course, it is hard to understand how every investor can be wrong. This is another cause behind the herd mentality.
Newbie investors are more prone to fall for herd mentality, as it is most likely that they have not tasted the negative effect of following the crowd.
How to Not Fall for herd mentality
Keeping emotions in check goes a long way in the investment journey. Here are some of the ways that will help you to avoid herd mentality.
Research: Research is the first step that every investor should take. Adequate research will help you to figure out the right investment option. It will also help you to avoid the wrong stocks. As a result, you won’t be tempted to jump to the latest hot stock or investment option.
Have people who will question your decisions: As investors, we take emotional decisions because we are not able to take an objective approach. Having a close circle of people who can help us to take the objective approach is indeed a blessing. They can help us to challenge and question the preferences that help us to make rational decisions.
Have a financial advisor:
If research is not your cup of tea, then you can take help of a financial advisor to help pick the right investment options for you. He or she will help you to guide better than your friends and colleagues.
Conclusion: Herd mentality is common among investors. Many at times, following the crowd, may result in wrong decisions. Hence, it is important to make a rational decision. You can avoid bias by researching, having an intimate support group and taking help of a financial advisor.