Why The Herd Mentality Is Dangerous In Investing
Humans naturally want to be a part of groups and communities. While being social can work wonders, there is also a harmful side of our desire to fit in.
Numerous studies have shown that humans are more inclined to make a decision if they see or hear about others making it. This is true even when they have little knowledge about the choice. In fact, an infamous study by the University of Leeds found that it only takes a minority of five percent to influence a crowd’s direction – the other 95 percent follow without realizing it.
This is known as the “herd mentality” – a phenomenon that causes us to blindly follow others. The herd mentality is a mental shortcut that causes us to act akin to herds of animals. Essentially, it tricks our brains into thinking we’ve discovered a missing piece of the puzzle when others are making a choice.
In finance, this is one of the largest – and most harmful – factors affecting investors’ decisions.
Look no further than the fervor over dotcom stocks in the late 1990s. It was largely driven by cheap money, market overconfidence and pure speculation; and most investors blindly followed the crowd. Once investors took off their blinders they were sorely disappointed.
Follow the herd, and you’ll often be led to do the opposite of successful investing behavior.
Prudent investors evaluate every decision through a long-term, data-based lens. The other, more difficult part, is avoiding the speculations of the loudest people in the room.
At LexION Capital, you benefit from a goals-based approach that’s strictly focused on achieving your financial goals and needs. If you’d like to learn more, please contact us today.