One long-held belief is that lemmings purposefully run off cliffs in their millions. This myth has become a metaphor for the behaviour of crowds of individuals who follow each other blindly, regardless of the consequences. Herd instincts are prevalent in all parts of life, including the financial industry when investors follow what they feel other investors are doing rather than conducting their own research.
A herd instinct is a type of behaviour in which people react to and follow the activities of others. This is comparable to how animal groups react to danger – whether real or imagined.
Following the crowd or herding can lead trends to amplify well beyond fundamentals. Prices can skyrocket when investors flood into ventures for fear of losing out or because they have heard something positive but haven\’t done their own due research.
This unreasonable optimism can lead to asset bubbles that eventually burst.
In the opposite direction, sell-offs can lead to market crashes when people rush to sell simply because others are doing so, a phenomenon known as panic selling.
If most people are heading in one direction, an individual may feel as if they are making a mistake by walking in the opposite direction. They may also be afraid of being singled out for refusing to join the bandwagon. Although herding is instinctive, there are strategies to avoid following the mob, especially if you believe you will be making a mistake. It necessitates self-discipline as well as a few considerations:
- Doing your own research is essential; study the facts and data and draw your own conclusions. Once you’ve completed your due diligence, then you can look at other people’s interpretations.
- Inquire about how and why individuals are doing things. Are they making decisions based on the movement of the herd? If you believe it is the wrong decision for you, don\’t be afraid to go against the grain.
- If you\’re distracted or emotionally charged, whether from stress or external factors, postpone making decisions.
Making investing decisions based on logical, objective criteria and not allowing emotions to take over is a solid strategy to avoid herd instinct. Another option is to use a contrarian approach, in which you purchase when others are panicking, taking advantage of bargains, and selling when excitement leads to overvaluation. As Jonathan Sacks once said, “The wisest rule in investment is: when others are selling, buy. When others are buying, sell.”
At the end of the day, it\’s human nature to want to fit in, so resisting the impulse to stray from your plan might be challenging. This is where financial planners step in, serving as a sounding board for your decision-making process.
