Herd Mentality
Posted By: Admin
If a million people do something, it must be right ? This is called social proof wherein we go by herd thinking rather than apply our mind to arrive at our own conclusion. It is a lazy way of making our decisions which can easily be rationalized as well. It is based on the belief that the more people who follow a particular process the more it is likely to be the right one. Is that true ?
Let us examine.
I had this experience.. some years ago there was a small banyan tree that was coming up near my house by the side of the main road. Over the period of time, somebody started going round that tree and some other person literally painted the tree with turmeric paste and started tying strings lo & behold, the tree in a span of three months had many people going round it in the mornings & evenings seeking divine intervention. I bet you in the next few months a small temple will come in this place and this will turn into a thriving spiritual destination. Now don’t mistake me to be atheist, I am deeply spiritual but a hundred people going round a tree isn’t going to make me believe in divine intervention. However seeing people go around the tree makes us believe that there must be some higher meaning to it and lead many more people to follow the routine.
Following others was not necessarily a bad thing.. it has kept us alive. In the absence of staying together Humans may not have had a survival chance thousands of years ago.. however the same is no longer relevant to survival, however our mind continues to be tuned to it. Stock Markets are based on herd behavior.
The principal is that unless the majority of Stock market participants believe that the future looks prosperous, the stock market will turn negative and go down. Yet making money in stock markets is about being invested in the right asset allocation so that you benefit on the way up and if the markets move down for some reason.. they will protect the downside as well.
If you are always part of the herd, then you will only generate sub-optimal returns because your returns will only be a lower average of the herd, whereas if you were to use independent thinking then chances are that your investment outcomes will be very different from average of market returns.
The factors that we need to consider for independent thinking are :
- Our risk appetite may be very different than those of the market at large
- Our needs / goals may be quite different from what others are pursuing
- Following our asset allocation rather than getting carried away by the market actions will give us better long term returns although our portfolio may appear to under perform in the short term.
So the next time the Equity market is soaring high, revisit these three questions and re-balance your portfolio, so that you take some profits so that when the trend reverses , you are better off having booked some profits earlier. Asset Allocation is the secret tool that will help you avoid the herd mentality in investing .
Are you following your Asset Allocation ? take some time to evaluate.. if you need some help, write to info@finsherpa.com.
Category Finsherpa | Tags Financial Freedom
