People are social creatures. We like being part of a team, club or society. In general, we like to belong and “fit in” and most people find it difficult to do things that make them feel “out”. Often, however, it is going against our herd instinct that will help us to make the right investment decisions.
Imagine a dinner conversation where you are discussing the merits of investing in building and construction shares. There may be people at the table who know people in the industry. Others may quote recent media reports on poor performance. These “insiders” and “experts” might agree that now is not a good time for construction.
Construction shares have also performed poorly in the recent past. There is general agreement that it will be a long time before construction shares will return to favour.
However, you have looked at the data for construction shares: the price/earnings ratios are low, the balance sheets of a few companies look attractive and some have decent dividends backed by sufficient cash. You believe that some of these companies may turn out to be good long-term investments. What will you do? Will you be the only one to argue your point; or will you agree and secretly cancel your buy order for a few construction shares when you get home?
Research shows that in most cases, the herd instinct will cause you to choose the second option.
Herd instinct comes back to our survival instinct: imagine a tribesman on the African savannah. He was served well by herd instinct and he had a much bigger chance of survival in the tribe than outside the tribe. Today, our brains have evolved to make us want to follow the crowd.
Market bubbles are one of the results. Often market participants will want to buy an asset just because everyone else seems to be buying it and the price is going up.
In addition, there is also the addiction to the feeling of attachment. The brain chemical oxytocin is released when attachment occurs (it is also called the love hormone). In other words, our brains make us feel good when we follow the herd.
Warren Buffett said, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” He is probably the best-known contrarian investor. In other words, he goes in the opposite direction as the herd — a strategy that has earned him a reputation as one of the best investors in the world.
It is helpful to realise that our natural inclination is to make investments that will make us feel good, despite the fact that we may rationalise these investments. However, in order to profit from opportunities in investments you will often have to make investments that will make you feel anxious. You may also have to go against the herd.
In our dinner party conversation, there is a third option: listen, keep quiet, check your facts and understand that you may feel uncomfortable with your investment decisions.
Sunel Veldtman is author of Manage your Money; Live your Dreams. www.sunelveldtman.com