Looking to make informed and intelligent investment decisions? It’s important to avoid herd behavior. Learn about the dangers of following the crowd and why it’s important to trust your own instincts.
One of the most common behavioral finance biases is herd behavior. Most of us tend to believe that a large group of people couldn’t possibly all be incorrect about something. Studies have shown this belief greatly affects our decisions.
Humans are also very sociable and following the group is an innate behavior for most of us. Who doesn’t want to be part of the group? But just because something’s natural doesn’t mean that it’s wise. The desire to eat chocolate is common, but succumbing to that desire on a regular basis could have negative consequences, too.
Examining the dangers of herd behavior will assist you in avoiding it in the future.
Be aware of the challenges that herd behavior can create in your finances:
1.You lose your true advantage. The greatest parts of you are the parts that are different from everyone else. Copying others is never the ultimate path to excellence.
- Your greatest investments are likely to be those where you made your own, inspired decisions.
2.Your investment decisions aren’t based on facts. Good decisions require accurate information. The opinion of a large number of people doesn’t necessarily provide you with that type of information
- You’re likely to cut your due-diligence short when you follow the herd.
3. Your investment decisions aren’t rational. A decision could be based on fact, but still be irrational. Herd behavior usually excludes a rational examination of the information that’s available.
4. The herd is frequently off-track. History is full of examples of a large group of people being incorrect. At one point, essentially no one believed the world was round.
- Imagine all of the things people might incorrectly believe now.
- Just because a lot of people believe something doesn’t mean it’s true.
5. It’s often too late by the time it becomes a trend. By the time many investors jump on the bandwagon, it’s too late to profit. But it’s never too late to lose money.
- Herd behavior has more potential risk than potential gain.
- Most investors are too late getting into herd investments and too late getting out.
- Most great investments are not very time-sensitive.
6.If you followed the herd in, you’ll follow the herd out. If following the herd was your primary reason for getting involved with an investment, you may lack the criteria for getting out of the investment.
- You’re putting yourself in the position of only being able to follow the other investors out. How will you know if they’re right?
- When other investors start dumping an investment, the value of the investment falls.
- Unless you’re one of the first to get out, you’re putting yourself in a position to lose money.
7. The herd forces an investment to be over-valued. When investors flock to an investment, the price is driven up by excessive demand.
- It isn’t uncommon for the price of an investment to rise above the intrinsic value of the investment.
- The price of a stock routinely rises or falls to its true value and over-valued stocks eventually return to reality.
8. You’re more likely to churn through investments. Constantly buying and selling investments is costly. There aren’t only transactional costs, but you’re also potentially subjecting yourself to more taxes by taking your gains more frequently.
Following the herd is a poor investment strategy because you lose the ability to make informed and intelligent decisions. Avoid putting your trust in the herd.
Remind yourself that it isn’t always smart to follow the herd. Be aware of the risk to which you’re subjecting your investments.
Make your own decisions and make them wisely. You can do better than the herd.