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An Investor’s Guide to Herd Behavior
What is Herd Behavior?
Herding is the idea that people feel most comfortable following the crowd and tend to assume the consensus view to be the correct one.
An Education in Herd Behavior
The lure of the herd can be difficult to recognize, especially if you don’t know the phenomenon exists. Have you ever been standing in a checkout line at the store, only to realize it’s not a checkout line, just a line of people? Or, have you attended a game between two sports teams you don’t follow but soon find yourself hoarse from cheering and buying team merchandise on the way out? That’s herd behavior.
Sometimes, examples of everyday herding can be harmless. Unfortunately, when it comes to investing, herd behavior can significantly impact results.
The Wisdom of Crowds?
Throughout history, many investors have faced strong temptation to join the investment bandwagon based on emotions, rather than a sound financial strategy. Simply put, we fear making mistakes or missing opportunities.
The illustration on this page shows four well-known economic bubbles. During the run up of these bubbles, investors bid up the prices of tulip bulbs, stocks and real estate to unsustainable levels. But, even more quickly than they expanded, these markets burst and contracted leaving the herd scrambling.
BUBBLES THROUGHOUT HISTORY1
WHAT CAN YOU DO ABOUT IT?
One of the best ways to make better financial decisions is to work with a financial advisor. A financial advisor will take the time to understand your individual needs and create an investment strategy that’s tailored to your specific goals, your individual situation and your risk tolerance.
As you navigate the market, an advisor can also help you keep your emotions and biases in check and stay on track with regular portfolio reviews and adjustments.
Next Steps
Every day we are faced with decisions—some are easier to make than others. Learn more about behavioral biases and the impact they can have on investment portfolios.
Other Investor Behavior Videos
Access more short videos to see how behavioral biases show up in our everyday lives.
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- Sources: Tulipmania Dec. 1634 - May 1637: Thompson, Earl A. “The tulipmania: Fact or Artifact?” Public Choice, 2007; Roaring ‘20s Dec. 1924 - Nov. 1929: Dow Jones Industrial Average; Dot-Com Jan. 1997 - Oct. 2002: NASDAQ Index; Real Estate Jan. 2002 - Mar. 2012: Case-Shiller Housing Index.
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