Fernando MonteiroWhat Is Everybody Else Doing?
April 12th 2010 15:54
Most of us have a herd mentality – and nature put it there for a purpose – but did you, dear reader, ever wonder what it does to you when it comes to investing?
Consider this news: testifying before The Financial Crisis Inquiry Commission, Charles Prince and Robert Rubin, respectively Citigroup’s ex-chief executive and ex-head of executive committee, said, according to a Bloomberg report that “almost none of their peers on Wall Street predicted that sub-prime securities would bring on a credit crisis.”
This prompted the commission’s vice chairman, Bill Thomas to say “do you just do what everybody else is doing because everybody else is doing it, and if you don’t do it you won’t make money?”
At this stage it could reasonably be asked what herd mentality is? Basically, it’s a need to do what is perceived that most people are doing on any sphere of activity. This way we pack together and become a herd where all head in the same direction. The funny question here is why we do this?
Probably for reasons related to our animal nature. Many animal species in nature pack in herds and often the purpose is to obtain protection against predators. You see, if the Gnu in the Serengeti herds, the lion can only attack the animals on the fringe, the ones taking refuge in the centre of the herd, and that is most of them, finding protection in its mass. Obviously, the main rule for herd behaviour becomes: do as you see others doing and be the best at it.
Implications exist for investors with a herd mentality: most tend to buy, stocks, property or any other investments, when everybody else is buying and so prices go much higher than they would otherwise. This also means that most investors buy at too high prices and post losses when the rush ends and values come down.
And, conversely, most investors tend to sell, say stocks, when everybody else is selling, often being forced to sell for ridiculous prices and then posting heavy losses. I suppose anyone would agree that buying high and selling low is not the way to a great fortune.
When there is a housing boom around, investment funds and any investing business, feel a need to participate in the boom or risk being seen as less profitable, a cardinal sin. This means that, whatever the competition is doing, others must also do and do more of it.
So, if every investing business around were, up to mid-2008, buying mortgage-backed securities rated AAA, with cheap borrowed money and you are not doing it, you are out – or you comply with the herd and join it. So did our two people above, Rubin and Prince in whose time Citigroup lost $US45 billion, by any means a crazy amount to lose.
But they purported to have done right just because they did what everybody else was doing – a typical herd mentality excuse. Perhaps at the time, because so many people were doing things that way, they felt that movement as powerful and compelling, and thought that because so many were doing it they must have been right.
We do not all need to have a herd mentality, though. A well know investor which does not have one is Warren Buffett, Berkshire Hathaway, Inc. chairman. Buffett, whose company is worth around $US160 billion, declaredly gets fearful when others get greedy, and gets greedy when others get fearful.
What this means is that, in a market downturn, he might find value in some companies and he buys them to keep for the long-term when their value will be properly appraised by the market. On the other hand, if markets are hot, he just avoids them or converts to fixed-interest part of his portfolio.
And judging by his proverbial wealth, yes, buying low and selling high is the way to a great fortune.
All a herd mentality person can do to avoid the pitfalls of herd behaviour in the area of investing, if he wishes, is to try develop his own thinking about the subject and try hard, rather than giving way to the inclination to follow others, to follow instead his own reason and judgement. By doing this you don’t necessarily become weird, but just genuine.
Consider this news: testifying before The Financial Crisis Inquiry Commission, Charles Prince and Robert Rubin, respectively Citigroup’s ex-chief executive and ex-head of executive committee, said, according to a Bloomberg report that “almost none of their peers on Wall Street predicted that sub-prime securities would bring on a credit crisis.”
This prompted the commission’s vice chairman, Bill Thomas to say “do you just do what everybody else is doing because everybody else is doing it, and if you don’t do it you won’t make money?”
At this stage it could reasonably be asked what herd mentality is? Basically, it’s a need to do what is perceived that most people are doing on any sphere of activity. This way we pack together and become a herd where all head in the same direction. The funny question here is why we do this?
Probably for reasons related to our animal nature. Many animal species in nature pack in herds and often the purpose is to obtain protection against predators. You see, if the Gnu in the Serengeti herds, the lion can only attack the animals on the fringe, the ones taking refuge in the centre of the herd, and that is most of them, finding protection in its mass. Obviously, the main rule for herd behaviour becomes: do as you see others doing and be the best at it.
Implications exist for investors with a herd mentality: most tend to buy, stocks, property or any other investments, when everybody else is buying and so prices go much higher than they would otherwise. This also means that most investors buy at too high prices and post losses when the rush ends and values come down.
And, conversely, most investors tend to sell, say stocks, when everybody else is selling, often being forced to sell for ridiculous prices and then posting heavy losses. I suppose anyone would agree that buying high and selling low is not the way to a great fortune.
When there is a housing boom around, investment funds and any investing business, feel a need to participate in the boom or risk being seen as less profitable, a cardinal sin. This means that, whatever the competition is doing, others must also do and do more of it.
So, if every investing business around were, up to mid-2008, buying mortgage-backed securities rated AAA, with cheap borrowed money and you are not doing it, you are out – or you comply with the herd and join it. So did our two people above, Rubin and Prince in whose time Citigroup lost $US45 billion, by any means a crazy amount to lose.
But they purported to have done right just because they did what everybody else was doing – a typical herd mentality excuse. Perhaps at the time, because so many people were doing things that way, they felt that movement as powerful and compelling, and thought that because so many were doing it they must have been right.
We do not all need to have a herd mentality, though. A well know investor which does not have one is Warren Buffett, Berkshire Hathaway, Inc. chairman. Buffett, whose company is worth around $US160 billion, declaredly gets fearful when others get greedy, and gets greedy when others get fearful.
What this means is that, in a market downturn, he might find value in some companies and he buys them to keep for the long-term when their value will be properly appraised by the market. On the other hand, if markets are hot, he just avoids them or converts to fixed-interest part of his portfolio.
And judging by his proverbial wealth, yes, buying low and selling high is the way to a great fortune.
All a herd mentality person can do to avoid the pitfalls of herd behaviour in the area of investing, if he wishes, is to try develop his own thinking about the subject and try hard, rather than giving way to the inclination to follow others, to follow instead his own reason and judgement. By doing this you don’t necessarily become weird, but just genuine.
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