Musings
Avoiding Herd Mentality in Investing
Why following the herd comes naturally to us?
When we get out of a flight, it’s normal to simply walk in the direction where majority of the people are walking. Mostly it’s ok to do that, as everyone is probably moving towards the exit. Further, each zone in an airport is clearly marked and unauthorized entry in each zone is restricted. But it may not be safe to ‘follow the herd’ in many other situations.
These days it’s so much pleasure to watch nature and animal documentaries with the improved cameras, movie-making techniques and the quality of our televisions. Like many animals in the wild, zebras usually move in herds, staying close to one another. Herding helps them to use their unique skin pattern to their advantage. Lions find it difficult to spot any one particular zebra as they get confused with the mass of many moving stripes. Even the weaker zebras enjoy better life expectancy by being part of the herd.
Unfortunately, we may not be able to draw a parallel from zebras when it comes to investing. The herd behaviour that we witness in the world of investing often surrounds a fad. Many investors jump into the trend, while simply sticking to the basics approach could have resulted in better outcomes in the long term. Remember, when zebras move in a herd, they are sticking to basics in their own way.
Some examples of herd behaviour from the history of investing
Historically, there have been many instances when investors jump in at the peak of a market cycle, across various asset classes and exit with substantial losses. Ironically, investors have been willing to take high levels of risk at a time when a market rally becomes overheated. Some of these instances are listed below:
- Dot-com stocks during the late 1990s
- Credit default swaps during the run up to 2008
- Global Financial Crisis
- Crypto currencies
- Tulip flowers during the 17th century Dutch Republic
On most of these occasions, the mistake of joining the herd is likely to have proven costly for many investors. In fact, the losses incurred during these times could leave an indelible mark in the memories of the investors that they turn extremely risk averse in future.
Do we need to stand out every time?
Not exactly!
Herd behaviour is not something we should feel guilty about. It comes naturally to us. Whenever we are not sure as to how to act, we look towards what others are doing for a cue. We all want to be accepted as part of the social set up. It is normal for most of us to take into consideration the social norms while making key decisions including buying a house, car, taking a vacation, venue for the child’s birthday party, etc. Social norms even apply to how we speak, stand, nod our head, etc. What’s interesting is that these considerations come naturally to us without even having to think. The idea logically extends to investing as well. Sometimes we accept additional risks just because others are taking them. Imagine scolding a kid as to ‘why she got drenched in the rain?’ The most likely response to the question would be ‘all my friends did it, so I did too!’ Similarly, many investors got into the crypto mania as a lot of others were doing the same without considering the risks. It is normal to feel left out
when all your friends are into commodities or options trading through a newly launched app in the market. It is definitely ok to find out more information about these new ‘avenues’ However, one should try and avoid the mistake of committing too much capital in the process.
How to avoid being pulled into a herd?
Taking the help of a professional financial planner can be a good start. Do we follow the DIY approach (Do It Yourself) when it comes to medical treatments? No, because it can be dangerous. Same applies to investing. Even a basic financial plan is likely to involve ascertaining your risk profile, long term goals and forming an ideal asset allocation. Once we follow these basics, you become relatively less likely to blindly follow what others are doing.
When your friend discusses the ‘next big new investment idea’ with you, your immediate reaction is likely to be “how would this fit into my asset allocation?” If you place a stringent personal filter that any new investment idea needs to pass the test of answering this simple question, it is easier to avoid being pulled to into herds.
Join the 'Healthy Herd' - The SIP Revolution
If you are exercising more, eating healthy, paying your taxes on time, donating for good causes, and so on, just because you find many others doing it, that’s great! There are many such examples of healthy herding. As on October 2024, there were ~10.12 crore mutual fund SIP (Systematic Investment Plan) accounts and ~ Rs.25,323 crore were the SIP inflows received in the month of October 2024 (Source: AMFI). It’s nothing less than a revolution of a massive scale that is currently underway. The simple SIP is gradually becoming the staple investment vehicle for many Indian households. While there are many reasons why SIP is an ideal choice for investing, a lot of investors may have started an SIP just because many others, including their friends and relatives, are doing the same. So, herding need not be harmful in all circumstances. However, it is important to know your investments in detail and keeping yourself updated over time.
SIP - Systematic Investment Plan
Views expressed herein involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied herein. HDFC Mutual Fund/HDFC AMC is not indicating or guaranteeing returns on any investments. Readers should seek professional advice before taking any investment related decisions and alone shall be responsible.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
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Why following the herd comes naturally to us?
When we get out of a flight, it’s normal to simply walk in the direction where majority of the people are walking. Mostly it’s ok to do that, as everyone is probably moving towards the exit. Further, each zone in an airport is clearly marked and unauthorized entry in each zone is restricted. But it may not be safe to ‘follow the herd’ in many other situations.
These days it’s so much pleasure to watch nature and animal documentaries with the improved cameras, movie-making techniques and the quality of our televisions. Like many animals in the wild, zebras usually move in herds, staying close to one another. Herding helps them to use their unique skin pattern to their advantage. Lions find it difficult to spot any one particular zebra as they get confused with the mass of many moving stripes. Even the weaker zebras enjoy better life expectancy by being part of the herd.
Unfortunately, we may not be able to draw a parallel from zebras when it comes to investing. The herd behaviour that we witness in the world of investing often surrounds a fad. Many investors jump into the trend, while simply sticking to the basics approach could have resulted in better outcomes in the long term. Remember, when zebras move in a herd, they are sticking to basics in their own way.
Some examples of herd behaviour from the history of investing
Historically, there have been many instances when investors jump in at the peak of a market cycle, across various asset classes and exit with substantial losses. Ironically, investors have been willing to take high levels of risk at a time when a market rally becomes overheated. Some of these instances are listed below:
- Dot-com stocks during the late 1990s
- Credit default swaps during the run up to 2008
- Global Financial Crisis
- Crypto currencies
- Tulip flowers during the 17th century Dutch Republic
On most of these occasions, the mistake of joining the herd is likely to have proven costly for many investors. In fact, the losses incurred during these times could leave an indelible mark in the memories of the investors that they turn extremely risk averse in future.
Do we need to stand out every time?
Not exactly!
Herd behaviour is not something we should feel guilty about. It comes naturally to us. Whenever we are not sure as to how to act, we look towards what others are doing for a cue. We all want to be accepted as part of the social set up. It is normal for most of us to take into consideration the social norms while making key decisions including buying a house, car, taking a vacation, venue for the child’s birthday party, etc. Social norms even apply to how we speak, stand, nod our head, etc. What’s interesting is that these considerations come naturally to us without even having to think. The idea logically extends to investing as well. Sometimes we accept additional risks just because others are taking them. Imagine scolding a kid as to ‘why she got drenched in the rain?’ The most likely response to the question would be ‘all my friends did it, so I did too!’ Similarly, many investors got into the crypto mania as a lot of others were doing the same without considering the risks. It is normal to feel left out
when all your friends are into commodities or options trading through a newly launched app in the market. It is definitely ok to find out more information about these new ‘avenues’ However, one should try and avoid the mistake of committing too much capital in the process.
How to avoid being pulled into a herd?
Taking the help of a professional financial planner can be a good start. Do we follow the DIY approach (Do It Yourself) when it comes to medical treatments? No, because it can be dangerous. Same applies to investing. Even a basic financial plan is likely to involve ascertaining your risk profile, long term goals and forming an ideal asset allocation. Once we follow these basics, you become relatively less likely to blindly follow what others are doing.
When your friend discusses the ‘next big new investment idea’ with you, your immediate reaction is likely to be “how would this fit into my asset allocation?” If you place a stringent personal filter that any new investment idea needs to pass the test of answering this simple question, it is easier to avoid being pulled to into herds.
Join the 'Healthy Herd' - The SIP Revolution
If you are exercising more, eating healthy, paying your taxes on time, donating for good causes, and so on, just because you find many others doing it, that’s great! There are many such examples of healthy herding. As on October 2024, there were ~10.12 crore mutual fund SIP (Systematic Investment Plan) accounts and ~ Rs.25,323 crore were the SIP inflows received in the month of October 2024 (Source: AMFI). It’s nothing less than a revolution of a massive scale that is currently underway. The simple SIP is gradually becoming the staple investment vehicle for many Indian households. While there are many reasons why SIP is an ideal choice for investing, a lot of investors may have started an SIP just because many others, including their friends and relatives, are doing the same. So, herding need not be harmful in all circumstances. However, it is important to know your investments in detail and keeping yourself updated over time.
SIP - Systematic Investment Plan
Views expressed herein involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied herein. HDFC Mutual Fund/HDFC AMC is not indicating or guaranteeing returns on any investments. Readers should seek professional advice before taking any investment related decisions and alone shall be responsible.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
