“Never underestimate the power of stupid people in large groups.” – George Carlin
A study on our eating habits found that, on average, if you dine with one other person you will eat about 35% more than if you were eating alone. If you’re out with a group of four other people you eat about 75% more and groups of 7 or more eat 96% more than if they were alone.
This is the herd mentality at work.
From an investing standpoint groupthink isn’t always a bad thing as markets tend to trend for long periods of time. But it can hurt your performance, especially at the extremes in investor sentiment, when you put the blinders on and assume that the crowd will be right always and forever. The list of groupthink investments that have gone terribly wrong over the years is a long one.
To deal with the herd mentality problem, here are the 8 symptoms of groupthink from The Little Book of Behavioral Investing by James Montier:
- An illusion of invulnerability: Members ignore danger, take extreme risk and are overly optimistic.
- Collective rationalization: Members discredit and explain away warning contrary to group thinking.
- Belief in inherent morality: Members discredit and explain away warning contrary to group thinking.
- Stereotyped views of out-groups: The group constructs negative stereotypes of rivals outside the group.
- Direct pressure on dissenters: Members pressure any in the group who expresses arguments against the group’s stereotypes, illusions, or commitments, viewing such opposition as disloyalty.
- Self-censorship: Members withhold their dissenting views and counter-arguments.
- Illusion of unanimity: Members perceive falsely that everyone agrees with the group’s decision; silence is seen as consent.
- “Mind guards” are appointed: Some members appoint themselves to the role of protecting the group from adverse information that might threaten group complacency.
Now here are some ways to avoid getting too caught up in the herd:
- Be aware of the consequences if/when the group is wrong.
- Seek out alternative viewpoints that disagree with your own and keep an open mind.
- Try to poke holes in your own argument. In the words of Charlie Munger – invert, always invert. Look at your ideas from the other side to better understand your own incentives.
- Understand the concept of mean reversion and the fact that investments can’t grow forever.
- Prepare to make mistakes.
- Write down your reasons for making the investment decision in the first place and review periodically to see if things have changed.
- Talk your ideas through with a trusted outside source that will give you honest feedback.
Decision Making: A psychological analysis of conflict, choice and commitment via The Little Book of Behavioral Investing
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