I didn’t know what a Lemming was. In case you don’t either, here’s what it is: “Any of various short-tailed furry-footed rodents of circumpolar distribution.” My next bright reaction was, “Huh?” Till I realized that what Warren Buffet’s referring to here is “pack behavior.” Montier describes it as the “willingness to subjugate one’s own thoughts for those of a group.”
And … you’ve guessed it right! This is exactly what Montier talks about in Chapter 14 of The Little Book of Behavioral Investing: How not to be your worst enemy.
As people, we tend to follow the herd. You’re not one of them? Really? When was the last time you made a contrary statement in a business meeting that your boss didn’t want to hear? And please, we’re all guilty of weird actions taken under the influence of peer pressure. The desire to be accepted, be part of a group … it’s a basic human need. And when we’re not careful, it leads to moral, ethical, and in this case, financial failure.
A number of experiments outlined by Montier prove that people who make smart accurate decisions when on their own miss the mark when made aware of a group judgment. They allow this information to influence their own sense of right and wrong, crushing their independent (and more accurate) thought. In one test, the accuracy rate of individuals’ answers fell from 90% to 59% once they saw other people’s results.
What’s even more interesting is the fear that’s triggered in our head on going against the crowd. Neuroscientists studied the brain scan of the experimental subjects during such tests. The found that:
- Going with a group answer decreases activity in the C-system, the part that handles logical thinking.
- Nonconformity triggers fear and pain. Non-inclusion or social ostracism activates the same brain parts activated by real physical pain.
Avoiding pain and fear can cost investors dearly. The proof of this lies in the fact that stocks sold by institutional fund managers actually outperform stocks they’re busy buying. Over a two year horizon, the difference is estimated to be as much as 17%. That’s a lot!
Group behavior has other ramifications, like the tentacles of an octopus. They protect their own, praising likeminded people and shunning those who refuse to buckle under the pressure. The “group think” behavior leads to faulty decisions based on:
- Over-optimism and over-confidence (of course, we can’t be wrong).
- Irrationality (blind collective rationalization).
- Rightful morality (loose sense of moral, ethical, logical or long-term consequences).
- Blanking out of dissenting views (don’t listen to the pessimists).
- Group pressure (arguments must not be aired).
- Blinders (no deviation from the perceived group consensus).
- Presumed unanimity (individual voices are drowned).
- Insulation of leaders (group cohesiveness priority over contradictory views).
So how do you beat this? By becoming a contrarian investor.
Warning: If you’re a professional investor with a yes-boss organization or even an educationist from academia, this view could get you out on your butt.
Now that we’re past that, here’s what you do:
First step: Admit you’re part of a herd. Curb the fundamental attribution bias. It makes us imagine we’re independent thinkers while the rest are easily influenced.
Breaking news! We’re all sheep!
Second step: Memorize the principles laid out by Ben Graham:
- Have the courage to be different.
- Be a critical thinker. To do this, you must understand why the market is not appreciating what you value as good stock.
- Stick to your principles. If you believe your investment plan is based on sound valuations, don’t get distracted. Stick with it.
Monica Samuel is doing a chapter-wise review of the book: The Little Book of Behavioral Investing: How not to be your worst enemy by James Montier. You can follow the series by following this tag: tlbbinvesting or by subscribing to this rss feed: tlbbifeed