Fin24.com | Scene vs. herd: How to stop group mentality wrecking your finances

Fin24.com | Scene vs. herd: How to stop group mentality wrecking your finances
Fin24.com | Scene vs. herd: How to stop group mentality wrecking your finances

Have you ever noticed patterns in the way that groups of people live their lives?

These patterns become more obvious and predictable when the size of the group of people increases.

Observing these patterns makes it easier to anticipate how people will behave in certain circumstances.

Investment markets like the stock exchange are like real-time windows into the behaviour patterns of large numbers of investors. When markets become volatile, it is often easy to see how investors start to display group (herd) mentality where they follow price trends without any thought of their own.

Herd behaviour is great when you are faced with life-threatening situations, but it can be a very damaging way to make financial decisions. Those investors who can step out of the herd and think for themselves can often make very profitable decisions in volatile markets.

Patterns all around us

A great example of humans behaving in a repeated pattern takes place every year at fitness gyms all around the country. It starts in January as everyone returns to work, gyms are crowded with eager newbies determined to get in shape. By Valentine’s Day, the gyms are back to normal, with the regulars plus a few newbies who have stuck to their training plans.

Sadly, by mid-winter gyms are fairly empty with a few dedicated regulars. There is a new influx at the start of Spring as people decide to get ready for Summer. Then gyms gradually empty again and by mid-October, they are back to normal until December, when they are quiet.

The consistency of this pattern would be amusing were it not for the fact that obesity is increasing around the world and lifestyle-related illnesses kill larger numbers of people every year.

Investment markets also have patterns

The creation of cryptocurrencies, and the frenzy they caused late in 2017, provides a great, high-speed example of a very typical pattern in investment markets. People discover the 'Next Big Thing' that is going to revolutionise the world. Then the early adopters buy into the story, and create momentum that accelerates demand for the Next Big Thing (NBT) and soon the price of the NBT starts to rise, quickly.

The fast-rising price of NBT creates a new group of followers who missed out on the initial price rise and because they missed out, they will pay whatever price is demanded to get into NBT because “it is sure to change the world” and “you cannot lose by investing”. Towards the end of this cycle, people become so frantic to buy more that they borrow money, sell their assets and give up their jobs to trade NBT.

Soon car salesmen who were lucky enough to buy some NBT at the start are now multi-millionaires with their own YouTube channels and podcasts on how to “make it big!” Inevitably, some commentators who urge caution are labelled as “old school” or “out of it” or “ready for retirement”. The pattern ends in a very typical way, it blows up spectacularly and costs many people their life savings. The collapse of Bitcoin’s price in December is very typical of many other bubbles that we have seen before.

Protect yourself from herd mentality

When you are making investment decisions, it is critical to remove emotion from your decisions, especially FOMO (Fear Of Missing Out). A bit of discipline, a fraction of delayed gratification and some planning is all that is required to avoid becoming another statistic.

To protect yourself from herd behaviour, you need to have your own strategy for your money. It is important to decide how much you want to set aside for long-term, higher risk investments; how much you need to keep available for immediate expenses and how you are going to manage debt.

If you see other people starting to get excited about a new Next Big Thing, you need to remember that it is ok to miss out on the hype because these cycles usually end badly for investors. If you suffer from FOMO, then invest a small amount that you can afford to lose in the Next Big Thing. It will be fun to watch the jump in value, but not damaging to your financial future when it collapses.

Warren Ingram is a Wealth Manager at Galileo Capital. www.galileocapital.co.za@warreningram

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