In investing, as in most walks of life, it pays to remember that childhood rhetorical question you’d get after you went along with something stupid your friends were doing. “If your friends were jumping off a bridge, would you do it, too?”
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The desire to go along with what the group is doing, and the fear of what might happen if you don’t, is hard-wired into your animal brain, says Brad Klontz, a certified financial planner and financial psychology professor at Creighton University. “Think about early humans,” he says. “People who didn’t care what other people did — the tribe kicked them out or killed them.”
That need to keep up with the pack could hurt you financially in the long run, though. “That herd mentality instinct is the one that hurts investors the most, especially during bubbles,” he says. “If you think you’re immune to it, that’s when it’s the most dangerous.”
Here’s why you may well be susceptible to this dangerous financial bias, and what you can do to overcome it.
How to identify the herd mentality
If you follow anyone who talks markets on social media, you’ve probably felt the pull of the herd, says Klontz. “I see it all over the place, and I feel it myself,” he says. “I think, ‘Don’t do that,’ but then, ‘Maybe I should. Should I buy dogecoin? It’s a joke, but that doesn’t mean people aren’t making money.’ That kind of thinking is huge right now.”
Spurred by online communities, people have piled into speculative investments, such as cryptocurrency and so-called “meme” stocks, without examining the investments’ underlying fundamentals or the risks that come along with them, says Klontz.
Video by Courtney Stith
Thanks to that demand, many early investors have made money in these trades. Dogecoin currently trades for 33 cents per coin, a 50% loss from where it sat after an early May trading frenzy, but well above the fractions of a cent it went for at the start of the year.
That success has amplified voices on social media that may be leading investors down risky paths, Klontz says. “There’s so much garbage advice out there that’s really harmful,” he says. “I saw someone on Twitter say that no one ever needs to own bonds. That not only ignores people’s individual financial situations, but, you do know that bonds trounced stocks for 20 years, right?
“There seems to be a collective delusion when markets are moving a certain way.”
How to avoid getting caught up in the herd
Following the herd can have serious consequences, Klontz says. For example, if you’re overexposed to speculative investments, a major chunk of your portfolio could get clobbered when the market pulls back. “You don’t realize it’s a mistake when you’re buying,” he says. “The mistake happens later, when there’s a correction.”
Financial experts suggest three ways to ensure that you’re keeping your investments on track, and not getting swept up in the fervor of the crowd.
1. Focus on your end goal
Ideally, your approach to investing won’t revolve around what you can do now, but rather where you want to end up, says Roger Ma, a CFP at lifelaidout and author of the book “Work Your Money, Not Your Life.” “It all starts with your goals, figuring out what you want, and aligning your investments with those goals,” he says.
“If you’re invested that way, you’re less likely to have that FOMO. You might say, ‘Ryan made a bunch of money on crypto, good for him.’ But if you’re invested for your goals, you can go on about your merry life.”
2. Take a breath
In a recent study of financial biases, researchers at Morningstar recommend investors create “speed bumps” to keep themselves from making impulsive portfolio decisions. This could mean you impose a three-day waiting period before you let yourself buy a new investment.
The goal is to let your rational brain catch up to your emotional impulses: “In these situations, we’re not rational. We’re rationalizing,” Klontz says. “We have an emotional response and then come up with an argument for it.” Having to pause allows you to consider the thinking behind your investing decisions.
3. Invest with a purpose
None of that is to say that you wouldn’t make money over the long run investing in cryptocurrency or speculative stocks. But financial advisors recommend dedicating only a small portion of your portfolio — no more than 5% to 10% — to those vehicles, with the rest geared toward steady growth. If you do make riskier investments, make sure you have a rationale that goes beyond, “I think it’s going to go up.”
“Maybe you assume bitcoin is going to be as good as gold, or half as good. Maybe you think it’s going to be a global reserve currency. There is money to be made under these scenarios,” Doug Boneparth, a CFP and founder of Bone Fide Wealth in New York City, recently told Grow. “Any serious investor in this space has to have a thesis for why they’re buying. ‘To the moon’ isn’t a thesis.”
The article “The One Money Bias That Hurts Investors the Most, According to a Financial Psychologist” originally published on Grow (CNBC + Acorns).