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Now I'm not passing judgement on this particular share as a security selection – there are far more qualified people than me to do so – but what intrigued me was why he'd selected this specific security. On pressing him for his reasoning, he struggled to articulate his thinking and my conclusion was that he may have succumbed to herd mentality, also known as the fear of missing out, or 'fomo'.
What is herd mentality?
People tend to mimic or emulate the actions of other people in a large group. Unfortunately for all of us, we don't always choose to imitate the rational behaviours of others. Sometimes, herd mentality stems from copying the actions of people of high status, but often, herd behaviour is the result of going with the crowd.
Herd mentality in markets
In the late 16th century, the Dutch tulip market was booming. Tulips were a novelty for most of the world and were one of Holland’s major exports. They were so popular that men were making and losing fortunes in one night. In fact, tulips were selling at as much as 10 times the price of the work from skilled craftsmen. The price of tulips skyrocketed thanks to trading in tulip futures. When the bubble (widely considered to be the first such financial bubble) finally burst in 1637, fortunes were lost. Why would people go crazy for tulips? The simple answer is herd mentality.
From our perspective almost 400 years later, trading on tulip futures seems ridiculous. Why would anyone do that? However, we should not throw stones. Two modern bubbles were almost as ridiculous: the dotcom bubble at the tail-end of the 20th century, and the subprime mortgage crisis of 2008. Critics of the cryptocurrency boom of recent years suggest that a similar phenomenon may be taking place in that space.
Modern investment decisions can be fuelled as much by emotion as logic, perhaps more so. We observe our peers funnelling cash into apparently sound investments – investments that are sure to go up and make us rich! When that happens, most people follow suit. Few individuals take the time and effort to do the research, but rather, are swept up in the rising tide of enthusiasm and hype.
In a Twitter thread from author Jim O’Shaughnessy in July, he offered, among other things, these sage observations on the predictability of human nature.
How to avoid the herd mentality and make better investment decisions
If you cannot give enough time to doing the research yourself, consult your financial adviser.
About the author
Wealth manager: Investec Wealth & Investment
Patrick is a senior private client wealth manager with Investec Wealth & Investment, specialising in providing holistic investment planning advice to some of South Africa’s high net worth and ultra-high net worth individuals, families and their associated entities.