Your Mind and Your Money - Herd Mentality
Monday, November 16, 2009Explore more of Your Mind & Your Money.
SUSIE GHARIB: Thanks Paul. While there are many reasons to buy a stock, many people do it just because others are buying. And that tendency to follow the crowd can lead an investor astray. As we continue our series "Your Mind and Your Money," Dan Grech reports that herd mentality seems deeply embedded in human psychology.
DAN GRECH, NIGHTLY BUSINESS REPORT CORRESPONDENT: Have you ever noticed how animals tend to move together in groups? Whether its birds, elephants or cows, they all seem to share the same instincts to herd. The question is: do we as humans share the same herding behavior?
DR. RICHARD PETERSON, AUTHOR, INSIDE THE INVESTOR'S BRAIN: Herding is a response having not enough information and thinking that others around us can actually give us a shortcut to how to make a decision.
GRECH: Dr. Richard Peterson is a psychiatrist who now manages hedge funds. He says the impulse to stick with the group dates back to our earliest ancestors.
PETERSON: If were in a group of people in the Serengeti and one person starts running, we probably want to pay attention to what they're running away from or start running with them, because those who didn't do so, would be a meal to the lions.
GRECH: Today, lions are less of a problem. But the desire to be part of a group still runs deep. Safety in numbers is one reason people join investment clubs like the Polaris investment club in Palm Beach Gardens, Florida. Once a month, club members meet to invest the cash they've put in the treasury. Sally Escott helped found the club 15 years ago. She says one strength of the group is that members do not always agree.
SALLY ESCOTT, POLARIS INVESTMENT GROUP: We don't get to the fisticuff stage. We just debate and if you're on the winning side of the vote, that's fine and if you are not, that's OK. You go do it on your own.
GRECH: That range of independent views has helped the Polaris club win a national portfolio contest eight years in a row. Co-founder Len Gilman says in other investment clubs, group think often prevails.
LEN GILMAN, POLARIS INVESTMENT CLUB: Our club does not have anybody who is monopolizing or strong arming or over influencing others. And this has been the downfall of some investment clubs.
GRECH: Studies have found that going against the majority is incredibly hard. People will generally suppress their own opinions instead. Dr. Gregory Berns is a neuro-economist at Emory University. In one of his experiments, volunteers were shown three-dimensional blocks in various configurations. They were asked: are the blocks identical? When the volunteers were alone, they almost always gave the correct answer: the blocks are the same. But when they were put with people coached to give the wrong answer, the volunteers changed their minds. They said the blocks were different. Berns says brain scans revealed why. The desire to please the group was so strong, it actually altered the way the volunteers saw the blocks.
DR. GREGORY BERNS, NEUROECONOMIST, EMORY UNIV., SCHOOL OF MEDICINE: There is, as far as our brains go, kind of no reality. The reality is what we construct in our minds. And that's influenced by other people.
GRECH: So studies of the brain confirm that people are very sensitive to peer pressure. But some people are able to withstand that pressure. They're not afraid to go against the crowd. They're called iconoclasts. Among investors, Warren Buffett is an iconoclast. He often goes against conventional wisdom on Wall Street. Peterson says being an iconoclast may seem risky, but it's often profitable.
PETERSON: In the financial markets of today, if you see a danger you can probably bet that everybody else has seen that danger as well. And in fact, it turns out it's probably best to buy at that time when you see the danger. It's very ironic but financial markets are completely counter intuitive.
GRECH: So herding may be good for cows. But if you're an investor, even a bullish one, it's one form of animal behavior you may want to avoid. Dan Grech, NIGHTLY BUSINESS REPORT, Cherry Grove Farms, New Jersey.
