Herd behaviour... when we instinctively join groups and do what we see everyone else doing. like the wildebeest in the image above. All it took was one of the herd to cross the river, then a few more. Eventually, the herd crossed over without giving it any thought.
When it comes to our financial stability, herd behaviour is when we follow the crowd and do what we see everyone else doing. We don’t want to be wrong, so we instinctively go along with the crowd.
This behaviour often results in panic buying and panic selling of our investments. This panic situation can create market bubbles or market crashes as we've seen in the past.
The dot-com bubble of the late 1990s and early 2000s, the financial crisis of 2008, and the COVID-19 crash in March 2020 are examples of herd behaviour.
According to Morningstar, “It’s natural to want to follow the crowd. But unfortunately, the crowd is usually running in the wrong direction.”
But, why does this happen? Why do investors follow the crowd?
For a few reasons:
We are more prone to herding behaviour when making difficult decisions. In our minds, we instinctively look for a shortcut. We look at the crowd and follow what they are doing. Financially, if we’re not confident about our financial strategy or expertise, we may instinctively choose to follow the crowd, and unfortunately, it’s usually heading in the wrong direction.
During times of uncertainty, we’re prone to herding bias. We seem to be in a time of rapid change. What will be the long-term impact of the pandemic? Or the impact of the war in Ukraine? For the last 3 decades, we’ve seen declining interest rates and low inflation. Now we seem to be seeing that trend reversing and creating some uncertainty, especially for investors born after 1980.
Going against the crowd is draining and uncomfortable. Our instincts tell us to go along with the crowd so we aren’t left behind.
Not following the crowd requires us to be more rational and make more logical choices. That requires us to pay attention. Right now our attention is already concerned with things like the cost of gas, food, housing and the uncertainties above. It takes a lot more effort now to make rational disciplined decisions.
So What Can We Do?
Avoid panicking. Stay disciplined and work with an advisor that can help you stay on track with your financial plans. Avoid buying high and selling low.
Engage the logical side of your brain. Remember, those who stayed the course with their investments during previous market crises, like the global financial crisis in 2008, did recover and saw positive returns in the following years.
Check with your financial professional who is experienced in guiding during uncertain times, since we are at greater risk for herding behaviour when we face uncertainty.
Finally, try to think differently and go against the crowd. Market volatility is a good time for buying low. Current valuations have not been this favourable since the beginning of the pandemic in March 2020 and the financial crisis of 2008.
When we are faced with setbacks, and challenging times, it’s essential to review our plans. Now would be a good time to revisit your financial plans. If you do not have a written plan, start planning for the coming recovery now.