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Herd Mentality: Why Do We Follow The Crowd? And Is It OK?

Around 20-25 gazelles are lazing around in the afternoon sun, casually munching grass. Suddenly, one gazelle jerks up its head... and starts running. It has apparently heard some strange noise. Seeing this, all other gazelles too start running. No one bothers to check whether the threat is real or imaginary.

This is nothing but Herd Mentality.

Humans too often exhibit this tendency to — blindly — follow the crowd.

Examples : Fashion trends, hair styles, movies, television shows, favourite eating joints, superstitions and much more (and also tragically mob mentality like lynching).

Dale Carnegie too warns “When dealing with people, remember you are not dealing with creatures of logic, but creatures of emotion.

Which brings us to the two key questions:
- Why do we follow the crowd?
- And, is it good?

Why do we follow the crowd?

Is it fear?
This tendency is probably the legacy of the early human history, when there was safety in numbers. Having ingrained itself deep within our brains, this behavior is very difficult to overcome... despite rational thought.

Or are we afraid of being different?
Swimming against the tide is not easy. And, the stronger the trend, the more strenuous the task is. It requires great courage and conviction to stand apart from the crowd. It is so much more comforting to do ‘accepted’ things and be a part of the group.

Or do we believe in the wisdom of the masses?
If most people around us are following a particular trend, it is but natural to presume that they must be doing something right. Surely, so many people cannot be wrong. It is but natural to think this way, because in many instances we do not possess all the information. So we end up trusting the crowd as it appears to possess the sum-total of all information. 

(Note: This, as per the classical economic theory, is the efficient market hypothesis. In other words, markets are — supposedly — efficient.)

Or is it FOMO i.e. Fear Of Missing Out?
Nowadays people are constantly on their smartphone checking their Facebook, Twitter, Whatsapp, Email or Instagram accounts. Why? They fear they might miss something important. Likewise if your friend has made big and quick money in some stock, you too jump in. You don't want to be left out and later regret missing the party.  

Or are we simply too lazy? 
A typical investor is lazy. He is averse to working hard to discover the potential gems in the market. Rather, the focus is on getting the hot tips from brokers, friends, colleagues etc. There is not even an iota of effort to, at least, verify the information.

(Blindly) follow the crowd and your investments could suffer deep losses.

And, is it good?

Whatever may be the underlying reason, the fact remains that we make many of our financial decisions based on what others are doing

And, more often than not, this has led to disaster. It is not uncommon for such tendencies to assume serious proportions.

Tulip Mania in 1637 is perhaps one of the first known cases of herd mentality in finance, when investors suffered huge losses. 

The dot-com mania in the 90s and the housing bubble in the US in 2007 are the recent examples of herd mentality that turned millions of investors into mere paupers.

By the way, to begin with the Americans investing in property was not a bad idea. However, it was this very demand that distorted the price structure when it exceeded ‘reasonable’ levels. With no specific definition of what is reasonable and what is excessive, we really cannot say when even the good investments turn into bubbles.

Being unsustainable, bubbles burst... sooner or later. 

Moreover, as the prices reach unreasonable levels — without reflecting the true worth  the correction is very sharp and very quick. Those who enter during the last phase of a bubble lose a lot, that too without receiving any warning.

Given this repeated history of bubbles, we need to question — ‘Maybe others are wrong.’

Similarly, when the markets are crashing, everyone turns into a seller. They all are running away from the market as if there is no tomorrow. Or, when the markets are in a boom phase, everyone turns into a buyer. They all are plunging into the market as if there is no tomorrow.

Both these actions i.e. EXCESSIVE PESSIMISM and IRRATIONAL EXUBERANCE often end in huge losses to the investors.

In fact, presently, we are witnessing the same herd mentality in financing the start-ups. Anyone with some spare cash, is willing to back a start-up company. So the valuations are turning expensive. Slowly — but surely — this too is turning into a bubble. And, like all bubbles in the past, this too shall meet the same fate. [Read this report on trouble in the start-ups in the Economic Times.]

Moral of the story: Do not follow the crowd. Never.

In the famous words of George S. Patton Jr. "If everyone is thinking alike, then somebody isn't thinking."

An Investment In Knowledge Pays The Best Interest ~ Benjamin Franklin

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