Human beings have a natural tendency to go with the herd. By banding together, we can face threats as a collective instead of as more vulnerable individuals — or so the theory goes.
However, while this might serve as a good rule of thumb in the wild, as an investment strategy it has the potential to create less, not more, security. In fact, diverting your investment funds to the less popular, somewhat under-the-radar assets could even net you with a greater return than doing what everybody else does.
The dangers of herd mentality in investing
It seems more and more Australians are looking at their neighbours when formulating their investment strategy. Rather than evaluating an asset on its own terms, they purchase bank stocks that pay high dividends, in the hope that the legions of other investors they’re following know what they’re doing.
Yet if the tale of the pied piper tells us anything, it’s that simply following whoever’s in front of you without thinking for yourself can be catastrophic.
We needn’t look to parables and children’s stories to confirm this to ourselves, however — history has plenty of good examples. As Scott Philips pointed out in a recent article for the Sydney Morning Herald, plenty of homeowners in America were confident that house prices would simply go up and up in 2007, before it all came crashing down.
Similarly, the 1990s dotcom boom (and eventual bust) occurred due to overconfident investors sinking their money into whatever internet-related businesses they could find, regardless of how sound these enterprises actually were. Again, the culprit here was investors following the leader, certain that if everyone else was doing it, it must be a good idea.
But you don’t have to give up on investing and turn to a high-interest savings account instead. There are alternatives.
What should you do instead?
Rather than looking at what everyone else is doing, investing is one enterprise that rewards the brave and bold individuals who dare to strike out on their own. Don’t simply look over your shoulder at the competition, but rather look for cheap investments that can provide long-term capital growth.
“Investors need to remember that intrinsic value emanates from earnings and that the principal growth driver of growing intrinsic value is to grow earnings,” explained Carlos Gil, chief investment officer at Microequities Asset Management.
The story of John Buckingham is perhaps one of the most famous examples of this. At the beginning of last decade, Apple was an unprofitable, has-been company whose shares were going for very little. Buckingham saw potential in the company’s innovative products and die-hard fan base, buying shares when they were cheap and selling them for far more by the time the iPod was released.
Such investors are called value investors — those who look for company shares they believe are undervalued by the market. In a sense, they profit from the errors made by the herd. It may be a strategy to consider.