The inclination to follow the masses in investment decisions, rather than basing choices on independent analysis.
Every so often, a stock or sector becomes the talk of the town, catching the attention of investors. The lure to join the crowd can be strong, and that’s precisely what herding bias is all about.
Herding bias is an evolutionary trait. During our early days as hunter-gatherers, staying with the group often ensured safety and survival. However, in today’s investment arena, this pack mentality can lead to poor decisions.
Herding can prompt investors to jump onto bandwagons, potentially inflating asset prices and creating bubbles with several examples over human history. It can lead to reactionary investment decisions, driven by fear of missing out (FOMO) rather than rational judgment. Herding can result in an under-diversified portfolio too, as investors pile into popular stocks or sectors.
Consider the recent “NFT boom”. Non-fungible tokens, or NFTs, gained massive popularity, attracting investors and sending prices soaring. However, when the hype around NFTs eventually deflated, those who had followed the crowd endured substantial losses.
Fortunately, there are strategies to mitigate herding bias. Firstly, awareness is key. Acknowledging this bias can prompt a more mindful approach to investing. Then, focusing on personal financial goals and risk tolerance is crucial. What works for others may not necessarily be the best for your unique situation.
Adopting a process-driven, disciplined approach to investing can help resist the allure of the crowd. This involves a thorough analysis of an investment’s fundamentals, rather than just going along with popular sentiment.
While the herd may seem safe and comforting, straying from the pack often leads to better investment outcomes. By recognising and counteracting herding bias, Aussie investors can steer their own course towards financial success.
