Have you ever been to a fishery? I’m talking about the giant fish ladders where all the salmon are swimming/jumping and splashing? It seems like there’s a never ending stream (pardon the pun) of fish – and they’re all heading in the same direction.
Following the herd works well if you’re a fish – or nearly any animal in nature – because there are strength in numbers. But does it work well in investing?
Not so fast, my friends!
When any asset class soars, investors can’t help themselves and jump right in. Pick a category: large cap stocks in the early 90s, technology stocks in the late 90s, real estate in the mid-2000s, or more recently gold, to name the latest few…the higher prices climb, the more people want in.
That’s completely backward.
Legendary investor Warren Buffett has a beautiful quote on the subject: “Be greedy when others are fearful – and fearful when others are greedy.”
What he means is simply this: When the market is peaking and prices are increasing day in and day out, it’s best to stay on the sidelines. Don’t follow the herd.
In fact, the primary driver to investors’ investment performance has nothing to do with selection of great investments, but rather the behavior of investors. According to Morningstar, investors in U.S. stocks mutual funds earned 2.3 percentage points per year less than the funds themselves. Why is that? That’s simple: Investors tend to get all wishy-washy as asset classes either “soar” or “plunge” and then react based on emotion and/or what the “herd” is doing.
How do you avoid “Following the herd?”
Professionals call it an “investment policy statement,” but it’s more simple than the name sounds. Make yourself some ironclad rules that you promise never to break no matter the circumstances.
For example, you could set up a systematic investment plan that continues no matter what happens day-to-day in the market. You could promise yourself to keep only 30% of your assets in large company stock funds and never more than 10% of your portfolio in any single investment. These rules will help you manage your money wisely with the long view in mind.
More importantly, they’ll help prevent you from being part of the herd!
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