#7 - Herding: Exploring and Refuting Common Investor Behavioral BiasesInvestor Behaviors
“Birds of a feather flock together… and so do investors.”
Bernie Madoff masterminded one of the greatest affinity frauds in history. Madoff fleeced a large segment of the New York and Palm Beach Jewish communities of an estimated $20 billion by preying on a prominent investor behavioral bias known as herding. (Wall Street Journal)
Herding is most easily understood as imitated patterns of behavior of large groups influencing the same behavior or decision, no matter how rational. We as humans are creatures of habit, including our investment preferences. Hedge funds show remarkably predictable patterns of buying and selling similar stocks. This almost uncanny pattern of investor group predictability, “herding” as it’s often called, is what enabled Bernie Madoff to orchestrate such an extensive Ponzi scheme.
Herding for financial investors can express itself in a collective group investing in the newest investment trends without evaluating the risk. The newest and hottest investment option may be gaining great traction in the news or social circles, but it’s never wise to invest without carefully consulting with your trusted financial advisor. They can best address any prospective downfalls or advantages of each investment option.
Herding can also overvalue an investment option and cause a downward value trend. As with all investments, do your research, rely on your trusted financial advisor, and remember that trends come and go but sound financial principles are timeless.