Imagine your reading this post in a busy coffee shop. All of a sudden you look up and see people running out of the shop. What do you do first? Chances are, you get up and follow everyone else. You might not even know what’s going on at first. Are you getting away from a dangerous situation, such as a fire in the coffee shop? Or is everyone running toward something or someone, such as a celebrity?
This is an instinctual reaction. There is perceived safety in numbers. It goes back to some of the earliest known ancestors and can be seen in many animal species today.
If we dig into this a little deeper, it’s actually a mental short-cut (technically called a “heuristic”) . In the coffee shop example, you didn’t have time to take stock of the situation to understand what’s occurring. Instead, you relied on actions of others and assumed they were making the right decision. It worked well for our ancestors and it continues to work well for us today. Except….
Except for when it comes to investing. Assume you’re watching the news and all everyone is talking about how XVZ stock is doing “great” and “everyone” is buying it. Unfortunately, the average investor will want to get in on it. They follow the hearding behavior of others and buy XYZ simply because “everyone” else is doing it.
That’s precisely the wrong time to be buying a stock, yet it’s so difficult to overcome this instinctual response. This is even more difficult when stock prices are declining and investors hear about so many people selling out of their investments. The instinctual response to follow the crowd kicks in. The investor will feel better and maybe safer knowing they are doing what everyone else is doing. But evidence clearly shows it to be a poor decision to follow the heard of other investors.
This is an example of our instincts working against us. Instead of reacting to the news, take a minute to take stock of the situation, assess what is going on, consult with your financial advisor, and understand how your decision to buy or sell an investment will affect your likelihood of reaching your financial goal.