We humans have a willingness to suppress our own thoughts to conform to those in a group. Our inherent crowd behavior helped us to survive in groups thousands of years ago but this type of behavior in investing today is detrimental to our portfolios and financial health. Ben Graham observed that the intelligent investor is likely to need considerable will power to keep from following the crowd.
We are all pretty good at researching facts, forming opinions and making decisions by ourselves. However, studies have shown that majority to people change their behavior in a group.
The famous Asch conformity experiments from the 1950s show just how easily influenced we are by other people. In the experiment a subject was seated around a table with nine other participants who were actually working for the psychologist in charge. The group was shown a series of cards containing lines of different lengths:
Each group member was then asked a variety of question about the lines, and was told to say his or her answerers out loud. In one question the group was asked which line on the right was the best match for the line on the left side. The participants that went first were told by the administrator to give out the wrong answer to several questions. The participants working for the administrator was asked as a group to insist that line A was the best match for the line on the left side creating a condition of groupthink.
When the test subjects were asked the same questions without the group present almost all gave the right answer, it is not particularly difficult to determine which line is the longest. However, when the subjects were first exposed to the wrong answer endorsed by the group, they gave the wrong answer more than 35% of the time.
In another experiment a group of 10 college students were recruited to perform a taste test on a new yogurt. They were asked to determine the new flavor of this yogurt. However, unknown to the test subject, 9 of the 10 students were part of the experiment. The students working for the experiment were told to repeat predetermined responses when asked about the taste. The test subject was the last to go.
The actual yogurt given to the participants was strawberry flavored but the participants were told to insist that it taste like vanilla. The result reveled that in 8 out of 10 cases the test subject went with the majority claiming that he tasted vanilla. When the test was repeated only 20% of those who got it right the first time stuck to their guns.
As Warren Buffett observed A public-opinion poll is no substitute for thought.
Researchers have found that are less intelligent when we interact in groups. In a similar experiment test subjects were undergoing a brain scan (MRI) while playing different games in a group. The researcher conducting the experiment found that when the subjects were in a group they seemed to show a decrease in activity in the part of the brain associated with logical thinking. Subjects that played the game alone showed an increase in brain activity and showed better result.Going against the crowd triggers both fear and pain. In an experiment a subject was told to play a computer game with three other people while having his brain scanned. The other players were actually computer controlled but unknown to the test subject. In the game the players were throwing a ball back and forth. After a while the players started excluding the test subject, throwing the ball less and less frequently to him. This social exclusion generated a brain activity in the anterior cingulated cortex and the insula, both of which are also activated by real physical pain.
Going against the crowd causes the equivalent of social pain and going against the crowd in investing when your money is at stake can lead to even stronger emotions. This may explain why it is so difficult to go against the crowd and why everyone seems to want to buy or sell at the same time buying high and selling low.
It is in our nature to conform to the group. Jim Rogers pointed out that a fund manager seldom gets fired for doing what everyone else is doing and losing money. You get fired for doing something different and losing money. This fear of standing out is part of the reason most fund managers show such a poor result and given that most professional investors make decisions in groups only exacerbates the problem.
There are powerful self-reinforcing mechanisms at work in groups. These self-reinforcing tendencies can lead to group polarization a phenomenon where members of the group end up in a more extreme position then when they started because they have heard the views repeated frequently by others in the group. This behavior on the extreme end leads to groupthink which is faulty decisions caused by group pressure, and leads to mental deficiency and lack of moral judgment.
1. Illusion of invulnerability Creates excessive optimism that encourages taking extreme risks.
2. Collective rationalization Members discount warnings and do not reconsider their assumptions.
3. Belief in inherent morality Members believes in the rightness of their cause and therefore ignore the ethical or moral consequences of their decisions.
4. Stereotyped views of out-groups Negative views of enemy make effective responses to conflict seem unnecessary.
5. Direct pressure on dissenters Members are under pressure not to express arguments against any of the groups views.
6. Self-censorship Doubts and deviations from the perceived group consensus are not expressed.
7. Illusion of unanimity The majority view and judgments are assumed to be unanimous.
8. Self-appointed mindguards Members protect the group and the leader from information that is problematic or contradictory to the groups cohesiveness, view, and/or decisions.
Be wary, we all like to think that we are independent thinkers but it is sadly just another failure to see our behavior for that it really is. We are more influenced by other than we like to believe. Even more dangerous is that we often dont recognize our own bias. We have a tendency to believe that we are less likely to be influenced by other people or events than our peers. We often see our self as independent and unbiased. The facts however are much different.
In a related experiment a group of Apple computer users were asked how influenced they were by the trendiness of the products relative to their peers. They were given a survey with five questions ranging from much less influenced to much more influenced of trendiness compared to their peers. The overwhelming result showed that Apple users thought they were less influenced than their peers by the trendiness of their product.
It isnt easy being a contrarian. Even the best and brightest investor must overcome the obstacle of conformity. Contrarian investors are often marginalized and sometimes even condemned. Going against the crowd takes courage and determination.
Ben Graham said that you are not right because people agree with you. You are right because your facts are right and your reasoning is right. Stick with your reasoning and dont be led astray by Wall Street fashions and illusions.