The Hindu Business Line : Why we herd

It is not just animals that herd. Last December, my friend invested most of his savings in momentum stocks. His investments are currently down 30 per cent; his blood pressure up considerably. Looking back, he wonders why he made such a foolish decision. My friend invested because his colleagues did so. He is not alone. All of us are often swayed by the crowd. Why do we herd?

Psychologists attribute herding to our fear that we might otherwise do poorly relative to our peers.

Pressure to keep pace

My friend was a careful investor, till he joined his new employer last October. He watched his colleagues make merry with their investments in mid-caps and small-caps. His exposure was primarily to large-cap mutual funds and bond funds. Pressure to keep pace with his colleagues forced him in late December to switch to mid-caps and small-caps. The rest is history.

It is not just with stocks. We flock together when we do not want to miss a “sure” thing. You might enroll for this “successful” slimming course because your friend claims it worked for her friend’s friend — only to find out that it does not work for both of you.

The problem with herding is that it often leads to a bubble. And bubbles always burst, as it happened with the technology sector in 2000. There seems to be another reason for this herd behaviour. Suppose a stock has just been hammered down for some reason and the market expects the price to go down further. If you were to buy the stock as a contrarian play and it goes down, the feeling of regret will be higher.

Join the crowd

You rationalise that you might as well join the crowd and buy momentum stocks. You can take solace from the fact that if the investment were to go wrong, you will not be the only one suffering! Even professional money managers display such behaviour. As for my friend, he may now regret his herding instinct. But this regret will gradually fade away — till he herds again.

(The author is an investment strategist.)

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