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Following the Herd? Groupthink

Posted by: Sam Lees
Membership level: Free
 
Your inability to think independently can be dangerous to your wealth.  But you’re not alone.  In this blog, we highlight some great examples of this problem and look at the solutions proposed by one of the best independent thinkers of our generation: James Montier.

Humans are (mostly) sociable animals.  However, our need for other people’s company has its downsides, particularly when it comes to investing and thinking clearly…and eating?

Studies looking at the relationship between the size of a group and the amount eaten show that the larger the group the more we eat.*

If you eat with one other person, you’ll eat 35% more than if you eat alone.

If you’re a group of five you’ll eat 75% more. More than 7 in the group? Statistically, you’ll eat 96% more than if you were eating alone.

This herd mentality – eating more in a group than we would on our own – can partly be explained by the term “groupthink”: The tendency for groups to take questionable decisions, ignore possible problems and discount the opinions of outsiders.

This same thinking that affects your dinner table also affects your investing.

In “The Little Book of Behavioural Investing” James Montier illustrates the 8 symptoms of groupthink as follows:

  • Considering too few alternatives to current thinking
  • No critical assessment of group members’ ideas
  • Selective information gathering
  • No contingency plans
  • Rationalising poor decisions
  • Belief in the group’s invulnerability and morality
  • Suppressing true feelings and beliefs
  • Maintaining an illusion of unanimity
  • Appointment of ‘mindguards’ to protect the group from negative information
You can see that there is a strong relationship between these elements. For instance, mindguards’ suppression of alternative viewpoints makes it easy both to consider too few alternatives and rationalise poor decisions because of insufficient alternative viewpoints.
 
How can you avoid the dangers of “groupthink”? There are simple things to do to mitigate this dangerous tendency. These may feel uncomfortable but they are key to a successful investment process that allows you to invest with open eyes and an open mind.
  • Write down why you bought an investment
  • Review your reasons regularly to see if things have changed
  • Seek out alternative viewpoints
  • Test your beliefs by taking a contrary position
  • Have respect for views that differ from your own
One of the reasons investors like Warren Buffett and Charlie Munger have been so successful is the time they have taken to gather information from a vast range of sources and to play Devil’s advocate.
 
A great way of testing one of your beliefs is by asking: “What if I’m wrong?
 
Following the herd isn’t always a bad thing. It is the foundation of momentum investing, which assumes that you’ll be buying into investments that are doing well on the basis that they will continue to do well for a defined period. 
 
But groupthink is insidious. It leads to bad decisions and an inability to accept or even acknowledge when your investing plan no longer applies.
 
The good news for investors is that this is a problem with simple solutions. 
 
FURTHER READING
 
 
 
*There have been a number of studies looking at this phenomenon. 
 
And this study from 2007 looks at food consumption in small and large groups of children.  There is a strong influence from our hunter-gatherer ancestors, as well as “social facilitation” because of our inherently social nature.
Topic: Investment research


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