Why “safety in numbers” might not apply to investing
06 June 2024
Being part of a group can make you feel like you’re less likely to fall victim to a mishap or other negative event. While the hypothesis might be true in some circumstances, the opposite may be said when you’re investing. Read on to find out why failing to follow the crowd could be a good thing.
The inclination to be part of a large group and adopt the behaviours of people around you is sometimes referred to as “herd mentality”. Following the same route as other people can give you a sense of security and help you feel as though you’re making the right decisions. After all, you might think: they can’t all be wrong, can they?
Yet, financial decisions should often be based on your circumstances. So, a safety-in-numbers approach could have the opposite effect and harm your long-term finances.
A fear of missing out could lead to you following the crowd
There are lots of ways that a herd mentality might affect your investment decisions, including a fear of missing out.
You could hear a group of friends or colleagues discussing an investment opportunity. They may be excitedly talking about the returns they expect to make and how it’ll help them reach their goals, from retiring early to paying for private school for their children. With everyone else seemingly poised to secure huge returns, you might be worried about missing out, and so follow the crowd too.
Similarly, reading news articles might lead to you seeking safety in even larger numbers.
Earlier this year, you might have read about the soaring value of US-based technology stocks dubbed the “Magnificent Seven”. With headlines like ‘The Magnificent Seven stocks are now roughly equal to the combined value of the UK, Japan, and Canada’s stock markets’, you might feel like you’d be missing a huge opportunity by not investing in these companies like other investors.
Even the moniker collectively given to these technology firms makes it seem like you’d be a fool not to invest some of your money in them.
Yet, delve a little deeper, and you could find that investing in the same companies as everyone else isn’t right for you.
Take Tesla, for example. While it is one of the companies that make up the Magnificent Seven, according to Bloomberg, between January and March 2024, it was the worst performer on the S&P 500 stock index. So, if you had invested, it might not have delivered the returns you expected if you simply read the headlines. What’s more, the company might not suit your risk profile or investment strategy.
Despite this, the view that there is safety in numbers still leads to people making investment decisions that aren’t right for them. Indeed, history is littered with examples of investors who followed the crowd and faced the financial consequences.
Investment bubbles: From technology to tulips
Investors believing there is safety in numbers may cause “bubbles” – where the market or a particular asset’s value rapidly escalates before quickly falling in value when it “crashes” – as demand rises as more people seek to get on the bandwagon.
Some investors might remember the dot-com bubble in the late 1990s. The widespread adoption of the internet led to the rapid growth of valuation in so-called “dot-com startups”.
Eager to capitalise on the rocketing growth of companies operating in this exciting technology space, investors started to pool their money in online shopping companies, communication firms, and more. Indeed, between 1995 and 2000, tech-focused US stock index Nasdaq rose by around 800%.
When the bubble burst in 2000, some companies failed, many without ever making a profit, and others lost a large portion of their market capitalisation.
Herd mentality harming investors isn’t a new phenomenon either.
In the 1630s, the price of fashionable tulips soared when they became seen as a status symbol across Europe. At the height of “tulipmania”, the rarest tulip bulbs traded for as much as six times the average person’s annual salary. To some, it seemed like everyone was making money simply by purchasing and trading bulbs.
A fear of missing out led to people purchasing bulbs on credit – and when prices started to fall, some victims of herd mentality were forced to declare bankruptcy as a result.
A tailored investment strategy could help you make decisions without following the crowd
So, if there isn’t safety in numbers, what approach should you take to investing? Creating a tailored investment strategy that focuses on long-term returns could help you reach your goals.
A “good” investment isn’t right for everyone. A friend may tell you about an excellent investment opportunity that sounds tempting. However, if they are investing for retirement in 20 years and you’re investing for a goal that is just five years away, your approach to assessing if an opportunity is “good” could be very different. For example, with a longer time frame, your friend’s risk appetite may be much higher than yours.
Rather than following the crowd, reviewing investments with your strategy in mind could help you select investments that align with your aspirations.
Contact us to talk about your investment strategy
We can work with you to assess which investments suit your needs. We’ll consider a wide range of factors, from your risk profile to your other assets. Please contact us to arrange a meeting.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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