During our childhood and teenage, most of us would have done those few things simply because everybody around was doing it. And perhaps the add-on reason can be because it looked cool.
Many of these mindless actions (most of the times) would elicit one response from our parents or teachers, “If your friends jumped off a cliff, would you do it too?”
If you ask me, I remember doing a lot of things just because my friends were doing it like joining a gym even though I wasn’t exactly a bodybuilding enthusiast. And opting for a course in computer programming, although I had zero inclination towards programming.
Thankfully I got rid of this habit after growing up, but sadly I can see this herd mentality a lot, especially among investors.
Herd Mentality In The Stock Market
So what exactly do I mean by a herd mentality?
By herd mentality, I mean behavior in which people act the same way as the people around them by ignoring their own feelings in the process.
Consider it like a sheep blindly following the flock, no matter where they go just because that’s what the herd is doing. In the stock market, herd mentality attributes to actions like buying a ‘Hot’ stock because everybody around is buying it. Another action can be panicking and selling your investments for a loss at the slightest signs of correction because everybody else is doing it.
Exemplary Examples Of Following Herd Mentality
While it is easy to follow others, such investment decisions based on a herd mentality can be detrimental to wealth creation. There are many such examples in the past that reveal how investor wealth has been destroyed due to the herd mentality.
One of the best examples is the burst of the dot-com bubble. Prior to the bubble burst, many tech companies witnessed a spectacular rise in valuation, thanks to the spread of the internet. During this period, companies could raise their valuation simply by addressing themselves a ‘dot-com’ company or adding a ‘.com’ to their name. Technology stocks were viewed as the hottest stocks to invest, and investors lapped up stocks at exorbitant prices.
When finally the bubble burst happened, it led to a massive crash of the NASDAQ, the second-largest stock exchange in the world by market capitalization, and nearly $5 trillion was wiped out in market value between the years 2000-02.
Reliance Power IPO
Another excellent example of how herd mentality destroys investor wealth is the mega Reliance Power IPO launched in 2008, which was touted to be one of the biggest IPO’s in the history of Indian markets. From vegetable vendors to shopkeepers and taxi drivers, to HNIs and foreign investors, people flocked in masses to invest in the IPO. I remember many investors liquidating their other stocks and even borrowed money from banks and finance houses to invest in it.
The excitement of investors over the IPO continued despite concerns over valuation expressed by few rating agencies over the overvaluation. With this, the company had almost no assets and cash flow. It was riding only on the Reliance brand name and also the euphoria around Indian stock markets.
The issue was sold out within the first minute of its opening on January 15, 2008, a record for a mega offering of Rs. 11,563 crore. But investors who received allotment were in for a rude shock, as the stock had a terrible start right from the listing date of 11th February, 2008. Reliance Power which surged 19 per cent to Rs. 538 on opening, dropped to Rs.355 within minutes and closed at Rs. 372.50 wiping out billions of rupees of investor wealth, never to recover till date.
The issue was sold out within the first minute of its opening on 15th January 2008, a record for a mega offering of Rs. 11,563 crore. But investors who received allotment were in for a rude shock, as the stock had a terrible start right from the listing date of 11th February, 2008. Reliance Power which surged 19 per cent to Rs. 538 on opening, dropped to Rs.355 within minutes and closed at Rs. 372.50 wiping out billions of rupees of investor wealth, never to recover till date.
You would be shocked to know that an investment of Rs. 10,000 in Reliance Power made during IPO would be worth just Rs.67 today. Even brand name Ambani, which was synonymous for wealth creation in stock markets earlier could not save Reliance Power.
Avoiding The Trap & Investing Like An Eagle
According to a study conducted by researchers Russell Jame and Qing Tong, most investors follow each other into and out of the same industries, and they tend to chase industries that have performed well over the past two years and sell the poor performers over the same period. This herd mentality leads them to buy high and sell low, which is just the opposite of buying low and selling high, the real way to create wealth in the long run.
The reason why people indulge in herd mentality in investment is the feeling that if so many people are doing something, it must be the right thing to do. But unfortunately, in real life and even in the stock market, this hardly holds true.
One’s own investment decisions should never depend on what their friends or relatives say. An individual should never invest in a particular stock simply because everyone around is investing in it. This strategy will never yield good returns and may result in substantial losses in the long run. Remember, your financial goals are different from the others around you. Instead, conduct a solid research and then take a call, goes without saying that you need to have a long-term view, just like an eagle.
Instead, conduct solid research and then take a call, goes without saying that you need to have a long-term view, just like an eagle. And one can have a long-term perspective, only when an investor has patience and research besides him.
With this, I would like to end this story by quoting my favourite quote from the most successful investor Warren Buffett – “Be fearful when others are greedy and greedy when others are fearful.”