Have you ever bought a shirt because a lot of your friends were wearing one like it too? Or did you want to get the newest smartphone because you kept seeing it in other people’s hands? The field of behavioural insights tells us that we have a strong desire to follow what others do. Herding is when many people do the same thing because others are doing it. It’s one of many behavioural biases people have. Find out more about herding and how it could impact your investing behaviour.
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What is herding?
The herd effect is a common behavioural bias, also known as herding. It is rooted in our human tendency to want to fit in with people around us. This is known as following the herd. We like to follow the crowd because it can help us simplify complex decisions, like investing. And it also gives us a sense of psychological comfort.
What does herding look like?
You will notice herding in many aspects of your life and the world around you. Some examples of herding include:
- Sports – If you’re a sports fan, you’ve experienced herding when thousands of people cheer for the same team. Herding is often referred to as the bandwagon effect. This stems from the tendency of some sports fans to jump on the bandwagon and root for a team that’s on a winning streak.
- Stockpiling – You might have noticed herding in early 2020. When the COVID-19 pandemic hit, shoppers struggled to find toilet paper, flour, and other products on grocery store shelves. That’s because people noticed that others were stockpiling these items, so they felt the need to buy them too.
- Meme stocks – You may recall when thousands of retail investors began trading meme stocks in early 2021. Meme stocks were fuelled by social media hype. As these stocks gained popularity, increasingly more investors followed the herd and began trading them.
Herding occurs when many people flock towards the same behaviour — primarily because it’s what everyone else is doing. It can take place in many different contexts, whether it be sports, shopping, or investing.
Our individual behaviours are prone to bias. That can make financial decisions challenging. Try our behavioural bias checker to understand how biases might be affecting your financial decision making.
How could herding affect your financial decisions?
Herding can affect your investments in many ways, including:
- Panic buying and selling – Our strong desire to follow others can push us to buy or sell investments out of panic, particularly during times of uncertainty.
- Investing in riskier assets – The promise of high returns from other investors who have received them can influence us to buy riskier assets (i.e., meme stocks).
- Lower returns –In many instances, following the herd when it comes to your investments has the potential to lower your returns in the long-run.
Following the behaviour of others may lead you to make investment decisions you otherwise might not have made. This can prove costly for you in the long run.
How can you protect yourself from the downside of herding?
Here are some useful tips to help you combat the effects of herding on your investing decisions.
- Question the herd – Take time to research new investments, understand your options and think critically. You want to evaluate whether you really think the herd is correct.
- Focus on the long term – Before making an investment decision, ask yourself whether the decision fits with your long-term goals and objectives.
- Develop a financial plan – A financial plan will give you confidence in your decisions and help remove some of the emotional pain you feel when you don’t follow the herd.
These tips can go a long way in preventing you from following the herd when it’s not in your best interest.
When it comes to your money, it’s a good idea to take a step back and evaluate decisions critically, rather than following the herd.
Learn more about other behavioural biases which might be impacting your financial decisions in ways you may not realize.
Summary
Herding can affect your financial decision making. It’s helpful to understand how it works, including:
- The herd effect takes place when many people gravitate towards the same behaviour, primarily because others are doing it.
- The herd effect is also known as herding or the bandwagon effect.
- Behavioural biases like the herd effect can influence your financial decisions, sometimes without you being aware of it.
- You can manage the influence of the herd effect by focusing on your long-term goals and developing a personal financial plan by working with a registered financial advisor.
