You’ve probably had a parent or teacher ask you, “If your friends jumped off a cliff, would you do it too?”
Of course not! That’s insane. You’re a strong and independent free-thinker. Why would you do that?
…but what if your friends weren’t jumping off a cliff?
Instead, what if they’re all buying the latest iPhone? Every day you see them playing with cool apps, taking great pictures, and talking about how great the phone is. After a while, it’s not so much a question of if you’re going to buy an iPhone but when.
This is herd mentality — and you’ve probably seen it before:
- Investors rushing to buy a specific stock because it’s supposedly “hot.”
- Parents frantically buying Tickle Me Elmos for their kids after they see every other parent doing it.
- Fidget spinners. Dear god, so many fidget spinners…
When it comes to your personal finances, herd mentality could mean the difference between getting swept up by the panic of a recession and keeping your head.
Let’s take a closer look at herd mentality and see how exactly it can harm AND help us.
What is herd mentality?
Herd mentality (also known as mob mentality) describes a behavior in which people act the same way or adopt similar behaviors as the people around them — often ignoring their own feelings in the process.
Think of a sheep blindly following the flock no matter where they go just because that’s what the herd is doing.
And this isn’t just pseudoscience: There have been peer-reviewed psychological studies conducted on the subject.
In 2008, Professor Jens Krause and Dr. John Dyer of Leeds University conducted an experiment where groups of subjects were told to walk in a random path inside of a big hall while not communicating with the other subjects. However, the researchers told a few of the subjects exactly where they should walk.
Guess what happened? They discovered that the people who were told exactly where to walk started being followed by the subjects walking “randomly.”
From Professor Krause:
We’ve all been in situations where we get swept along by the crowd. But what’s interesting about this research is that our participants ended up making a consensus decision despite the fact that they weren’t allowed to talk or gesture to one another. In most cases the participants didn’t realise they were being led by others.
In the end, they found that it took just 5% of people walking confidently to influence 95% of the other walkers to follow them.
And looking around, you’ll see examples of this type of behavior everywhere:
Herd mentality example A: Black Friday madness
The day after Thanksgiving consistently reigns as one of the biggest shopping days of the year. It’s also the one day where you can count on completely sane and reasonable people to regress into wild-eyed, feral monkeys ready to step on each other’s neck for a flat screen TV.
Why? Why do people forgo spending a relaxing holiday with friends and family to get punched in the face so they can save 30% on a blender?
An Auburn University study found that the experience of shopping can actually be enhanced when there’s a large crowd around you, turning an otherwise bad experience into a fun one. What might seem objectively like a bad idea becomes a “good idea” with a few more people around us.
Pictured: More fun than Disney World?
Herd mentality example B: The dot-com bubble
Cast your mind back to a simpler time. A time of Starter jackets, Jonathan Taylor Thomas, and ska music. I’m talking about the 90s.
Along with your dope Pog collection, the 90s also were the dawn of a new and exciting piece of technology called the internet. As soon as people realized you could monetize the internet, investors of all stripes began to pour millions upon millions of dollars into different “dot-com companies” (businesses that exist online).
However, many of these investments turned out to be pure speculation — resulting in the infamous dot-com bubble. So after years of investing in shady tech companies that often didn’t have a product to begin with, the bubble burst in the early-2000s. Scores of tech companies went belly up and even more investors lost their millions.
One prime example? Pets.com.
Here it is in all its nightmare-inducing glory.
When the company went public in early 2000, they saw their shares rise to $14. However, the dot-com bubble soon burst and they saw their market value tank to a measly $1/share. Hundreds were laid off as the company buckled later that year. Now, their domain redirects to PetSmart’s website and the company exists as a sad example of herd mentality.
Herd mentality example C: Disney Theme Parks’ firework shows
It’s the happiest place on Earth. A magical land where you can meet your favorite Disney princess, eat turkey legs the size of your own leg, and get songs stuck in your head for years.
One of their most clever usages of mob mentality comes in the form of their famous nightly firework shows.
Back in the early years of the park, Walt Disney had a problem: Families all over America were clamoring to get into Disneyland…but they left as soon as they hit up all the rides they planned to go to.
After all, this was the earliest days of theme parks in general. People had no frame of reference and no idea what to expect when they showed up to Disneyland. So when families started showing up, they followed the other families — staying for as long as they needed to go on certain rides and then leaving.
Walt needed to find a way to keep them there though, or else he took a hit in opportunity costs.
That’s when park planners came up with the idea of having a fireworks show so that families had something to look forward to at the end of the day. Soon families started staying in the park longer, as word-of-mouth spread the news of the fireworks show at the day’s end.
The plan worked. People stayed until the end of the day, and more than 50 years later you can still see that example of herd mentality in action at Disney parks all over the world.
Herd mentality example D: The housing market crash
It’s been more than a decade since the housing market crashed in 2008, and in many ways, the effects of it are still being felt today. And though the reasons behind the crash are incredibly nuanced and complex, it all boils down to a bubble caused by a massive amount of homeowners being unable to pay their mortgages.
The result of the crash led to millions of people losing their jobs, scores of people losing their homes, and consumer spending dropping by 8%.
While there are many factors that caused the crash, I want to talk about how mob mentality ran rampant after it.
Because when the housing bubble burst, investors got nervous. They were so nervous they found themselves falling prey to a herd mentality behavior called “panic selling,” wherein people sell off their shares en masse due to paranoia and fear, resulting in stock prices plummeting. Investors got scared that if they kept their money in the market, they would lose it. This resulted in people pulling their money out of the market. Which resulted in prices going down and… well, you know how this ended.
Can herd mentality be good?
While many examples of herd mentality can seem downright scary, it’s not all doom and gloom. Herd mentality can actually be a GREAT thing if you let it be.
Michael Bond, author of The Power of Others: Peer Pressure, Groupthink, and How the People Around Us Shape Everything We Do, wrote that herd mentality can actually “change the course of history.”
The Egyptian revolution of late January and early February 2011 was a stunning example of cooperative power (even though its achievements have partly been squandered). What’s more, those who gathered in Tahrir Square to demand the fall of Hosni Mubarak had the time of their lives.
One retired businessman who traveled from Alexandria, Egypt, to join the protesters told me: “I found something lovely. There were all kinds of people. From universities, secondary schools, preparatory schools. Homeless people. People from every religion. All divisions disappeared. Everyone had one purpose. I was really crying, for this was the first time I saw the Egyptian people unafraid of anything.”
Aside from changing the landscape of politics, herd mentality can also be leveraged when it comes to your investments — or at least Warren Buffett thinks so. “Be fearful when others are greedy and greedy when others are fearful,” he says.
What he means is that you should always be more than willing to go against the herd when it comes to your investments. The person who is going to come out on top of a bubble burst or market crash is the one who keeps their head and doesn’t immediately dump all their stock.
Which brings us to…
What YOU should do to use herd mentality to your advantage
By its nature, herd mentality is difficult to spot in the moment. After all, a snowflake doesn’t realize that it’s a part of the avalanche. Same goes for you when you’re swept up by market trends.
But if you do find yourself in the midst of a herd, keep in mind BOTH the dangers and benefits of herd mentality. And remember that Warren Buffett quote from before: “Be fearful when others are greedy and greedy when others are fearful.”
And if you’re new to investing, we want to show you exactly how to do that.
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