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Avoid the Financial Herd Mentality

By Mindset Wealth

Humans have existed for close to 200,000 years focusing more or less exclusively on survival: hunting, gathering and loss aversion. Find something to eat and avoid being eaten. The need to think long-term, and to imagine a future that’s different from the past, is a relatively recent phenomenon.

Russ-Wigle-chartIf we had to imagine a scenario for which the human mind is most ill-equipped to handle, it would be something close to the stock market, which is unsympathetic, future-based and perfectly designed to feast on emotion. It’s also filled with obstacles that prevent our brains from making objective and insightful decisions.

The chart below shows how investor emotions drive investment decisions. The dark green line rising from left to right is the performance of the S&P 500 index. The lighter green area shows the net dollar flows of capital into equity mutual funds, while the gray area shows the net dollar flow of capital into bond mutual funds.

Notice the billions of dollars flowing into equity funds from 1995 to 2000, when the investment crowd was racing to buy technology stocks. More money went into the market in 1999 than any other year in the last 20 – just in time to catch the crash that soon followed. This is classic herd behavior that hurts investors again and again.

What’s happened over the last five years is the exact opposite of the ’90s. The investment crowd has given up on stocks and has a new love affair with the safety and security of bonds. A buy-and-hold equity investor would have recovered from her 2008 losses and would be enjoying all-time highs. Those who followed the crowd into bonds, however, are suffering through the lowest interest rates in a generation.

The take-away should be to work with an advisor, whose job is to draw you away from the crowd and stay objective rather than emotional. An advisor will encourage you to be diversified, which often means buying stocks when others race to bonds and holding bonds when everyone else is chasing stocks.

Don’t follow the herd; follow your advisor.

This article was originally published in the Apr/May 2013 issue of the Comox Valley Business Gazette.