“When we all think alike, we don’t think very much.” Albert Einstein
Countless studies in Social Psychology demonstrate the influence of groups on the decisions we as human beings make. It is virtually impossible for a decision made as a group to be in alignment with the potential decisions each individual within the group would have made independently.
In The Little Book of Behavioral Investing, expert James Montier explains:
“Groups have powerful self-reinforcing mechanisms at work. These can lead to group polarization—a tendency for members of the group to end up in a more extreme position than they started in because they have heard the views repeated frequently. At the extreme limit of group behavior is groupthink. This occurs when a group makes faulty decisions because group pressures lead to a deterioration of “mental efficiency, reality testing, and moral judgment.”
Examples of such failed decision-making have been monumental throughout history. They are evident in events such as the Vietnam War and the Bay of Pigs fiasco. In more recent times, we see evidence in connection with the Challenger space shuttle disaster and the CIA intelligence failure over the belief that Saddam Hussein had weapons of mass destruction hidden away.
According to Montier, groupthink predominantly has eight potential risk factors:
- Illusion of invulnerability. This leads to excessive optimism, encouraging extreme risk-taking.
- Collective rationalisation. Assumptions are rationalised with no consideration of contradictory warnings.
- Belief in inherent morality. The belief in the rightness of the cause itself overrides its moral rightness.
- Stereotyped views of out-groups. Effective responses to conflict are thwarted by unrealistic, negative opinions of any opposition.
- Direct pressure on dissenters. There is pressure not to go against the group’s views.
- Self-censorship. Perceived group consensus is all-pervasive and prevents deviation and/or the expression of any doubts.
- Illusion of unanimity. A unanimous majority view is assumed.
- “Mind guards” are appointed to guard against group exposure to information that is a risk or contradicts the group’s cohesiveness, view, and/or decisions.
It follows that these risk factors and ensuing behaviours can be psychological barriers to effective investment decision making and pose a challenge to investors. But by being aware of this, it is possible to identify and eliminate behavioural traits that would otherwise impede investment endeavours.
The difficulty lies in having the conviction of knowing you are right even if it goes against the crowd and the courage to take action in this regard.
This is important to us at WellsFaber. We pride ourselves in helping you ascertain your unique financial goals and helping you navigate the complexities of reaching them.