As an investor, it's easy to "follow the herd" and just do what everyone else is doing. When the market is soaring, and everyone is pouring money in, it seems to make sense to be aggressive.
Conversely, when we're in a long bear market, and everyone around you seems to be selling their stocks, or just sitting on the investment sidelines, then you probably feel pressure to do the same. But in the investment world, going along with the crowd can be a costly journey.
Intuitively, you might feel that it's actually "safer" to act as others around you are acting. After all, you may reason, there's got to be some common rationale for investment behavior.
Unfortunately, though, that's not the case. When the investing public acts in unison, two things are usually happening:
- Over-reaction to past stimuli -- If masses of people make similar investment decisions, they're usually reacting to past stimuli, such as news of a "hot" market sector.
At one time, these types of events may indeed have been highly relevant to investors. But what was true then may not be true now. Yesterday's hot sector may have cooled off today -- and its prospects for tomorrow may look even worse.
- Decisions driven by emotions -- You may have heard that "fear and greed drive the market." And that saying is usually true when you see huge run-ups or declines in stock prices. When the market is going up, greed can cause investors to keep buying and buying, under the mistaken belief that prices can keep moving higher indefinitely.
As a result, stock prices are driven to unsupportable levels. On the other hand, investors' fear of losing money can cause them to sell their holdings at the wrong time, and then jump out of the market. When enough people do this, overall prices can be pushed lower than would otherwise be the case.
So, what can you do to avoid this type of investment "group think?"
For starters, strive for objectivity. Evaluate a stock on its own merits. Are its financial fundamentals strong? That is, does it have a strong track record of earnings and a manageable debt load? Is its management team solid? Do they seem to have a clear vision of where they want to take the business? How about the company's products? Are they competitive within their industry? Is the industry itself strong, or is it declining?
These are just some of the questions you should be asking about any stock you're considering.
To make an informed investment decision, you need to have a detailed understanding of the company and its prospects.
To get this kind of information, you may have to do some digging. But you'll find it's worth the effort. The more you know about your investments, the more comfortable you'll be with them. You won't get this knowledge by "running with the herd" -- so you may have to blaze your own trail.
Ross Hage is a licensed financial adviser with the firm of Edward Jones. For more information, call (928) 468-2281.