Tendency of an investor to mimic the actions of larger group whether it is rational or irrational is called herd behavior. Examples of consequences of herd mentality are tech bubble and subprime mortgage crises.
It is a common human tendency to feel insecure when not acting in a group and hence people follow the flow. Even if your clients do not have a positive view on an investment, they are more likely to do it because of the herd and vice versa.
We spoke to a few individual MFDs to understand how they deal with clients falling prey to herd mentality.
Vishal Dhawan of Plan Ahead Wealth Advisors, Mumbai
I strongly believe that there is no harm in accepting the wisdom of herd, but only if it is rational. When I come across clients suffering from herd mentality, I simply remind them of their financial goals and risk appetite. I ask them questions like why are they investing their money, what if they lose x amount of money due to market volatility and so on to make them realize that their goals and risk taking ability are different from others.
The next step that I follow to protect my clients from herd mentality is making them aware of this bias. I give them examples of how many people end up losing money after falling prey to this bias by investing in bitcoins and company fixed deposits like Sahara.
Bhavik Udeshi of Bhavik Udeshi and Associates, Kolkata
Over the last few days, many investors have shown their interest in buying small cap funds just because their friends have bought it.
In such situations, it is better to sensitize clients about their risk appetite. I usually ask them to go through risk profiling test again before investing in a fund. These clients change their mind on their own after seeing results.
In addition, I tell them about bubbles and crashes in the stock market which are the perfect examples of the outcome of herd mentality. Tech-bubble and subprime crisis are all examples of herd mentality.
