Don’t Lose Money Chasing the Crowd

Investing is easy, right? Buy low, sell high. Walk away rich.

But before we all sagely nod, close this article, and drive away in one of our many Lamborghinis, maybe we can admit we’ve had trouble abiding by this basic tenet of investing in the past. Perhaps you bought GameStop stock in 2021 or pulled money out of investments during the early coronavirus market panic?

You’re not alone in feeling swayed by the ups and downs of the market, but these decisions can be costly. Return-chasing—investing more in an asset when returns have been good and taking money out when returns have been bad—has been found to reduce the long-term returns an investor sees compared with those who did not chase returns.

So, why is it so easy to make this mistake, even when you know it’s the exact opposite of what you should do?

The Behavioral Biases Behind Counterintuitive Decisions

In short: Because you’re only human.

Humans are social creatures. Most of the time, this is our superpower. Imagine trying to build a city, or even just a shed, entirely on your own. And building it without any tools invented by another person, any materials sourced by somebody else, or any knowledge acquired by any method other than your own trial and error.

You probably wouldn’t get far.

Our tendency to pay attention to and learn from others has allowed humans to do incredible things, but it can also lead us astray because it makes us prone to herding behavior. Herding behavior is when we feel compelled to act in a way that aligns with what others are doing, even if it is not the action we would take in a vacuum. When things are on the way up, herding behavior is what undergirds FOMO; when things are on the way down, it encourages panic selling. It is, in essence, what your mother was talking about when she asked if you would jump off a cliff if all your friends were doing it.

And other cognitive biases can further encourage return-chasing. For example, when we see a stock enjoy a meteoric rise, we might assume the stock will continue to do well without considering other important factors—this is caused by our tendency to focus on recent events (availability heuristic). Or loss aversion, the acute sense of pain we feel when losing money, may lead us to counterproductively decide to sell holdings when they are down.

3 Tips for Learning to Stand on Your Own

Although it can be hard to resist the crowd, knowing what you want and establishing behavioral guardrails can help mitigate the pull of others’ excitement.

Use these three tactics to get started:

1. Know your goals. We are always investing for a reason, but you need to know what you are investing for more specifically than just “the future.” Well-articulated and meaningful goals help people stay motivated and committed to their goals. So, what does that future you’re investing in look like? Take time to articulate your goals—you can use tools to work through them on your own, or seek out help from a financial advisor. When you feel the pull of the crowd, bring your focus back to these goals and resolve to stay committed to the plan you developed to make them a reality.
2. Know your investments are set. Automate your investing as much as possible. It can be hard to consistently make the decision to put money into the market when it is down, or to stay the course or not to invest in the asset du jour. By automating your investments, you can make the right decision for your future self. This way, you will not have to make the right decision repeatedly, each time ignoring the pulls of the crowd, because you already made the decision once and let automation repeat it for you.
3. Know how to step away. If you wanted to, you could always be engaging with the market, but that doesn’t mean you should be. Constantly seeing what others are doing can spike the desire to go with the herd. Set limits for yourself to help reduce this pressure based on what compels you to step away from your plan. This might look like setting lockout timers on apps, reading market news just once a week, or checking your portfolio only when you’re meeting with your financial advisor. You can’t follow the herd if you don’t know where it’s going.

There are times when getting swept up with the crowd can be good (think of the fun you can have at a concert or sporting event). But when it comes to investing, you can resist this costly urge by knowing what you want and what you need to do to get there successfully.