Don't get caught up in crowd mentality

By DAVID MOON, Moon Capital Management, LLC
June 27, 2010

The insular cortex is a portion of the cerebral cortex area of the brain that is linked to a person’s emotions, self-awareness, interpersonal experience and other types of psychopathology.

According to researchers, it may explain most of our investment decisions.

A paper titled “How the Opinion of Others Affects Our Valuation of Objects” was published in the June 17 issue of Current Biology, an academic journal. The paper explains the brain physiology that occurs when individuals agree with others about the value of an object, whether or not there is any rational evidence to support the valuation. The researchers played music for each of the subjects, after which only some of the listeners were also provided “expert reviews” praising the music. The brain activity of all of the subjects was being observed via an MRI scan throughout the entire process.

Not only did the opinion of the so-called expert reviewers affect the opinions of the subjects, the influence could also be observed in the part of the brain where pleasurable reactions are triggered by things such as food and sex.

The researchers concluded that we feel better when we agree with others, especially if we perceive the other people to know more about the subject than we do. This feeling can be as strong as the pleasure we receive from the confirmation of a loved one or the decadence of a hot fudge sundae.

This sort of neural pattern also explains why the stock market is a schizophrenic place, capable of quickly vacillating from despair to bullishness to pessimism within a period of 18 months.

There is a biological explanation for the herd mentality of Wall Street.

We all know that this mentality is silly. Institutional investors all talk about their proprietary research processes or black box tactical asset allocation widgets, but in the end, most of them end up owning some large percentage of the same 100 or so stocks.

The highly-paid investors feel just as good when their decisions are confirmed by others as do 401(k) participants with modest account balances.

Here is one example. I literally selected it at random.

The UBS PACE Large Company Growth Equity fund owned 161 stocks on December 31, 2009. The UBS PACE Large Company Value Equity fund owned 113 stocks. Presumably these value and growth funds would provide some diversification.

The two funds owned 36 of the same stocks. So much for growth vs. value diversification.

Many investors get wrapped up in how much they have invested in growth funds, value funds, mid-cap funds, small-cap funds, large-cap funds, baseball-cap funds, etc. The reality is that you can’t tell what a mutual fund owns by its name – even funds within the same fund family.

Most of us, at one time or another, have told our children to be themselves. They shouldn’t mimic someone else. They should make their own decisions and not be influenced by peer pressure.

It’s good advice.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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