Think for yourself

8 Apr 2011 by Jim Fickett.

Neither following the herd nor unthinkingly betting against the herd will make you money.

The Economist has an amusing article on the wisdom (not!) of the crowds. It goes beyond critiquing herd behavior to hit at unthinking contrarian decisions as well:

To investigate the investment success of crowds, The Economist asked Morningstar, an investment-research firm, to send us fund-flow data and performance statistics for its American mutual-fund range. We then applied some simple tests. Did investors plonk their money into an asset class that had been performing strongly over the previous 12 months? And was their judgment borne out over the subsequent 12 months? …

The most popular sector, measured by the net inflow of money, had generally performed well in the previous year, beating the average sector by more than two percentage points. Investors were clearly chasing the trend. Alas, over the next 12 months that most popular sector lagged behind the average by just under three percentage points. On around 60% of occasions, the return of the most popular sector was much lower after investors bought it than before.

The mob’s behaviour might still be useful if it acted as a contrarian indicator. Here there is good news and bad news. So-called “pariah funds” did beat the most popular sectors, but they also failed to beat the average.

It is remarkable how many investors make really stupid decisions. It would seem that if you don't try to be overly sophisticated, but just avoid the really dumb moves, you would have to beat the market. I don't know how to prove this, though it is the case that many of my best moves (buying gold when it was totally out of fashion and cheap, disbelieving the tech bubble and getting out of stocks, and betting against the market in 2007) were blindingly obvious.

At the very least it is clear that there are people who think for themselves and who do beat the market.