SUSIE GHARIB: Many investors fall into the trap of following the crowd when it comes to investing. The experts call it “herding,” a topic we’re exploring this month with our partners at “Kiplinger’s Personal Finance.” As we continue our series, “Your Mind and Your Money,” I talked about herding with Professor Terrance Odean of the Haas School of Business at the University of California-Berkeley. My first question: how widespread is herding among individual investors?
TERRANCE ODEAN, HAAS SCHOOL OF BUSINESS, UNIV. OF CA: Well, we find a lot of evidence that individual investors tend to get excited about the same stocks at the same time and to lose interest in other stocks as the same time as each other. So there is a strong tendency for investors to buy at the same time as each other and sell at the same time as each other.
GHARIB: Professor Odean, I understand a few years ago you did some research that suggested that investors are gravitate towards attention- grabbing stocks, stocks that make the headlines. So how does that fit into what you just said in terms of this pattern of following the crowd?
ODEAN: What a lot of investors do is basically they wait for a stock to catch their attention. And then if it suits their preferences, they buy it. Now as it turns out, attention-grabbing stocks tend to grab everybody’s attention at the same time, something going on, a big news story. So we see individual investors heavily on the buy side of stocks that are in the news or trading unusually much.
GHARIB: Is this the same motivation that goes into individuals who are in investment clubs? I understand you did a study that shows that the club’s performance compared to the S&P 500 was much worse because of some herding concept. Tell us why these clubs did so poorly.
ODEAN: In a club, typically when the club meets one or two members will pitch an idea for a stock. And for social reasons, you don’t really want to pitch something that will later embarrass you. So people tend to go with stocks that have a strong rational. They will go with a stock that’s been doing very well over the last year for which there is maybe good news reports or a good story goes along with it. Now as it turns out, that’s often a stock that a lot of other investors are buying. And sometimes those investors are pushing the price of that stock up too high and subsequently the stock under performs.
GHARIB: We hear so often that investors tend to buy high and sell low. Is there any connection between market timing and herding?
ODEAN: I think there is. My colleagues and I have looked at every investor in Taiwan, in the Taiwan market. And we found that when individual investors as a group were putting more money into the stock market in Taiwan, the market subsequently did less well over the next six months. And when individuals were pulling money out, the market subsequently did better. We find very similar things in the U.S. when it comes to individual stocks. So we find that the herding by investors tends to forecast future returns and negatively so.
GHARIB: So is there any advice you can give to people so that they don’t get over influenced by herding or investing styles of other people?
ODEAN: Yeah, I guess my first advice would be buy and hold well diversified mutual funds. And my second advice would be if you are going to trade, make your own — do your own independent research. Don’t listen to what your neighbor has to say.
GHARIB: All right, we’ll leave it there. Thank you so much for talking to us, we appreciate it.
ODEAN: Happy to do so, thanks, Susie.