A Fascinating Insight – The Folly Of Herd Mentality

One particular article from Hargreaves Lansdown’s (HL) May 2012 edition of their monthly investment literature caught my attention. It is titled ‘The psychology of investing’ by Ben Yearsley, a HL Investment Manager; his findings are eye-opening.

He identifies one of the most well known and successful investment funds during the 1980’s and 1990’s, which was the ‘Fidelity’s Magellan fund’. The fund delivered an eye-watering average annual return of 20%! Its stellar performance was principally attributed to the star fund manager ‘Peter Lynch’.

However, the intriguing part of this article is when Ben Yearsley goes on to highlight Peter Lynch’s belief that the average investor in his fund only generated an annual return of 1-2%.

The reason for this disparity – the fund didn’t deliver its returns smoothly. Therefore investors typically bought in after 3 or 4 years of phenomenal performance and consequently sold when they became disillusioned with poor performance. Had investors stayed invested for the whole period, they would have shared in the funds spectacular returns. I hazard a guess that this divergence is true of many top performing funds today.

Hargreaves Lansdown motto to investors is ‘Time in the market, not timing the market’. I couldn’t agree more.

Interestingly, he then displayed a graph highlighting fund inflows (purchases minus redemptions) since 1992 set against the FTSE 100. The results – Investors purchases of collective investment products nearly always peaked at the tops of the market, in this case 1999 and 2007.

In my view, this revelation certainly buttresses the case for contrarian investing and illustrates the psychological folly of following the herd. For example who would have believed that March 2009, the nadir of the market, would have been the right time to invest?  It would have taken tremendous courage, but of course that’s the precise time you should have been investing.

Successful Investors would do well buying when they were scared witless. For example, Spanish and Italian equity markets presently trade at over a 60% discount to their CAPE (cyclically adjusted price to earnings ratio), according to Haver analytics. Despite the possibility of a euro zone breakup, does any investor reading this article possess the bravery to seize the potential buying opportunity?

Finally, I think it’s apt to finish on this well known quote by the American investor Warren Buffett, “Be fearful when others are greedy and be greedy when others are fearful”.

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