Peer pressure is at the heart of why investors demonstrate herding behaviour. Psychologists tell us that we adapt our behaviour to our circumstances or context, and as a consequence we are continually comparing ourselves to others. This is not necessarily a bad thing, but unfortunately we usually compare up rather than down.

For example, assume you were invested in a unit trust fund, and it was ranked as the 30th best performing unit trust. Research shows that you are more likely to compare your fund to the 29 funds that have outperformed it, rather than the over 700 funds that have underperformed it. Particularly if you know somebody who has a better performing fund!

Unfortunately, our behaviour doesn’t end at comparison, but very often we make decisions on this basis. The influence of social pressure is central to why we have bubbles in investment markets. People herd together for fear of missing out on a boom, or being caught out in a decline.

Mental mistakes

Cognitive or mental mistakes are very simply errors of judgment that we make, primarily because we are lazy when using our brains. A simple example of this when investing is that we tend to attach too much importance to recent performance and do not apply our minds to long-run statistics.

This happens frequently in the share market, where it is much easier to say, "the trend is your friend", than to consider what has happened over the long term historically.

What we do know is that over time the South African share market will deliver a real return to investors over about seven percent above inflation. There is much historical data to support this observation. The problem is that at times the share market can deliver a real return of over 30 or 40 percent. This can raise unrealistic expectations about what the share market can deliver over time, and tempts us into action that may be inappropriate.

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