Why we're bad at investing parts 7 & 8: We follow the crowd, and we compare ourselves to others

Let’s keep this thing moving - two short sections this week. We’d all be better off if we followed the crowd less, and comparing ourselves to others is one of the quickest routes to unhappiness. Let’s consider how they make us worse at investing.

We follow the crowd

“I don’t know how to be rich.”

I have heard many variations of this phrase over the years, often from people who have recently sold businesses, and who are overwhelmed by the prospect of managing significant liquid wealth, and all the responsibilities that come with it.

There is a belief that there are things that the newly wealthy are “supposed” to be doing, and so they often look to others to guide them. With the right guidance, this can be very helpful. But just as often, they just end up repeating the mistakes of their friends and associates.

This is why I often see people with the same advisors as their friends, or invested in the same funds, or in the same private companies.

Social proof is a powerful force. Many have built their wealth management businesses around it. Bernie Madoff used it to bring in the cash needed to keep his pyramid scheme operating.

But the influence of social proof can be insidious, creeping up on you where you may not expect it. Peer learning groups have been created to bring together wealthy investors, and while they have some benefits, they can also lead you down the wrong path. I cover this in my book Low Risk Rules. For now, be aware that others may not have it figured out as well as they appear to. Be careful following the guidance of non-experts when it comes to managing your wealth.

We compare ourselves to others

One factor driving risk taking, high portfolio turnover, and investment restlessness is the fact that we are constantly comparing ourselves to others.

Studies show that most people would prefer to earn $80k while their neighbors earn $60k, rather than earn $100k when their neighbor earns $120k. This has a couple of insidious effects.

First of all, it’s not healthy. Because no matter how much wealth you have, there will always be someone with more. Knowing that you have “enough” will allow you to live with peace that a rich person always pursuing “more” will never know.

Second, it’s a large contributor driving bull markets and asset bubbles. As a stock market advance matures, you inevitably hear more stories about people you know getting rich. Often these people getting rich are absolute morons. And so you think, “if they can do it, it must be easy,” and you open a brokerage account and start trading volatile and risky stuff just to try to catch up.

As Charles Kindleburger wrote in Manias, Panics and Crashes: A History of Financial Crises, “there is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.” It’s a quote that cuts to the bone, only because it is so true.

Comparing ourselves to others is a flaw that encourages risk taking at the wrong times. Because when everyone is making easy money and the market is ignoring risk, you need to be leaning in the other direction. As Buffett famously said, “be fearful when others are greedy, and greedy when others are fearful.”

What I’m asking you to do goes against human nature.

It requires self-awareness and self-control.

It’s really difficult.

And that’s why it works.