Behavioral Investing

March 17, 2007

The field of behavioral economics is a fascinating foray into the human mind. It refers to how human and social cognitive biases impact the investing strategies of investors. These biases can be exploited by other investors to make better decisions in the stock market. These anomalies, as they are known, are many. The one that I am writing about today is called groupthink.

Ian Janis coined the term groupthink in the early 1970’s to describe errors made by groups when making collective decisions.  Although the original theory was developed to explain group decisions in the context of foreign policy decisions, the conditions and symptoms that allow this to thrive can apply to any group decision-making. Janis outlined seven conditions which if present would lead to groupthink. 

The relevant conditions as applied to investing that make this likely to occur are insulation of the group, homogeneity of members' social background and ideology, and high group cohesiveness.  Investors exhibit these three conditions de maximus. Janis also outlined 8 symptoms of groupthink. I have listed three that are relevant to this discussion and in parentheses and italics have put down what part of investing exhibits this symptom:

 “The emergence of self-appointed mindguards - members who protect the group from adverse information that might shatter their shared complacency about the effectiveness and morality of their decisions,”   (The Sell Side)

“A shared illusion of unanimity concerning judgments conforming to the majority view.” (Everyone else owns it)

“Collective efforts to rationalize in order to discount warnings which might lead the members to reconsider their assumptions before they recommit themselves to their past policy decisions” (Talking heads on CNBC)