Yellowstone Financial, Inc.

Fighting the herd mentality

Ted Turner’s offer to donate a small herd of buffalo for the fields outside of Boulder appears to be dead in the water.

Many wanted the presence of these majestic creatures to bring back the days of Chief Niwot when the plains were free. Being a financial geek, I looked forward to the buffalo as a constant reminder of how a herd mentality can trample your financial future.

Going with the herd can hurt you when plunging into a sure-fire investment winner (greed) or fleeing the ongoing collapse of another (fear). Fear and greed have made millions for a select few shrewd traders, but most investors heed it unwillingly to tank their own returns.

When we think about investor greed, imagine an investment that you must possess. Look for the feeling of scarcity and the importance of acting right now. When you feel panic in your heart that you won’t be able to get in on a good deal, then in most cases you’re close to making a bad decision.

The most recent example of greedy herd mentality is Facebook, which had an IPO just over a month ago at $38 a share and now trades under $29. Unprofitable greedy investments do not need to be as flashy as Facebook. They can take the form of loading up on the latest hot mutual fund. Morningstar ratings do wonders for fingering the funds that have been beating their peers. But their star ratings only show past performance.

There’s the tale of the CGM Focus Fund (ticker CGMFX), the once five-star financial press darling and the best performer of the last decade with an annualized return of 18 percent. Its current one-star rating notwithstanding, even the last decade was a disaster for most of its followers with an average investor return of -11 percent annualized.

How does the average CGM Focus Fund investor perform 29 percent worse per year than the fund itself? The answer is horrible investor timing.

Once CGM racked up an incredible 80 percent return in 2007, billions flowed in from investors hoping to see continued supercharged performance. The next year it lost 48 percent of its value, putting it in the 96th percentile among its peers. In 2009 and 2011, it performed even worse.

CGM Focus and Facebook are not isolated examples of greed gone bad. Look up the performance of Legg Mason Value Trust (LMNVX), Muhlenkamp (MUHLX), and Davis Venture Fund (NYVTX) for more examples of failed speculative runs by individual investors.

Fear is perhaps a more powerful form of herd behavior than greed and can also decimate investor returns. Simply look at the periods when individual investors were liquidating stock mutual funds. October 2008 and March 2009 both saw tremendous outflows of individual investor money away from stocks. Fleeing investors did a good job of calling the March 2009 diabolical S&P 500 low of 666 points.

So talk to your friends and family. What do people fear? Is it the collapse of the Euro and its impact on the world economy? It may be the domestic political situation and gridlock in Washington. Fear may represent investment opportunities while mass greed should give you pause.

You don’t have to be a twitching day trader to take advantage of investor psychology. Instead, with an informed, time-tested investment strategy that includes regular rebalancing you are already buying the fear and selling the greed.

If you don’t have the time, steel, discipline, and knowledge to carry it out on your own, perhaps the single greatest value a financial planner can offer is a coherent strategy and the moral support to stick with it.