Why Investors Herd: Jason Zweig’s Latest The Intelligent Investor Column in the WSJ

I do not always agree with Jason Zweig’s recommendations, but we definitely share a similar investing philosophy, and I do agree with him often. The usual reason that I disagree with Jason is that he is more resigned than I am to the idea that individual investors have no chance to earn outstanding risk-adjusted investment returns. He is in the Bogle camp and he most often recommends that individual investors invest in index funds. But, in Jason’s The Intelligent Investor column in Saturdays’ Wall Street Journal titled: “Have You Herd? Your Adviser is Scared to Set You Straight,” he writes about the importance of avoiding herding behavior. This is another instance in which I completely agree with him.

 The key passages:

Investment professionals are supposed to exercise independent judgment; in Warren Buffett’s words they should be fearful when others are greedy and be greedy when others are fearful. It doesn’t always work out that way…

He then demonstrates that pension fund portfolio managers are just as poor at timing markets as individual investors who plow into hot products near the peak of the cycle and withdraw in record numbers near the bottom, which I wrote about in an earlier post.

The stampede into bonds coincided with a rush out of stocks that may be intensifying. A recent survey of financial advisers by Charles Schwab found that 77% planned, over the second half of 2010, to maintain or even raise the proportion of their clients’ assets that are invested in bonds…Yet bond prices are near all-time highs and future returns are likely to shrink…By selling stocks as they fell and buying bonds as they rose, advisers may have ended up exposing clients to more risk, rather than less.

Jason wrote that there are two possibilities for this instance of herding behavior: First, because of the financial crisis, investors are watching their advisers closer than before. He then quotes a survey of advisers who said they were reluctant to invest in equities when they knew that their investors were frequently looking at their portfolio selections.

A second reason: Advisers would rather not disabuse you of your biases and strongly held opinions. He explains that notion using a quote from Antoinette Schoar, an economist from MIT:

“Chasing past returns is kind of a nice bias from an adviser’s point of view,” she adds. “It generates more fees”—especially for advisers who earn commissions each time they sell stocks or mutual funds…your adviser might not give you a second opinion. He might merely echo your own, making you think he is smart because he agrees with you—and clearing the path of least resistance to his next commission. Sometimes acting like sheep just pays (the adviser) better.

Don’t be sheep. If you recognize your adviser in these paragraphs, you should fire him or her.

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