How the Fear of Missing Out Makes Investors Risk Blind was the subject of a provocative paper published several years ago by the Graduate School of Stanford Business (GSB).
Written by Marguerite Rigoglioso1 (October 1, 2007), the paper posed a penetrating question about a perennial problem.
‘People tend to cluster around risky categories,’ the author observed, ‘out of a desire to avoid missing the next big thing.’
Herding around risky investments
The insight might be dated but that doesn’t make it any the less true. People have an alarming tendency to herd around risky investments, and flourishing bubbles that inevitably burst. We saw it in the dot.com bust. We saw it in the subprime mortgage market bust. Who knows what the Bitcoin frenzy has in store for us, though I’ve got a pretty good idea.
I’ve written about loss aversion – the tendency for individuals to prefer avoiding losses rather than accruing gains – in the past. Originally proposed by a pair of Israeli psychologists, Amos Tversky and Daniel Kahneman, loss aversion stands at the heart of financial decision-making. They wrote a scholarly treatment of the issue called Prospect Theory2: An Analysis of a Decision Under Risk and their approach has spawned an expanding literature on risk taking.
The role of peer pressure
But loss aversion is by no means the end of the story. According to Ms. Rigoglioso, ‘two Stanford researchers say that, investors fear under performing relative to their peers more than the risk of a loss.
She references that in three related theoretical studies, Peter DeMarzo and Ilan Kremer, along with Ron Kaniel of Duke University: ‘have discerned that individual investors care deeply about how their level of wealth compares to that of others in their peer group and community. Investors fear being poor when everyone around them is rich, concludes DeMarzo, Mizuho Financial Group Professor of Finance at the GSB.
Five cautionary words
The fear of missing out.
These five familiar words encapsulate one of the most insidious pathologies in investing. It’s part of what you might call the circuitry of temptation, one of whose mainsprings is the fear of missing out on the big score – that transformational investment that converts someone’s fortunes from solid to sensational.
The big score
The prospect of a big score – and the pathological fear of missing out on it – is the biggest temptation there is in investing. As Eric Roberge3 warned in an article in Forbes (December 20, 2017, This Might Be The Biggest Temptation You Face When You Invest): ‘Don’t randomly chase down hot tips and insider secrets.’
Mr. Roberge wrote, ‘Many people waste a lot of time and energy seeking out the one investment to solve everything. It’s really tempting to think if you can just unlock a secret that only rich people know about, you can be wealthy too.
The researchers behind the Graduate School of Stanford Business (GSB) research referenced earlier, found that investors tend to herd particularly around high-tech investments that have the potential to revolutionize the entire market and promise a big upside—technologies like fiber optics, internet-related infrastructure, and so forth.
‘These are typically high-risk stocks that, in seven out of eight cases, are likely to go bust. People however, are willing to invest in them in the hopes that they’ll hit that once in a lifetime jackpot,’ says DeMarzo.
Conclusion: The Bible got it right
‘And lead us not into temptation, but deliver us from evil.’ (Mathew4 6:13). These are eleven of the most powerful and prophetic words in the English language. Temptations come in many disguises. And, of course, not all of them are insidious.
Building personal wealth is a laudable goal, not a malevolent fixation. But as Mr. Roberge correctly points out: ‘It’s not sexy or flashy, nor is one magical thing going to allow you to breeze your way to your goals without work or effort.’
It’s a process based on small, consistent actions implemented over time. When considering get rich quick schemes, it’s often best to consider the level of risk you wish to incur prior to investing a substantial amount of assets in something that may prove uneventful.
Michael Fahy, The Michael Fahy Group, CIBC Wood Gundy, 604-691-7207.