Investing's Biggest Irony: Everyone Thinks They're a Contrarian

The battle between you and groupthink.

Feb 14, 2014 at 11:57AM

C

Robert Shiller won the Nobel Prize in economics last year for his research on spotting market bubbles. He's also a pioneer of behavioral finance, developing brilliant explanations for how psychology causes us to do dumb things with our money. 

Shiller didn't just see last decade's housing bubble coming; he was in a position to do something about it. From 1990 to 2004, Shiller sat on the economic advisory panel of the Federal Reserve Bank of New York, holding the attention of the only people in the world powerful enough to stop the housing bubble by raising interest rates.

So here's the trillion-dollar question: Did Shiller warn his Fed colleagues that the housing bubble was doomed to burst, taking the economy down with it?

Yes -- but only timidly.

"I felt the need to use restraint," Shiller said in Dan Gardner's book, Future Babble. "The consensus in the group was that there was no bubble and no need to raise interest rates. To suggest otherwise was distinctly uncomfortable. I [made my point] very gently, and felt vulnerable expressing such quirky views."

Shiller summed up the experience perfectly: "Deviating too far from consensus leaves one feeling potentially ostracized from the group, with the risk that one may be terminated."

Here is a man of unquestioned authority who had conviction in his beliefs and understood -- no, discovered -- the psychological tricks our brains play on us when thinking about money.

Yet he still felt pressure to conform.

If Shiller is vulnerable to groupthink, believe me, you and I are, too.

The word "groupthink" was first used not to describe amateur lemmings, but coined in a 1972 study showing how seasoned professionals working in their field of expertise tended to follow each other off a cliff toward bad decisions. It doesn't matter how much experience or education you have in a subject. Most of us are hardwired from birth to follow the crowd.

One of the biggest ironies in investing is that while almost everyone thinks they are a contrarian, almost no one actually is. I remember 2007, right before the market peaked. Just about everybody I knew thought they were a value investor, zigging where others zagged. But at investing conferences, you found out that all these guys were basically buying the same stocks. What people thought was a contrarian view was actually rampant groupthink. It felt great when you, the "contrarian," had your views confirmed by another "contrarian." But contrarianism isn't supposed to feel good, and you're not supposed to have it confirmed by others. That's why so few can actually do it. It's rare -- not impossible, but rare -- that someone can remain blissfully content when everyone else around them thinks they're crazy. One of the nastiest tricks our minds play is convincing nearly all of us that we can be that person.

After World War II, there was widespread fear and curiosity about societies conforming to a unified belief, namely communism. Sociologists began studying how humans conform, and conducted some fascinating studies.

In the 1950s, Solomon Asch brought a group of students together and asked them to solve a set of problems, such as whether two lines were the same length. These were simple problems with obvious answers. But several of the students weren't trying to pick the right answers. They were actors working for Asch, purposely giving the wrong answers in front of their peers. 

Asch repeated the study with varying numbers of actor-students blurting out the wrong answers. His conclusion: Three-quarters of the test subjects went along with the actors' wrong answers at least once. In any given experiment, at least one-third of test subjects ignored the obvious answer and followed the actors. Just one in four consistently gave the right answer even when their acting peers disagreed with them.

Even when everyone around you is giving an obviously wrong answer, your tendency to second-guess yourself, not want to embarrass yourself, and your natural desire to fit in can trump every bit of rationality you think you have.

Rather than assuming you can be a contrarian investor, and learning the hard way that you can't, I think it's better to put your finances on some form of autopilot, especially if you can build a contrarian bent into that system. It's how you become a smart investor while taking emotions out of the equation.

Dollar-cost averaging -- investing the same amount of money each month come rain or shine -- is one of the best ways to do this. This doesn't necessarily mean you have to invest in index funds. Investing, say, $1,000 a month, every month, into a group of your favorite stocks might beat saving up cash and tactically trying to get in after a market crash. This is probably the most sensible strategy for investors with a history of following the crowd to buy-high, sell-low disappointments.

If you're investing a mix of stock and bond index funds, rebalancing your portfolio at the same time each year is another way to automatically become a contrarian. Say you want a portfolio with 80% stocks and 20% bonds. If stocks have a great year and push your portfolio to 85% stocks and 15% bonds, you sell a portion of your stocks and use the proceeds to buy bonds until the 80/20 ratio is back in balance. Do this every year. You'll probably do great over time.

Still think you have the disposition to be a contrarian? The best way I know to go about this is to plan out your contrarianism ahead of time. I do this with a chart directing how much money I plan to invest when the market falls by a certain amount. My goal is to use history to guide my contrarianism, investing enough money in moderate market downturns while keeping a sufficient amount to take advantage of lower prices if things get worse. If I had $1,000 in my contrarian fund, I'd deploy it like this:

Market falls by this much

I invest this much

Historical frequency

10%

$100

Every 11 months

15%

$220

Every 24 months

20%

$300

Every four years

30%

$130

Every decade

40%

$125

Every few decades

50%

$125

2-3 times per century

What's important is that you understand that your ability to think you're a contrarian is probably not as powerful as your innate desire to fit into crowds. Anything you can do today to make investing less emotional will make you a better investor tomorrow. 

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics. 

 

Contact Morgan Housel at mhousel@fool.com The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers