Practice

Mob Mentality
Are your clients behaving wisely, or are they just
following the herd? By Michael B. Horwitz

WHAT'S THE "FEKI.-GOOD, MUST-HAVE"

portfolio hedge this week.-^ Is it an old

standby, such as real estate or gold, or
a newer fetish like inflation-protected
bonds or oil and gas drilling partnerships.^
Lately, my clientsand yours too, I
bethave been voicing alarm about the
rising price of gasoline. It's easy for
advisers to empathize with their clients'
pain since most of us have shared the
experience of watching our dollars drain
80

May 2005

FINANCIAL PLANNING

from our wallets as we pumped gas into

our tanks. (Note to advisers whose first
instinct is to minimize the pervasiveness of a problem: Years ago when there
was a public seare about a toxin contaminating all ofthe fiour produced in the
United States, one newscaster began
the story with tbe warning, "For those
consumers who use wheat products...")
Other concerns that clients express,
such as the "problem" of a declining

U.S. dollar in relation to the euro, have a

less immediate or visible effect on our
pocketbooks and financia! well-being
than the price of energy. Nonetheless,
advisers understand that it's their professional responsibility to weigh these
challenges to clients' financial security.
It's certainly reasonable for elients to
probe us for an analysis of the impact of
foreign banks unloading U.S. dollars,
the gaping current-accounts deficit, and
the soaring federal debt. Most of us do
accept that part of our job is to offer
them the "long view"some historical
background, a description of market
forces, tbe role of diversificationfollowed by concrete suggestions for modifying a financial plan or portfolio in
light of these factors.
Of course, some advisers raise these
issues without waiting for elients to ring
the alarm bells. But what happens when
clients hurtle past our balanced analysis
and nuanced recommendations and
then firmly assert the "best way" to protect their portfolios from loss or position
them forgains.^
These clients just "know" they must
buy Exxon or invest in Vestas, a maker
of wind turbines. They insist that their
very economic survival depends on euro
futures or that owning South African
beachfront property is sure to heat up
their returns. Whatever the "problem
du jour," these clients have found the
"solution du jour."
When my clients start extolling the
virtues of a private offering from a Main
Street bank or the splendid vision of a
tiny biotech startup that's traded over
the counter, I suddenly feel as ifi bave
become a subject in one of Solomon
Asch's famous experiments on social
infiuence. For those of you who don't
recall the details of his studies from
your psychology course, Ascb asked
groups of college students to judge
which of three lines was the same size
as a reference line on a white card. The
groups were composed of seven to nine
people, all but one of whom (the unwitting subject) were confederates of the
experimenter. 7"hc subject was put at
the end ofthe row of people, and each
Continued on page 81

MOB MENTALITY
Continued from page 80
person was asked to answer out loud.
Fhcrc were 12 trials with difTetent reference cards. With the first two cards,
everyone in the room identified the
same lines. But beginning with the
third card, Asch had his confederates
pick lines that were clearly not the same
size as the reference line.
Needless to say, subjects expressed
some bewilderment at first, altering
their viewing angle or joking nervously
about whether they were seeing things.
But, faced with a decision that, in isolation, no one would ever get wrong, the
subjects went against the evidence of
their own eyes about one-third of the
time70% of subjects changed their
real opinion at least once.
When the subjects were debriefed,
Asch found that "wanting to be liked"
by the other people contributed to the
subjects' conforming to the group opinion (the subjects were, after all, a group
of young adults and late adolescents).
More important, however, is the fact
that many subjects actually believed
that the group had a better answer than
they did.
Okay, I admit I would prefer being
liked by my clients, since there are a tot
of drawbacks to them not liking me
(losing their business, for example). But
do I really think that my clients have
good ideas, or do I actually believe they
are the Linwitting victims of a media culture that's awash in messages such as
"Seven Keys to Overcoming HypcrInfiationin2()()5"?
1 he truthful answer is, I probably
think a little of both. For although I
endeavor to inform and educate clients
to my point of view, I am vulnerable to
being infiuenced by their views, tooas
pertepti\ e or as misguided as they may
seem to me at the moment.
In his recent book The Wisdom of
C/vwds. James Surowiecki, a writer at
The New Yorker, presents a fascinating
survey of the behavioral research on the
social decision-making process. Surowiecki shows that groups with a greater
diversity of perspectives on a problem
do make better decisions.

www.Financial-Planning.com

Surowiecki's finding may appear

self-evident until you realize that the
previous statement is true even when
people who know much less about the
subject matter ate added to a group of
subjecr-matter specialists. So a small
group, say two or more individuals, will
make a smarter decisioneven when
the average "intelligence" of the group
is dilutedas long as there is a mechanism to foster, collect, and aggregate the
different perspectives.
One upshot of the social decisionmaking research is that the so-called
"herd mentality" can be ver>' adaptive.
If you are walking down the street and
suddenly everyone else is running in

follow that such groups always make

good decisions.
'l'he Internet bubble, as most of my
readers will recall, occurred when many
people were absolutely sure the best
companies to buy were the ones whose
business models seemed to consist of
losing money on every sale but making
it up in volume; rhe stock price of many
of those technology companies rose to
what we now know, in retrospect, were
ridiculous levels. So what happened to
the vaunted "wisdom" of the crowd in
this situation?
Apparently, the craze was caused by
indi\ iduals who became too dependent
on the judgments of others around
them (unsound as those judgments eventually turned out to
be). In a real sense, the diversity and autonomy of the individual decision-makers got lost
in the stampede to catch the
momentum of stocks that were
going up ver>' quickly. And lest
we forget, watching other people get extremely rich by buying into those then-fashionable
companies was all of the social
proof many of us required for several
years before the crash.

While I try to inform and

educate clients to my point of
view, i am vuinerable to being
infiuenced by their views, too
as perceptive or misguided
as they may seem to me.
the opposite direction, what are you
going to do.'' You don't stop and take a
comprehensive opinion survey. Wm spin
atound and start running in the opposite
direction, too.
You run, not because of social pressure to conform, but because you are
relying on "social proof." You may not
know why the group is running, but if
everyone is doing it, you believe that
they must have a good reason (i.e., they
have better information at their disposal
than you have at yours). And as we have
already seen, groups often do have better information than many individuals
do, so imitating the group can actually
be an efficient way to make a decision
in an uncertain situation.
At this point you may be asking,
"Aren't stock bubbles and crashes like
the Internet and telecom crazes of the
1990s examples of herd mentality gone
wrong.'" They sure are.
But just because it's true that groups
often make better decisions than an
individual would, it doesn't neccssarilv

'l'he lesson that I am learning from

all of this is the need to become aware
of my defensive impulses when clients
eagerly volunteer they have found, say,
the perfect hedge fund. I need to resist
the temptation to lecture them on all of
the downsides. When you think about
it, what is really to be gained in the end
by shutting down the conversation in
this way.'
After all, perhaps they have found
the "solution dii jour" and perhaps they
haven't. But I am persuaded that we
will arrive at better answers by fostering
a truly open exchange of ideas.
FP
MichaelB. Horwitz, Ph.D., CFP, owns Life
Strategies Financial Planning, a fee-only
financial planning and asset
management
firm in Austin, Texas. He saw adults and
adolescents in his counseling psychology practice before becoming a full-time planner in
/ 999. He can be reached at michael@caringfinancial.com.

FINANCIAL PLANNING

May 2005

81