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The massive downturn in the markets during December 2018 marked one of the most irrational moments in financial market history. Christmas dinner was even interrupted for some financial planners and financial advisors who rushed to adjust their portfolio strategies. The market was hugely oversold by the collective groupthink fear of investors. Market values have recovered consistently during the first quarter of 2019, demonstrating how overblown these fears were.

Financial planners and financial advisors need to understand this market downturn was a lesson in human social psychology, and learn steps to avoid letting their clients succumb to this irrational behaviour en masse.

During this past December, investors suffered from groupthink and the bandwagon effect. The term “groupthink” was popularized through the work of Irving Janis, a research psychologist at Yale University who published a book on the concept in the early 1970s. Groupthink happens when a group of people winds up thinking in the same way when the pull of the group extinguishes independent perspective. It can happen for various reasons, but, most likely in this case, alternative views were ignored or avoided.

The bandwagon effect has much older origins as a psychology term dating back to the mid-19th century. In simple terms, as many already know, to “jump on the bandwagon” has become a cynical description of going along with the crowd.

There have been many research studies around the power of social influence; specifically, peer pressure and conformity. One such famous study was conducted in 1951 by Solomon Asch, a pioneer of social psychology. Asch asked eight students to participate in a “perceptual study,” but in reality, it was a psychological experiment.

Basically, the eight subjects were shown a slide with a line, and then another slide with three lines of different sizes. The subjects were asked which line in slide two matched the size of the line in slide one. Unknown to the eighth student, the first seven students in the study were hired actors who would sometimes give the wrong answers in unison, causing the one true student to conform and give the wrong answer. Through 12 trials, 75% of participants conformed at least once while 25% never conformed. In the control group, with no actors to conform with, less than 1% of participants gave the wrong answer.

People conform for two main reasons — they wish to fit in with the group (normative influence) or they believe the group is better informed than they are (informational influence). The latter may have been partially to blame for December 2018.

The Asch study was criticized for its simplicity and bias — such as the fact that all the participants were white males — but Asch followed up with more robust research.

Gregory Berns out of Emory University in Atlanta did a new version of the Asch experiment in the 1990s with the added twist of using a functional magnetic resonance imaging (FMRI) machine to scan the brain activity of the participants. His study used a similar methodology to Asch and discovered that as participants gave wrong answers to visual puzzles (as prompted by staged peers giving deliberate wrong answers), the parts of their brains handling judgment and deliberate action were not activated. Rather, only the part that processes visual information was stimulated. This meant that their actual perception had shifted by manipulated peer input. “Seeing is believing what the group tells you to believe,” Berns concluded.

Berns also discovered that the contrarians who didn’t go along with the group and gave the correct answers had increased activity in the brain region that deals with fear and stress. This showed that humans are more wired to “go with the flow” and fear going against the group.

Financial planners and financial advisors can use two simple but powerful techniques to help their clients avoid these traps.

First, humans are social by nature and self-identify with various groups — professionally, socially and spiritually. Therefore, you need to understand who your client’s peer group is and ensure their peer group’s advice is not contrary to your independent and professional advice. You can show them what winning investors do to achieve their investment objectives over time so clients can identify with that group.

Second, use what Daniel Kahneman and Amos Tversky called “the outside view,” which can counterbalance the “inside view” that is swayed by emotion and peers. The outside view is third-party, neutral data-driven evidence, while the inside view is more of a gut feeling and anecdotal, and may be what a person’s desires or emotions are telling them.

Showing clients independent research of what works in different types of markets can appeal to the informational influence that social psychology studies have highlighted.

The power of groupthink can make investors follow the group when markets are irrational and adversely affect the long-term value of their investment portfolios. Financial planners and financial advisors who recognize the power of these social influences on their clients and take appropriate measures will better help their clients stay on target for retirement.