Timeless Investment Classics (Part II): Understanding the Hopes, Fears, Greed of Crowds

by: Joseph L. Shaefer

From March to December 2010, I am re-reading and reviewing one timeless investment classic that I keep and refer to on the bookshelf within arm’s reach of my desk.

Not to disparage any investment book hot off the presses in 2010 or written in the last 40 years (including my own!) but to be considered a “classic” the book must have stood the test of time. I figure 40 to 125 years should provide a pretty good crucible. I believe these books can teach us more about human nature, investing, and wealth and risk management than anything written before or since. All 10 I will re-read and review this year are still in print, still selling today. There’s a reason. Each offers still-fresh, unique, and well-worth-reading insights that will simply make you a more relaxed, more confident and better investor… Here's a link to my #1 pick. (Of course, if you want to buy my book as well, who am I to discourage you?)

#2 -- The Crowd: A Study of the Popular Mind

Gustave Le Bon, 1896

As Gustave Le Bon wrote in the introduction to this slim little gem, six generations ago:

The substitution of the unconscious action of crowds for the conscious activity of individuals is one of the principal characteristics of the present age.

No truer words were ever spoken about the psychology of how people tend to invest in this "present age"!

Why is it that otherwise rational people take on a herd mentality when investing and seek the comfort of knowing that hundreds of thousands of like-minded individuals think as a group and share their biases and perspective? Is it because the lonely path of iconoclastic thinking and contrary investing may yield better results but is also, well, lonelier? To be wrong when all others are right, even if that latter path yields them little or no return, is to subject oneself to the derision of the social unit. And to be right when all others are wrong, even if that former path is wildly profitable, is to subject oneself to the envy and resentment of the social unit. It takes a strong individual to be an individual.

I hasten to point out that The Crowd was not a book written about the stock market. Au contraire! It was written to try to understand group psychology, whether the group was a criminal organization, an electorate, a jury or a parliament. But understanding the group dynamics of each of those is a good practice ground for understanding the emotions and actions of one camp or another when debating a stock, an industry or a sector. And The Crowd offers, via these other avenues, unique insights into what makes people do the things they do from within the warm incubator of like-minded individuals.

In that light, how different is the following observation of the French Revolutionaries (from page 187 of my 1952 Ernest Benn Ltd edition) from what many of us see in certain of our national-level politicians today:

The most perfect example of the ingenuous simplification of opinions peculiar to assemblies is offered by the Jacobins of the French Revolution. Dogmatic and logical to a man, and their brains full of vague generalities, they busied themselves with the application of fixed-principles without concerning themselves with events. It has been said of them, with reason, that they went through the Revolution without witnessing it.

At its lowest level of over-simplification, Le Bon's thesis in The Crowd is that the behavior of crowds is based on sentiment and emotion rather than intellect and research. That may seem rather obvious today since other social scientists have been agreeing with and building upon his work for over a century. But how many of us invest accordingly? Do we seek to understand the hope, fear, greed, mistakes and misinterpretations of the crowd or do we seek to find “facts” for why the market rises or falls on a given day, week, month or year?

Most of us want to know “why” the market declined today. We are satisfied when we hear the evening news: Oh, it was because Apple (NASDAQ:AAPL) declared lower sales on its iPhone. Or because Goldman (NYSE:GS) was sued by the SEC. Or because Greece is not going to get a full bailout from Germany. Ah, we say – now it makes sense. Of course it went down.

Le Bon would no doubt say, “Faaahhh on your reasons.” It declined because there were more sellers than buyers so the price began moving downward to attract more buyers. It declined because more people became nervous, or got a wild hair from something they overheard at the giant media water-cooler, or received a message on their dentures from alien life forms. It is sentiment that moves crowds, not reason. And being a member of a crowd causes one to behave differently from the way one would behave as an individual.

Le Bon saw crowds as a psychological phenomenon rather than a physical one. Individuals can form a crowd having never met or come together simply by having a common cause. This type of influence can easily be found in groups such as members of a particular occupation or calling, religious sects or even entire religions, sports teams and their fans, and so on. Then there are the crowds of advocates for the bullish camp and the bearish camp in any market. Market agnosticism is a very difficult path to tread, yet it seems to offer the best hope of long-term success.

That is because of two concepts offered by Le Bon. First, a crowd effectively has a mind of its own and, second, individual behavior is altered by membership in the crowd – often to the point of subjugating misgivings or original thinking to the will of the crowd. That’s why I have suggested in a number of previous articles that you decide who to listen to – including here on SA – by how successfully the writers have made you money, not by how much you agree with their dogma or rhetoric on the government, the economy or the market.

I heartily recommend this book to you, just as I did the first in this series, Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay. Yes, both are written with what we today might consider a certain quaintness of style more popular in the 1800s than in today’s frenetic, multi-tasking, cut-to-the-chase tweeting and twittering. So – investing-wise: how’s that working out for you?

Next month we rush headlong into the 20th century with 1935’s The Battle for Investment Survival by Gerald M. Loeb. Try not to get nosebleed from the pace…

Author's Disclosure: No securities recommended. In 1896, none of our current recommendations were in existence…

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