Should You Run With the Herd? The Bandwagon Effect Explained
By the Inspired Investor teamMay 23, 2023
Question of the Week: Are trendy investments right for you? Find out about the bandwagon effect and how it can skew your decisions.
Groupthink. Peer Pressure. FOMO. Herd mentality. There’s no shortage of ways to describe the human tendency to follow the crowd – the so-called bandwagon effect.
We see the bandwagon effect at play all around us, from nutrition trends to how we vote in elections and, not surprisingly, investing decisions.
A famous social experiment from 1962 called “Face the Rear” showed how people are willing to make unusual decisions in order to align with a group. In the experiment, people walked into an elevator to find everyone facing backwards. Their position was odd, yet new riders – one by one and captured on camera – rode the elevator facing away from the doors in an act of conformity.
Why we follow
Other people are a powerful influence. As social animals, being part of a group can be comforting. As such, what other people chase can serve as a signpost for what we could do. Following the herd could be a mental shortcut in some situations, especially when quick judgements are needed.
Did you know?
The expression “jump on the bandwagon” dates back to the mid-19th Century. Dan Rice, a famous clown back then, campaigned for an American presidential candidate Zachary Taylor. Rice had a secret weapon: a circus bandwagon. At campaign events, he urged people to “jump on the bandwagon.” And they did. The stunt proved so effective that it helped Taylor win the presidency.
Think twice before jumping
Just because you could do something doesn’t mean you have to do it.
That’s especially true when it comes to money matters. History is full of such examples, from the tech bubble in the 1990s to the 2008 housing crisis. More recently, investors are reminded of the perils of the bandwagon effect in the saga of GameStop, whose stock price exploded from just under $40 a share to $483 in a little over a week, only to come crashing back down. It’s simple supply and demand. When a lot of people want to buy something, the price goes up.
The problem with the bandwagon effect is that popular doesn’t always equal smart. Because popularity can lead to quick price surges, the bandwagon effect can potentially be profitable for some investors – but if you’re following the pack, it’s difficult (read: impossible) to predict when the tides may turn.
Every investor’s situation is different, so it’s important to make decisions based on your unique goals rather than what others around you are doing. It’s wise to consider your own risk appetite, personal asset mix and what makes sense for your specific portfolio needs. When it comes to your investments, it’s a good idea to be aware of the herd, but always make your own decisions.
Things our lawyers want you to know
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.