By Jason Zweig | 12:50 pm ET Sept. 5, 2014
Image Credit: Christophe Vorlet
For investors, emotions can be contagious. With U.S. stocks near record highs and European bourses sizzling, now is the time to immunize yourself against the risk that a sudden selloff will infect the markets—and you—with panic.
New research helps explain how financial contagion spreads and how to protect yourself against it.
Paying attention to the right people turns out to be hugely important.
Several recent experiments led by Garriy Shteynberg, a professor of psychology at the University of Tennessee, have explored what he calls “shared attention.” The experiments find that when you pay attention to the same thing at the same time others do, you will remember it better and be more inclined to act on it.
Knowing that other people like you are focusing on the same thing—a movie, a sunrise, the price of a stock, a financial feed on Twitter—also intensifies your emotional reactions, whipping up your enthusiasm for anything positive or deepening your fear of something negative.
Of course, humans tend to be conformists, and many investors move in herds. And people are also empathetic, mimicking the moods of others, especially those close to them.
But Prof. Shteynberg’s research finds that shared attention will influence your emotions even when you have no idea what other folks are feeling. His latest work, published in peer-reviewed journals, is based on more than a dozen studies of well over 1,000 people—most of them drawn from the general adult population, rather than just the college students who typically participate in such experiments.
“We simply think more about any object or event that we experience simultaneously with someone who is similar to us,” he says.
I learned this myself when I ran through one of Prof. Shteynberg’s shared-attention experiments online. First I was asked to rate how happy and how calm I felt (so-so, I responded). Then I chose an avatar to represent myself from among a small collection of animals; I picked a koala. Next, I was told that another person would participate—and that he or she had also chosen a koala. We would watch a video together online at the same time.
It turned out to be 36 seconds of footage about homelessness. I couldn’t take my eyes off it, and I found it much more distressing than I expected. When it was over I was asked to rate my mood again; now I was very unhappy and not at all calm.
The explanation, according to the researchers: The “presence” of the other koala was enough to intensify the experience for me. Paying attention to the same thing as someone else, but not at the same time, has much less effect on people’s emotions. And concentrating on the same thing with someone who is different from you also barely registers.
It takes remarkably little for someone else to seem like your peer. Had it been an owl or an elephant instead of a koala, the research has found, my reactions would have been much more muted.
That’s not all. So far as I knew, I focused on the same video with only one other person—a much weaker form of shared attention than when millions of people are transfixed together by traumatic market news. I never knew what the other “koala” thought about the video, so there was no direct way for my feelings to be influenced by his.
Finally, although the experimenters had led me to believe that another person was watching, the second koala was nothing but an image on a screen. I had watched the video alone.
Why should investors care? There is strong evidence that people who live near each other increase their ownership of stocks around the same time; that 401(k) investors put more money into stocks when their co-workers have recently earned high returns that way; and that mutual-fund managers are more likely to invest in a company when other stock-pickers in the same city are also buying it.
In each case, these studies found, investors are likely talking about stocks with their peers.
These people aren’t merely trying to conform to the crowd; their actions may have been shaped by shared attention.
In a survey published in 1989, the future Nobel Prize-winning economist Robert Shiller found that for 62% of individual investors and a shocking 75% of institutional investors, the decision to invest in stocks with hot recent returns had nothing to do with a “systematic search.”
Instead, these investors seemed to chase whatever grabbed their attention the most because other people were talking about it. Prof. Shiller found that institutional investors talked about their hottest stocks with an average of 21 other people, or three times as much as they discussed their more ordinary holdings—what he called “an extremely high infection rate.”
So try to socialize—in the real world and in online social media—only with investors who are calm and methodical. After all, whatever your peers pay attention to, you will also concentrate on—so following more-sensible people will help inoculate you against panic.
As Warren Buffett likes to say, investors should “hang out with people who are better than you are.” In the end, the investors you follow may be as important to your returns as the investments you own.
Source: The Wall Street Journal
http://blogs.wsj.com/moneybeat/2014/09/05/the-badness-of-crowds-pick-your-peers-wisely/?mod=WSJBlog