Dangers of jumping on a bandwagon

There are a number of pitfalls to 'copycat investing' and sometimes it pays off to ignore the hype.

It’s a famous old adage that investors are driven primarily by fear and greed. When news turns bad, our fear that it will get worse leads to panic selling, often followed by missing the boat when the market bounces. Greed is another example of the herd instinct overwhelming our rational thoughts. Here are two common situations where greed affects our ability to make sound investment decisions.

Markets move in cycles but the timing of these is largely unpredictable

Academic evidence suggests that attempts to profit from market timing are likely to be futile. The media only reports when there are extreme movements in markets, such as hitting a record high/low or moving more rapidly than normal; newspapers do not report ‘boring’ steady performance. Expect to read stories picking out examples of huge gains made by a select few stocks accompanied by adverts from product providers urging you to jump on board this apparently unstoppable gravy train. However, this is exactly when alarm bells should be ringing. Instead of taking more risk, now might be time to take less. Or just ignore the hype and do nothing.

Another situation will be an offer to invest in a product that appears to have an extraordinarily strong performance record. In most walks of life past performance does give a pretty good guide to the future but in the case of investment it really doesn’t work at all. The main reason is that there is a tremendous amount of ‘noise’ in the data. As the time period lengthens, the ratio of noise to facts reduces but only slowly.

One explanation for a strong recent performance record can be that this style of investment is in fashion. When a style is working everyone using this strategy will profit (regardless of skill) and the opposite is true. A common example would be just to invest in ‘boring’ companies paying large dividends and with good cashflow. This is an entirely sensible approach but there will regularly be periods when it isn’t very profitable. Just like hemlines, investment fashions change. So, if this style is being actively promoted it probably means that it‘s already well into a phase of outperformance and sooner or later that will come to an end.

EQ tip: in the investment world ‘boring’ is often the safe option, herds are rarely right.

I have a question...

We're here to help. Quickly get to the answer you need by speaking to an EQ financial adviser now: Call 020 7488 7171 Mon-Fri, 8:30am-5:30pm
  • Search the EQ library

  • Find articles by theme

Some Free EQ Guides

10 Tips for Investing a Windfall

Coming into money isn’t something that happens often. Before you commit yourself to spending, investing, giving gifts or even giving up your job, here are some tips on how to make your windfall work for you in the long run.

Financial Planning Services

EQ is a Chartered Financial Planning firm able to offer a wide range of services to private clients including tax optimisation, retirement income planning and estate planning.

Final Salary Pension Transfers

The April 2015 Budget saw the most radical changes to the pensions landscape for a generation, but the new flexibility on offer is only available to personal pension holders. Members of final salary schemes can only access the new rules by transferring to a personal pension.

Saving Inheritance Tax

This guide explains how planning ahead of time can provide for – and in most cases reduce – the amount of tax that is ultimately due on your estate.

Spring Clean Your Finances

When it comes to money, it is fairly easy to get so entangled in the jargon that you lose sight of basic sound financial planning principles. This guide provides some pointers on important steps to take, and a few pitfalls to avoid, along the road to a healthy financial future.