Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Groupthink

What it is:

Groupthink is a psychological phenomenon whereby pressure within a group to agree results in failures to think critically about an issue, situation or decision.

How it works (Example):

Let's say John, Jane, and Jeff are fund managers for the XYZ mutual fund company. They meet weekly to discuss their investing strategies and their top picks. The three get along well and trust each other's judgment.

One day, Jeff proposes buying shares of ABC Company for his fund. He plans to make a large buy and says he likes the company's fundamentals. John and Jane go along with the plan and buy the stock for their funds, too. Two weeks later, the stock has fallen by 50%.

John, Jane, and Jeff are the victims of groupthink. They didn't independently analyze the stock and relied on everyone else in the group to point out flaws in Jeff's thinking.

Psychologist Irving Janis coined the term in 1972. Janis cited eight signals of groupthink:

  1. Excessive optimism
  2. Discounting warnings
  3. A belief that the other person's motives are ethical
  4. A belief that people outside the group are troublemakers or create conflict
  5. Pressure not to disagree with other members of the group
  6. Failure to express doubts or differing opinions
  7. Assumption that what most of the group believes is what all of the group believes
  8. Members who "protect" the leader from conflicting information or dissenters

Why it Matters:

In the investing world, groupthink is akin to a "herd mentality." Knowing how to recognize groupthink provides a tremendous opportunity for contrarians to recognize when investors are buying or selling without thinking. This allows contrarians to question trends and even go in the opposite direction.

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