Last weekend I enjoyed what many refer to as the “end of summer” here at the Jersey Shore. Despite the fact that Labor Day weekend doesn’t even come close to ending this beautiful time of year here in New Jersey, I managed to take away a valuable lesson that applies to the markets.

I was relaxing in my chair Saturday afternoon, when I noticed a few lifeguards running across the beach. They were heading towards the stand about fifty yards in front of me. It seemed like they had some type of news to share with their fellow guards. I was too far away to hear anything they said, but apparently I wasn’t the only person watching this all unfold. Next thing I knew somebody yelled, “Shark!”.

I’m sure you can guess the beach’s reaction to this expert pronouncement: concerned conversation and extreme curiosity. It started out with just a few beach-goers getting up, walking to within viewing distance of the ocean, and craning their necks, but before long they’d been joined by many more. Increasing numbers stood waiting for a fin to emerge from the water, except that it never came because there was no shark.

The guards eventually dealt with the concerned masses by letting them know they were spreading the word about a potential missing child, not a shark. (Side note: the child was shortly located, no harm done)

What’s the lesson for investors?

Beware of information cascades. These events occur when a group with incomplete information assumes that whatever the crowd is doing must be correct. This behavior derives from our tendency to mimic others. Frequently this works out well for us, think about children learning to talk and walk, however it can just as easily lead us astray.

Sure, it was only a minor inconvenience for those who got up to join the shark watch last weekend, but it can be a lot worse when we’re talking about investments. The market provides prime examples of herd mentality all the time. Sometimes relying on strength in numbers works and sometimes it ends very poorly.

Having a financial plan and clear investment strategy can help investors avoid information cascades and stay the course. Don’t assume the masses are always correct. Instead of following them blindly, follow your plan deliberately. Sometimes that might mean you roll with the masses and other times it might mean you fly solo. At least you’ll be able to say you did it your way and stuck to the game plan.

Now Go Talk About It!