Robin Powell
Cameron Peng/ London School of Economics
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RP
Financial history is littered with examples of speculative bubbles that eventually burst, from Tulip Mania in the 1630s to the dotcom bubble in the late 1990s.
There are several reasons why such bubbles develop. One of them is the power of story-telling.
CP
Every time we look back at a historical kind of episode, we often have a narrative associated with it. It tells a story that has much more context to it. It has much more.
There is a logic. There is like, you know, what memory psychologists will call so many cues. It's not just about the numbers. Also about, you know, when the market was doing like this, how did people feel, what was, you know, the market?
What were the analysts were saying? All of these things, it's just much more concrete. And I think that makes the entire thing much more believable, if you know what I mean. It's not just about just the cool numbers, but now you almost like in the story. And I think that, you know, really get people to believe in what they want to believe.
RP
Another common feature of speculative bubbles is what behavioural experts like Cameron Peng call herding behaviour.
In other words, investors blindly follow other investors, assuming, often wrongly, that those investors have done their research and know what they’re doing.
CP
What happens in the herding behaviour is that I don't really necessarily have anything, you know, concrete about a particular asset or particular stock. I don't really know. What is the value of a tulip. Tulip or bulb or. I don't really know the value of Microsoft in during the internet bubble. But then, you know, my friend bought it and got a good return out of it and I got to know about it.
And then for me, it was like, okay, maybe I don't know anything about it, but apparently my friend is and then I'm just going to repeat what this person does. And then when that kind of guy gets aggregated and every a lot of people are started doing that, that really gets people to herd. And I think this is what basically happens is that one person's opinion gets magnified and gets repeated, by many others.
RP
Many investors enjoy the excitement of speculating on a particular investment.
But a far more sensible strategy is to have a broadly diversified portfolio and stick to it.
CP
There is a bit of a disconnect. We have all of these insights about how you know what people should be doing, but they are not really taken by a lot of, you know, people who actually make decisions. We have to take, you know, these things that we found about how investors trade more seriously and better connect with, you know, the finance media about how things are done.
I'm basically putting all of my money in extremely diversified, funds that are like, you know, everything. So I, I think when I was a choose you, then that was like, you know, having fun with like stock trading. But now I'm like doing extremely, kind of like passive, investment. And I think that's, that's done reasonably okay for me.
But, yeah, I, I study behavioural finance, but I think in my own portfolio decisions, I'm extremely irrational.
RP
So, beware of investing in something just because others are. And remember, that’s their choice.
It’s much better to focus on playing your own game instead of trying to beat others at theirs.