Born to Herd

One evening around 40000 years ago, on the steppes of East Africa, a small group of our distant forefathers prepared to hunt down a woolly mammoth. There was, of course, enormous risk in pursuing such a large beast. But these hunters belonged to an band of about 40 men, women and children who had endured a long drought. A single mammoth could feed them all for many weeks, so the prize seemed well worth the risk.
The men spent that evening sharpening spears and building up their courage; the next day, they recited incantations passed down from their ancestors and dabbed their faces with colorful paint and blood portions. The knowledge that a few might be sacrificed on the tusks of the mammoth was largely forgotten in the excitement of preparation and the anticipation of reward.
Surprisingly, that scene from the mists of time tells us quite a bit about investor behavior today. Many human social and emotional drives emerged over millions of years of evolution. Our species’ earliest survival instincts, inherited from pre-human ancestors, drove them to hunt in packs – especially when they preyed on much bigger species – and to aggressively defend their band. Strong herd emotions helped prehistoric peoples summon the will and courage to take risks, to join such hunting parties, and to collectively protect their families and villages. To act individually would have been exceedingly irrational. To act as a group was vital to survival and thus highly rational. Each and every one of us is descended from those who took such joint risks and survived.
Modern cultures still incorporate some of these behavior patterns. The same herd instinct – those strong and emotional group impulses, the collective exuberance and excitement of the hunt or of battles against marauding predators or rival groups – has been passed to us. It often manifests itself in our investment decisions. And while at times investor herd behavior has been highly destructive, it has also produced many of capitalism’s great achievements.
Participants in economic bubbles join the crowd, even though, in the final analysis, individual losers often vastly outnumber individual winners. But just as the herd instinct allowed the prehistoric hunting party to accomplish something significant for the group – something that no individual could do on his own – so it has occasionally hastened major developments that benefit whole economies. The railway booms of the nineteenth century revolutionized transportation in America, Western Europe and Africa helping open new markets. The Internet frenzy created a revolutionary aid to communication and commerce.
Yes, such booms and busts often cause economic instability and massive investment losses, with no commensurate benefits for many. And yes, in recent years, they have spawned some outrageous betrayals of investor trust. But by fueling investments in high-risk, high-return ventures, they also have produced broad benefits for society that might not otherwise have occurred, or at least not as quickly.

This is a twist in the traditional view of economists, who typically define the individual’s behavior as irrational in the context of group behavior. In Manias, Panics, and Crashes: A History of Financial Crises, economist Charles P. Kindleberger noted that “mob psychology or hysteria is well established as an occasional deviation from rational behavior”; in such situations, ”the action of each individual is rational – or would be – were it not for the fact that others are behaving in the same way”. The Economist Robert Shiller, in Irrational Exuberance, argued that herd like behavior, ”although individually rational, produces group behavior that is, in a well defined sense, irrational.” In neither view does it make much sense for individual investors to enthusiastically join the “irrational” pack. And yet investors frequently do, and they have done so repeatedly over the centuries. Something more instinctual than economic logic must be at play.
John Maynard Keynes recognized the primal origins of these “irrational” economic forces. “Our decisions to do something positive,” he wrote in The General Theory of Employment, Interest and Money, “… can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.” These “animal spirits” developed over millions of years of evolution. They gave early man the courage to migrate out of a small patch in East Africa to populate unknown lands and the cohesion to survive enormous adversity – several Ice Ages, massive droughts, predatory beasts, and hostile neighbors. Today, the residual, instinctual legacy of these prehistoric peoples drives herd like, “irrational exuberant” investment decisions that, while often harming individual investors, may collectively benefit society. As descendants of those successful mammoth hunters, we do what over eons we have become hardwired to do.