Why Can’t Investors Think For Themselves?
The always awesome Jason Zweig unearths a new study that tells us why investor sentiment seems to change on a dime.
Sometimes the most interesting answers to financial questions come from scientific labs. A study published last week in the journal Current Biology found that the value you place on something is likely to go up when other people tell you it is worth more than you thought, and down when others say it is worth less. More strikingly, if your evaluation agrees with what others tell you, then a part of your brain that specializes in processing rewards kicks into high gear.
In other words, investors often go along with the crowd because—at the most basic biological level—conformity feels good. Moving in herds doesn't just give investors a sense of “safety in numbers.” It also gives them pleasure.
Humans of course seek to maximize pleasurable behavior and thus go along with the crowd. Benjamin Graham, the father of value investing, long tried to convey this bit of behavioral wisdom to investors when he wrote “the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities.”
Some of the worst violations of common sense are rationalized with the simple phrase “everyone else is doing it.”
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The Study Abstract:
The opinions of others can easily affect how much we value things. We investigated what happens in our brain when we agree with others about the value of an object and whether or not there is evidence, at the neural level, for social conformity through which we change object valuation. Using functional magnetic resonance imaging we independently modeled (1) learning reviewer opinions about a piece of music, (2) reward value while receiving a token for that music, and (3) their interaction in 28 healthy adults. We show that agreement with two “expert” reviewers on music choice produces activity in a region of ventral striatum that also responds when receiving a valued object. It is known that the magnitude of activity in the ventral striatum reflects the value of reward-predicting stimuli [1,2,3,4,5,6,7,8]. We show that social influence on the value of an object is associated with the magnitude of the ventral striatum response to receiving it. This finding provides clear evidence that social influence mediates very basic value signals in known reinforcement learning circuitry [9,10,11,12]. Influence at such a low level could contribute to rapid learning and the swift spread of values throughout a population.