Behavioural Finance - Conformity bias
Why are we affected by the conformity bias?
There are two main reasons why a person’s opinion is often influenced by those of others. The first is the social pressure of conformity which can be a powerful force. As social creatures, we all want to be accepted by others and following the behaviour of the group is an ideal way of achieving this.
The second reason is the common belief that a large group of people can’t be wrong. Even if you are convinced that your particular course of action is the right one, you may still find yourself following the decisions of the crowd believing that they must know something that you don’t.
Fashions and trends
There are clear examples in contemporary behaviour that underline the prevalence of our herd mentality with many us following certain fashions that help identify ourselves with others, and them with us.
Trends, whether they involve clothing, hair styles, exercise regimes, diet plans or anything else, are essentially a matter of imitation, with different people copying one another on the basis of conformity.
Stock market bubbles and crashes
Herd-like behaviour also manifests itself in the context of global stock markets.
Bubbles and crashes are common features of stock market trading and they arise, largely, due to individual investors following the behaviour of the crowds of people that are either frantically buying or selling certain stocks.
The consequences of herding and conformity on major stock markets can be hugely damaging even on the scale of the global economy. However, our urges towards imitation are generally very difficult to overcome or set aside. Rarely, do many of us, as individuals, wish to be the odd one out and stand apart from the crowd.
The Nudge Concept
One means by which experts look to take account of conformity biases and herding instincts is to make use of nudge theory. Nudge theory essentially aims to encourage individuals to make “good” decisions without having to resort to implementing legislation, thereby still allowing individuals to make their own choices.
One famous example, often quoted to explain nudge theory, is that of the men’s urinals at Amsterdam’s Schiphol airport. It seems that signs in the gentlemen’s restrooms, encouraging due care and attention, were failing to prevent wet floors. As a result, staff decided to use the concept of nudge theory to attempt to improve the situation. Innovatively, the image of a fly was placed on the inside of the urinals. This, evidently, focused the minds of the patrons of the said restrooms, giving them a target to aim for, thus nudging them into the correct behaviour and lessening the amount of cleaning required!
Another, altogether less novel, example of nudge theory in action is the UK government’s implementation of the auto-enrolment initiative that opens up pension plans on behalf of employees around the country.
Employees can still opt out of their workplace pension schemes but, by making enrolment the default position, their instincts to herd together and copy one another can be channelled towards the positive action of saving for retirement.
Making choices for the right reasons
As ever in financial planning, the aim for individuals is to overcome whatever biases or instinctive tendencies might be at play when they come to make decisions that will affect their financial future.
Whether it’s with regard to a workplace pension or an investment strategy of any sort, individuals need to be as fully informed of their options and potential outcomes as possible. A good understanding of all the relevant issues is key in order to ensure that any financial planning is based on sound, rational decision-making and is not dictated by what other people are doing.