What Is Tesla Stock Worth Right Now? (TSLA)
Plus, some thoughts on social-proof tendency
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Today, we released a new podcast with our friend Simon Erickson from 7investing. Listen to the episode on YouTube, Spotify, or Apple Podcasts.
For today’s newsletter, I want to talk about social-proof tendencies.
We have been researching the Nomad Investment Partnership for next week’s podcast. It should be a fun time analyzing one of the best investment funds of the 21st century.
In a speech by founder Nick Sleep, he discusses the importance of the social-proof tendency in investing:
“First, Social Proof/Group psychology. Well, we all know something about the dysfunctionality of group-based decision making, you’ve got one guy leading the debate, he’s the authority figure, he suggests a course of action, everyone anchors off that suggestion, maybe bonus time is looming so no one wants to object. You are all aware that a competitor across the road has just taken the same course of action. And nobody objected. Social Proof. And, of course, it’s a perfect disaster. We all know that social decisions can be suboptimal, but even so, that is how most decisions are made… At least on the boards of public companies and investment firms I know.”
Everyone is doing this so I should do this too. Or, maybe better said, I will be comfortable doing this. Or taking this stance. Or buying this stock everyone loves.
There is major social proof tendency with index fund investing. Everyone I know outside the investing world buys low-cost index funds for their retirement accounts. This is even more true for people in their 20s and 30s (a lot of people older than this hold active mutual funds).
Passive has now taken a 50% share of investable assets, with no signs of slowing down.
And why should it? The philosophy has worked for decades. It probably will continue working, too, although I don’t think we should completely disregard the passive bubble people. They are smart and make a convincing argument.
This is my problem with index investing, though:
Most people who own index funds are clueless about them.
“Over the long-term, the stock market goes up”
“I need a diversified portfolio”
“Index funds beat most investors over the long-term”
A lot of this is social-proof tendency. Everyone else owns passive investments (which aren’t actually passive, by the way). Everyone tells me passive investing is the best way to save for retirement. So that means I should invest that way.
People will have millions of dollars in savings and have no idea what they own. Many understand that they own “the stock market” but that can mean plenty of different things depending on what passive vehicle you buy.
Maybe people don’t need to understand what passive investing is and everything will be fine. But there is definitely social-proof tendency here, which can lead to bad outcomes.
I’m definitely not buying an S&P 500 index fund at a 3% earnings yield when I can get a 4.5% yield from a high-yield savings account. I mean, who would if they just thought about it for a second? Few who own passive vehicles are going through this thought exercise in 2024.
There is social proof tendency in real estate investing. All the marketers tell us we need to start “building equity” and take a mortgage out on a house as quickly as possible. Everyone should own a home, right? Well, if you take that idea too far you end up with the GFC.
There is clearly social proof tendency in individual stocks that turn into huge winners. Apple is one. Nvidia is the clearest example today. Everyone owns Nvidia, it is making them rich, so why shouldn’t I get in on the trend? Everyone is saying the company is great, they are probably right.
And if I’m wrong, at least I owned what the crowd did so I don’t stand out. It is comfortable to buy what’s trendy and what everyone else owns.
But that is not how the greats put up huge compounded returns. I’m confident it is not how the greats will put up huge compounded returns in the future, either.
To be a great investor, you have to have anti-social proof tendency, otherwise known as a contrarian mindset. While it doesn’t guarantee success, it is a prerequisite for outsized long-term returns.
This is how someone puts up 20% annual returns for 20 years, like Nomad.
More to come on next week’s podcast covering the Nomad Investment Partnership.
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Well said. I was having coffee this morning with the manager of a >$1bn value hedge fund based in London, and we discussed something along these lines. He was saying that within his investment team, most of the analysts have shifted with the crowd to focus on GARP/quality. So even the value funds aren't immune to it!