It is hard to break away from the crowd. Going along with the herd has deep roots in psychology. In the field of Behavioral Economics, herd behavior happens when individuals act as a group and do things as a group they would not do on their own.
Herd behavior often results in the individual losing their ability to think independently and weigh the pros and cons of decision-making on their own.
There are two accepted explanations for herd behavior:
First, the social pressure to conform and the need to be accepted often means behaving in ways that go against an individual’s instincts and better judgment.
Second, there is the attitude that this many people can’t possibly be wrong. (My Dad regularly says, “if this is such a good idea then how come nobody else thought of it?”; my reply, “Dad, just because nobody thought of a MHP Lawyer/Owner podcast doesn’t mean it is not a good idea!”)
While the masses get caught up in herd behavior, a group of investors goes against the grain – the contrarians. The contrarian looks for opportunities that are mispriced because of a lack of media coverage, popularity, or stigmas and biases.
So, when everyone else is avoiding an asset, the contrarian is gravitating towards it.
Contrarians go against the herd not only in terms of particular assets but also in terms of timing. When everyone else is selling, contrarians are buying. Warren Buffet is famous for saying, “Be fearful when others are greedy, and greedy when others are fearful.”
Contrarian investing isn’t easy.
“A willingness to subjugate one’s own thoughts for those of a group is a sadly common behavioral affliction.”
–James Montier, author “The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy.”
Following the herd takes no energy. Something that is hardwired in our psychology is easy to do. Now, going against that nature and breaking a habit – breaking from the herd – is hard. In fact, neuroscientists have found that when an individual breaks from the herd, he or she experiences fear. Makes sense to me. When breaking from the herd, you’re alone and susceptible to proverbial predators. You may also be subject to the ridicule of the herd. Remember middle school? Anyone wearing clothes or hairstyles everyone else considered weird was ridiculed. (Or, worse yet, hearing words that rhyme with Ferd and are common bathroom words for children.)
Being a contrarian investor takes confidence. It takes faith to think for yourself – whether in middle school or with your investments. Those with the confidence to go against the grain can find contrarian investing rewarding, but the drawback is that it also requires patience.
That’s because most investments that the herd avoids are alternative investments available only in the private markets.
The challenges of investing in private passive opportunities – especially intangible assets – are two-fold. One, private investments, unlike their public counterparts, are not liquid. You can’t just sign up to an online trading platform and invest in minutes. You first must qualify to invest with private investments since they are only available to qualified investors meeting certain income or net-worth requirements (e.g. “accredited investors).
Then, once qualified, the company will provide you with its offering materials (private placement memorandum) detailing the opportunity. You will need to review and scrutinize these materials and perform your due diligence to assess the opportunity’s viability. Then, after all that, there’s the matter of capital. While public stocks can be bought for as little as pennies, private investment minimums are typically tens of thousands.
The second challenge for contrarian investors when investing in passive opportunities in intangible assets is timing. These investments are illiquid and have long lockup periods, typically a minimum of 5-7 years for management to carry out its business plan fully and for the asset to mature to reward investors with cash flow and optimal appreciation.
Logically, contrarian investing makes sense. While the masses chase certain assets (think stocks and bitcoin) – driving up their prices into overvalued territory, undervalued opportunities exist that can be potentially rewarding.
Contrarian investing makes sense, but it’s easier said than done. Do you have the confidence to invest in foreign markets? Do you have the courage to invest in an asset that may draw the ridicule of other investors? “A trailer park? You’ve gotta be kidding, right?” How many times have we heard that? (The haters are laughing less than they were in 2014 when I started in MHPs!) Finally, do you have the patience to see your decision through?
Passive investments take time. Do you have the confidence and patience to let your investments germinate, grow, and mature? If so, then contrarian investing might be for you.