Growing up, I was fascinated by the TV show “Who Wants to Be a Millionaire?”  For those less familiar with the show, its premise was quite straightforward: contestants had to answer 15 consecutive questions correctly to win a million dollars. When contestants found themselves stuck, they were granted three valuable lifelines. These lifelines included “50:50,” which eliminated two incorrect multiple-choice answers, “Phone a Friend,” where they could consult a knowledgeable friend or family member, and “Ask the Audience,” where each audience member could cast a vote for what they believed to be the correct answer.

After a successful 15-year run, it was revealed that the “Ask the Audience” lifeline boasted an impressive success rate of 92%, significantly outperforming the 66% success rate of “Phoning a Friend,” where contestants turned to their smartest acquaintances for assistance.

This example highlights the significance of the “wisdom of crowds”.  In the world of investing, the “wisdom of crowds” is a concept that has gained significant traction over the years. Coined by James Surowiecki in his book of the same name, this phenomenon suggests that a diverse group of individuals, when collectively making decisions, can often outperform even the most knowledgeable experts.

Principles of Wisdom of Crowds

To correctly use the wisdom of crowds in investing, you need to follow the right steps to make an informed decision. 

  1. Diversify Your Sources: Seek information and insights from a variety of sources, including financial news, social media, and investment forums. Diverse perspectives can help you make well-rounded decisions.
  2. Collaborative Research: Engage in discussions and collaboration with other investors. Platforms like online forums can be excellent places to share ideas and learn from others.
  3. Data Analysis: Leverage data analytics and sentiment analysis tools to gauge market sentiment. These tools can provide valuable insights into crowd sentiment and help you make informed investment decisions.
  4. Stay Informed: Stay attuned to current events and market trends. Being well-informed equips investors to comprehend and adapt to changes in the investment landscape.

Common Pitfall

However, one must tread cautiously in the pursuit of the wisdom of crowds. In today’s technologically driven era, the “herding” bias often prevails over true crowd wisdom. Many investors tend to follow trends rather than diversifying their information sources. A glaring example of this is the “meme stock” phenomenon of 2021.

A survey by the CFA Institute revealed that a substantial 34% of investment decisions were influenced by “herding” behavior, indicating that investors frequently forgo diversification in favor of following the crowd.

(Source: CFA Institute)

In summary, while the wisdom of crowds holds potential in the world of investing, it is essential to recognize the pitfalls of herd behavior and strive for genuine diversification in information sources to make informed decisions and navigate the complexities of financial markets effectively.

Presented by the Financial Planning Committee of Lake Street, an SEC Registered Investment Adviser

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will be successful. Investing involves risk and you may incur a profit or a loss.