When more people offer an opinion, there is a better chance of coming to a right answer – this is the idea of the so-called “wisdom of crowds”. When choosing an investment or other financial product, it can be easy to think “the crowd” knows best. Unfortunately, it isn’t always true.
Let the many decide?
US financial journalist James Surowiecki popularised the phrase “the wisdom of crowds” in his 2004 book. If a group of people are asked to guess how many jelly beans are in a jar, the average estimate can be almost the true number, and often better than any single guess made by one person, he points out.
The concept traces back to a passage in Aristotle’s Politics, where the Ancient Greek philosopher notes that “the many” can in certain conditions make better decisions than individuals or small groups.
Crowds can be clever
The “average guess” from large numbers of independent individuals can be surprisingly accurate, in a variety of areas including horse racing and the share market. Crowds can prove “remarkably intelligent” and “they can even be smarter than the smartest person in them”, as Surowiecki explains in a TED Talk on the power of social media.
Today, eye witnesses to an event can quickly team up on social media to send videos, blogs, texts and other media from multiple viewpoints, giving an overall picture, he says.
But not all crowds are wise
One problem is that people often like to agree with each other – which is why courts of law try to keep members of a jury from outside influences during a trial. People can affect each other negatively when it comes to spending or investing too.
For example, some people may buy shares because others have done so, without doing their own research. A Ponzi scheme is a related type of scam, where earlier investors encourage new investors to follow them, and people have lost large sums of money.
The “herd behaviour” effect, when people copy others’ choices, is well known. It takes courage to stand out – especially if unsure of the facts or when a decision is complicated, or if there is a need to please others. It is easy to assume someone else might know better – but this can lead to costly errors.
“She’s a witch!”
There's a comic illustration of how crowds can come to stupid decisions instead of wisdom in a famous Monty Python sketch, where a group of medieval peasants execute a woman as a witch simply because of a single accusation.
The rest of the group quickly get caught up in the atmosphere, while the reasons given that “prove” the woman is a witch become increasingly ridiculous, as people compete to show off their knowledge and to be proven right.
Decide for yourself
A crowd can be easily swayed by others’ bad ideas. To avoid this, a wide variety of people can work individually to develop different viewpoints, as Surowiecki’s book points out. It draws on a 1907 paper by statistician Francis Galton, who found that a large number of people with diverse backgrounds can be even better at estimating the weight of an ox than a group of farmers who know a lot about cattle.
Galton’s paper confirms that people working separately can more easily develop varied opinions, based on a fuller perspective of the facts. Read his paper here.
Whose idea was it?
However, Surowiecki also points out that few groups really are independent of other people’s viewpoints. With modern media like the internet, for example, the beliefs and ideas of others – whether true or false – are widely available.
The problem is made worse by natural human foibles like herd behaviour and confirmation bias. It might pay to avoid assuming “the herd” or even peers will come to the right decision about finance, or anything else – instead, seek out a wide range of alternatives.