The Dow Jones Industrial Average is making record highs, knocking the 2007 peak off its pedestal, but investors aren’t celebrating.
-Frank Holmes, U.S. Global Investors
Since the Dow hit its March 2009 low, many sage market players followed the stimulative monetary and fiscal policies, ignored the noise of pundits predicting doom and gloom, and invested heavily in equities. Only in retrospect can their bold calls be recognized as wise.
I often look to social sciences and psychology to help investors understand the importance of the collective genius. In one of my favorite books, The Wisdom of Crowds, James Surowiecki points to statistics scientist Norman L. Johnson’s maze experiment as one of many illustrations of intelligent group decisions.
Johnson sent groups of people one-by-one through a maze, recorded their paths and timed the results. Do participants take a left or a right? How many steps does it take to make it through?
Then, he calculated how many total steps each individual took to reach the end of the maze. The average ended up to be 12.8 steps, but the group collectively did much better, taking only nine steps. More importantly, “there was no way to get through the maze in fewer than nine steps, so the group had discovered the optimal solution,” wrote Surowiecki.
Time and time again, Surowiecki found evidence of collective decisions to be superior to individual results, whether researchers asked people how many jelly beans are in a jar or how much an ox weighs. The “collective guess was very accurate, and was better than the vast majority of individual guesses.”