Why Following Financial Trends Can Hurt Your Future

By Annie Mueller | September 23, 2011 AAA

There's one key problem with financial trends, and that's the word "trend." A trend is, by nature, something that lasts for a limited period of time. Financial trends tend to follow an ebb-and-flow pattern: periods of prosperity followed by periods of decline followed by periods of prosperity, and so on.

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Sometimes that pattern is limited to particular segments of the market or the globe. But the pattern is fairly constant. Financial trends are created when "everybody" catches on to some great financial opportunity or move. But the masses are a bad indicator of smart money moves; once everybody has caught on to a great financial trend, the trend is already on its way down in the pattern. Hence, we get to experience trends coming to what seems like an abrupt end: the dotcom bubble and the housing bubble for example. (For related reading, see Why Housing Market Bubbles Pop.)

Most people aren't financially savvy. They may know a little about accounting or have a few thousand dollars in the stock market, but most of us aren't financial experts by any means. We gauge the worth of any financial investment by looking at it through a risk versus reward lens. If the reward is greater than the risk, we figure it's a good move.

However, that lens is clouded by the "everybody else is doing it" nature of trends. We automatically view a financial opportunity as less risky if we can see crowds of other people doing the same thing. We find safety in crowds, and our instincts tell us that we are safe if we follow the crowd. So we measure the risk as disproportionately lower when the opportunity (buying a house with no down payment!) is popular. (For related reading, see 6 Reasons To Avoid Private Mortgage Insurance.)

Obviously, we're all learning that the crowd doesn't know squat about good financial opportunities. Current financial trends include large companies downsizing, midsize companies cutting costs and small companies throwing up their metaphorical hands in despair. On an individual and family level, many of us are on a trend "wait it out until things get better."

The Bottom Line
It's not that you should go spend money you don't have just to avoid following a trend. Rather, use your own common sense. But common sense might take a look around. Common sense might see some great opportunities that the crowds aren't seeing, because they're all too busy recovering from the last trend.

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