The wisdom of the crowd

The wisdom of the crowd is one of the most important concepts in investing. In this video, Robin Powell speaks to behavioural finance expert Mark Higgins about why collective judgement usually beats individual insight.

It’s a principle that dates back more than a century to a livestock fair in 1906, where a statistician observed something remarkable about group guesses. Since then, the idea has helped shape how we understand financial markets, especially stock prices.

Every day, millions of investors buy and sell shares, each making a judgement about what something is worth. The combined result is a market that reflects a vast pool of opinions and information. That makes it extremely difficult to outsmart, no matter how much knowledge or experience you have.

So what does this mean for your investment strategy? Higgins explains why trying to beat the market is often a waste of time and money, and why a simpler, lower-cost approach makes more sense for most people.

1. Group averages outperform individuals

When many people estimate the same value, individual errors cancel out, making the average guess more accurate than most single predictions.

2. Markets are broadly efficient

Market manipulation and insider trading were made illegal in 1934, which created a level playing field. Millions of daily trades reflect collective wisdom, which makes beating the market on a consistent basis exceptionally difficult.

3. Index funds harness crowd wisdom

By tracking broad markets, low-cost index funds leverage collective insights and deliver more reliable, cost-effective returns than most active strategies.

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Transcript

Robin Powell: A fundamental concept investors need to understand is the wisdom of the crowd.

Mark Higgins: It was developed by an English statistician called Sir Francis Galton, and based on a competition he observed at a livestock fair in 1906.

The attendees were asked to guess the weight of an ox and there were 787 guesses and what Galton discovered was that the average guess was only nine pounds off the actual weight of 1,198 pounds. 

Furthermore, he observed that more than 90% of the individual guesses were worse than the average. And the principle here is that when there's an uncertain value and people have access to the same information, the error of their guess is kind of above and below. The worst guesses tend to cancel out and the average guess is going to be better than the majority of individual guesses. 

RP: The stock market is an excellent example of the wisdom of the crowd in action.

Every day, millions of investors around the world place millions of trades, each time expressing an opinion as to how much a particular stock is worth. 

So the market is like a giant super-computer, and therefore very hard to beat.

MH: This is why it's just so hard for investors to benefit from securities analysis. Once insider information and market manipulation were outlawed in the 1930s with the Securities Exchange Act of 1934 in the United States. Essentially the playing field for information became fair, market manipulation and insider trading were no longer allowed. And then the wisdom of crowds prevented outperformance by almost everybody and it's been that way ever since. 

RP: So the wisdom of the crowd means that markets are broadly efficient. What, then, is the best way to invest?

MH: The most important lesson is that almost all investors are just better off investing in index funds and getting broad market exposure. Rather than actively managed funds, because actively managed funds are trying to essentially violate the wisdom of the crowds and they're charging a lot to do it.

So, you know, despite claims by advisors, by consultants,  this is the best approach spending money, spending your time, which is often more valuable than money  on constantly hiring and firing active managers, constantly tweaking asset allocation based on, you know, what's happening in the moment. It's just not adding value, and it's a waste of time.

RP: Occasionally markets do get things wrong, and that’s why we have financial bubbles. 

The problem is, bubbles are extremely hard to identify while they’re actually occurring.

So, although they aren’t always perfect, current market prices are the most reliable guide investors have as to how much assets are worth.

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