The Crowd Knows Best

Statistics Show Accurate Advice And Solid Solutions Hail From The Masses

(CBS) 
"In the security markets we have no Lake Woebegone where all kids are above average. We are average in this business of professional investing and that is why index funds win because they give you market return at zero versus managerial guys who charge 20-25 percent," Bogle says.

What about when the crowd gets it completely wrong? For instance, the bursting of the prosperous stock market bubble in the late 1990s.

"Crowds go wrong when diversity really breaks down," Surowiecki says.

Lack of diversity, Surowiecki explains occurs when independent thought within the crowd ceases. He adds that, "crowds also break down when people start paying too much attention to what those around them are doing."

Surowiecki uses Amazon.com as an example. "Most of us weren't really saying to ourselves, 'What is Amazon.com really worth as a company? How much money is it gonna make over the next 20 years?'

"But what we were really saying to ourselves was, 'What does everybody else think Amazon.com is worth?' and, 'What is everyone else gonna be willing to pay for, for this stock if I buy it now? So, when I try to sell this a month from now.' And so, what happens is you get just wrapped in this loop," Surowiecki says.

"It's just this kind of vicious cycle, where everyone is really just looking at what everybody else is doing," he adds.

Surowiecki offers a second example, this time from the animal kingdom.

"Most of the time, says Surowiecki, it works for certain kinds of ants to follows the ants in front. That is, until one ant gets lost. Then it's curtains for everyone.

"And what happens is they eventually end up in this giant circle. And what happens is they will literally walk around and around, for hours, or maybe even days, until eventually, they get tired, and just die," he says.

Pressed to describe the ideal people to lead a crowd, Surowiecki says, "If we're trying to make a good decision, or predict the future, the knowledge we need is buried in the heads of people who you would never think to ask."

NewsFutures is an Internet prediction market where serious bettors try to predict the future. Using play money (because in the United States it is still illegal to bet real money on the Internet) bettors can gamble on just about anything.

"This is more than just sport and games. There's real information to be gathered from these markets," says Emile Servan-Schreiber, NewsFutures' chief executive officer. He adds of his site, "It taps directly into the collective intelligence of the audience."

Servan-Schreiber believes that "The one thing that is key is that you can trust people. And the Internet has showed that every time you put a community together through the Internet, it generates great, new possibilities for all of the rest of us."

Prediction markets are becoming so significant that Harvard Business School Professor Anita Elberse not only teaches the subject, she has made it her business.

Elberse looks to a Web site called the Hollywood Stock Exchange, which allows users to buy and sell motion pictures as if they were publicly traded stocks. The prices fluctuate depending on the success of the films at the box office.

In turn, Elberse says movie executives pay attention to the activity on the virtual stock exchange as a guide to how they should spend their studio's money.

The deference toward the gut feelings and opinions of the masses leads Elberse to conclude, "One expert will never know as much as a group of people."

So there you have it: crowd wisdom. That experts often know less than they think. Amateurs, together, know more than any one person knows, and that people can be trusted to find the truth.

It's an old lesson that Surowiecki is sharing anew.

"If you go back to Machiavelli and "The Prince," what does he say? He says, 'Do not surround yourself with yes men,' and that this is what the Prince has to watch out for.

"But," Surowiecki adds, "apparently what it comes down to, it's just very hard to follow that good advice."