You and Your Biases – Does this Sound Familiar?
I continue today with my periodic review of investors’ most dangerous instinct-driven biases. Since I’ve just returned from a CPA conference in distant Las Vegas, I thought I’d celebrate by covering familiarity bias.
What is it? Familiarity is a mental shortcut we use to more quickly trust (or more slowly reject) people, places and things that are familiar to us.
When is it helpful? At the conference, I found myself selecting snacks I recognized, gravitating to attendees I’d met before, and anyone wearing Washington Capitals gear. (The CAPS had just won the Stanley Cup for the first time in their 42-year history.) That’s familiarity bias lending a helping hand.
When is it harmful? While helpful, or at least harmless in your travels, familiarity can create a false sense of security when you’re investing. Considerable evidence tells us that a broad, globally diversified approach enables investors to capture expected long-term market returns while best managing the risks involved. Instead, investors tend to overweight their portfolios with their own country’s investments. Americans stock up on U.S. companies, Canadians favor Canadian holdings, Germans love German stocks, and so on.
Clearly, we can’t all be correct at once. Confusing “familiar” with “safe,” can trick you into giving up some of the actual safety found by employing global diversification to spread your financial risks around.
How to overcome? In January 2018, U.S. company stock made up 54% of global equities (based on market cap). If more than 54% of your stock holdings are in U.S. companies, recognize that you may be letting familiarity bias affect your prudent investment plan. While you’re at it, if you own more of your employer’s stock than you could afford to lose (think Enron, MCI and Circuit City), consider consulting with a fiduciary advisor about how to manage this highly familiar, but also highly concentrated risk.