The Biased Investor (Part 7)
Does familiarity breed contempt?
Source: Public Domain
Some people love novelty. Others want to go with what they know. When it comes to money, evidence shows that people overwhelmingly prefer things they are familiar with to what they don’t know very well.
“This isn’t just a human factor. I discussed before how a researcher played musical tones around fertile chicken eggs, and found that when the chicks hatched they preferred the sounds they had been exposed to while in their eggs. He coined the phrase, “preferences need no inferences.” We don’t need to think about something to like or dislike it.”
This can show up in our investment portfolios. The “home country bias” is well-documented: investors tend to overweight companies that are based in their own nation. French investors have more French companies, Spanish investors own more Spanish firms, Japanese investors favor Japanese firms. But the familiarity affect holds true regionally as well. In the US, northeastern investors favor financial firms, Midwestern investors overweight industrial stocks, West Coast investors own more tech firms, and so on.
Source: JP Morgan
What should investors do? First, recognize your bias. Having a headquarters near your home doesn’t necessarily mean you know a company better. AIG is based in New York City, but the operations that caused it to collapse in 2008 were located in London. Second, US investors need to be especially careful right now that they don’t exclude the rest of the world from their portfolios. For the past several years, the US stock market has been the strongest in the world. But nothing stays the same. Outperformance leads to overpricing and subsequent underperformance. What goes around comes around.
Source: Bloomberg, Global Financial Data
Just because you’re familiar with something doesn’t necessarily make it a good investment. And past returns don’t predict future returns.
Douglas R. Tengdin, CFA
Chief Investment Officer