Is Familiarity Bias a Threat to Your Investments?

An area of study focused on how psychological influences can affect market outcomes, a key aspect of behavioral finance studies is the influence of biases. Biases can occur for a variety of reasons and can usually be classified into one of five key concepts.

One of the more common behavioral biases in finance is familiarity bias, which is when we choose certain options because they are already known to us. And although it might be fine to go to your favorite restaurant again and again, it’s not necessarily the best way to choose something as important as where you invest your money. 

Understanding Familiarity Bias in Investing

Also known as the familiarity heuristic, this type of behavioral bias in investing is when people tend to invest in what they know, such as domestic companies, organizations they work for or companies that create products they like. 

Familiarity bias can occur in many ways. You may resist investing in a specific company because of the industry, where it operates, what products it sells, the management, who the clients are, marketing tactics or how complex its accounting is.  

One of the best ways to ensure your financial health is by limiting the possibilities of financial biases. Here are some of the ways you may be unknowingly indulging in familiarity investing — and what you can do about it.

Investing Only in Companies You Have Heard of or ‘Like’

Just because you love your flat-screen television or heard that a new clothing chain is popular doesn’t mean these companies are good investments. Before you put your money where your bias is, make sure to conduct a real analysis of the company and the industry rather than make an emotional investment decision based on your perceptions and preferences.

Choosing Only U.S. Investment Opportunities

The global economy keeps growing, and in many cases foreign stocks outperform those in the United States. Yet, many people are hesitant about making investments abroad — out of fear, a lack of knowledge or both. A 2022 article in the Journal of Financial Economics found that as of 2018, U.S. residents held roughly $2.4 trillion in international equity mutual funds, which may sound like a lot, but actually accounts for only 26% of all equity mutual fund assets under management. 

Making investment decisions influenced by familiarity bias can limit your potential. Investing only at home can lead to missed opportunities for growth and a lack of diversification, which can hurt your portfolio. It’s a good idea to look into all available options — all over the world — rather than staying too close to home. 

Committing to Investing in the Company You Work for

Employers often offer their employees a “share” of the business, creating opportunities to invest in themselves and their futures and, hopefully, have that investment pay off. But this can be risky if it encourages you to put too much of your money in one place rather than having a broader portfolio and, thus, a smaller risk. 

Of course, there is nothing wrong with investing in yourself and the work that you do, but be sure to know the reality of your workplace’s level of risk — and invest accordingly.

There is nothing wrong with sticking to what you know — we’re human, after all, and take comfort in the familiar. But it’s important to understand that this is an inherent bias that may not be the best foundation for making decisions about your investments. 

As with anything that is such a large decision, try your best to be objective, do your research and make decisions based on what you find instead of what you feel. And, perhaps most important, consult a professional to help you consider and choose the best options for you.

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