Quizmaster, Doug Hutchinson, presents his quiz for the month. Here, Doug discusses the pitfalls of familiarity bias.
Consider this Scenario:
Your friend Jake is considering different investment options and he asks for your advice.
"I'm thinking about investing my retirement account in a tech sector equity strategy. I've worked in the tech industry for years and I know the space well so that is the area of the stock market that I'm most comfortable with."
"I'm also thinking about investing some funds in my personal brokerage account in the equity of a local Fortune 500 Company. I know a couple of people in my circle of friends who work there so I feel comfortable investing in that company's stock."
What feedback should you give Jake about his investment decision making process?
Solution:
Jake is demonstrating a familiarity bias in his investment choices. Familiarity bias is the tendency of investors to gravitate to investment options that they are most comfortable or familiar with.
Just because Jake works in the tech industry does not necessarily make that particular sector a good investment. Moreover, Jake's strategy of investing in only one sector will lead to a retirement account that is lacking the sector diversification benefit that can improve risk adjusted returns over the long run.
Jake is also demonstrating a familiarity bias by wanting to invest in a local company. He may be comfortable investing in that local company because he knows people who work there but that familiarity doesn't necessarily make that company’s equity a wise investment.
A significant risk to an investor's wealth is including biases such as familiarity biases in their investment decision making process. Jake should consider working with a financial advisor who could build a well diversified portfolio structured to help him meet his financial goals.
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Does your portfolio exhibit a familiarity bias? If you'd like to work with a financial advisor to determine if your investment strategy includes familiarity bias, call 1-800-541-7774 or contact us here to get in touch with one of our Wealth Managers. If you are (or will be) investing more than $500,000 in assets, you can jumpstart your review by starting your free, personalized investment plan here.
This quiz is intended for informational and illustrative purposes only. This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information presented is general information that does not take into account your individual circumstances, financial situation or needs, nor does it present a personalized recommendation to you. The information and opinions contained in this material are derived from sources deemed reliable, are not all-inclusive and are not guaranteed as to accuracy.
