What is familiarity?
It might sound familiar. It’s the instinct to favor what we know, and it drives us to be loyal – sometimes irrationally so – to the things we’re exposed to most. It’s why we repeatedly choose the same routes and restaurants, and why the more we hear a song, say a name or visit a place, the more we tend to like it.
Familiarity can make us creatures of habit, comfortable in our routines and hesitant to try new things.
Studies have shown that not only do we favor what we know, we also assign higher value to it. For instance, we tend to find the familiarity of symmetrical features more attractive and that we often believe attractive people are more intelligent and trustworthy.
Familiar = Flawed?
In the case of financial planning, leaning too heavily on the familiar can lead to an underdiversified portfolio. By trying to play it safe, people who stick with what they know might actually be inviting risk.
For example, someone choosing investments based on familiarity may be overweighted in domestic securities, or a disproportionate number of their investments could be large, well-known companies or those they’ve worked for. Often, people investing in “familiar” securities are so comfortable with a name alone that they do little research into a stock’s underlying characteristics – such as risk profile.
In some cases, knowing the bias exists isn’t enough to counteract it. Research from Vanguard found that investors are aware of the preference for their own country’s securities, called the “home bias,” but still actively lean in to the familiar by overweighting domestic holdings at the expense of foreign investments in their portfolios.
Familiarity is also often the culprit behind significant overconcentration in portfolios – when a substantial portion of an account is invested in just one or two stocks. Employees at large companies are regularly overconcentrated in their company’s shares, and it can have dire consequences. One of the most notorious examples is Enron. Just before the firm’s collapse in 2001, 62% of the assets employees held in their 401(k)s comprised shares of Enron’s own stock, which left people trying to rebuild not just their careers but also their retirement savings.1
When familiarity factors into your financial decisions:
- You might be overweighted in domestic securities, well-known companies, or companies you’ve worked for.
- You might risk increased losses by concentrating a large portion of your portfolio in a particular investment, asset class or market segment.
- You may not be considering whether your investments are the best fit for your portfolio from a risk-reward perspective.
- You may have avoided unfamiliar planning solutions – certain types of insurance or trust arrangements, for example – that could provide a more well-rounded financial plan.
Clinging too tightly to the known can put your plan in peril. However, you can take steps to strike the right balance of familiar and fresh in yours.
How you can break out of the familiar
- 1. Don’t let a company’s name or how you feel about its product be the only thing you consider when investing. Look at the security’s underlying characteristics – risk level, historical performance, industry and company research, etc.
- 2. Make sure you include data and objective research in your decision-making rather than relying solely on your gut or “comfort zone.”
- 3. Expand your financial fluency – just because you aren’t as knowledgeable about a certain financial solution doesn’t mean it shouldn’t be part of your plan. Ask your financial advisor for insights and don’t be afraid to do some of your own research rather than sticking with only those strategies most familiar to you.
- 4. Look for help. Seek out the perspectives of people whose beliefs differ from your own and professionals with specialized expertise. In the case of your financial future, it helps to work with an objective third party – like an experienced financial advisor – who can offer perspective in addition to wealth planning and investment support.
There’s much to be said for the comfort – and often the quality – of the familiar, but it’s important to remember that while the unknown can be a risk, the well-known isn’t always the better choice. That’s why learning to resist the lure of the financially familiar can help you broaden your potential.