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Navigating Familiarity Bias in Investing: Understanding its Impact on Australian Investors

Familiarity bias in investing

Investing can be a complex journey, often influenced by cognitive biases that affect our decision-making. One such bias, familiarity bias, can significantly impact investors, leading them to make choices based on what feels comfortable or familiar rather than on objective analysis.

In this article, we’ll explore familiarity bias and its implications for Australian investors, with a focus on two related biases: status quo bias and anchoring bias.

Understanding Familiarity Bias

Familiarity bias refers to the tendency of individuals to favour investments or assets they are familiar with, even if there are better opportunities available elsewhere.

This bias can lead investors to overweight domestic assets or industries, such as property or banking stocks, simply because they are more familiar with them, overlooking potentially superior investments in international markets or other sectors.

The Impact of Home Bias

One common manifestation of familiarity bias among Australian investors is “home bias.” Home bias occurs when investors disproportionately allocate their portfolios to domestic assets, such as shares and real estate, at the expense of international diversification.

While it’s natural to feel more comfortable investing in familiar markets, home-country bias can result in a lack of diversification and increased exposure to local economic risks.

Just imagine: You’ve invested all of your money into Australian property and shares, then a recession hits and you lose your job. Now you have no income and you have to sell your Australian shares, which will now be at a loss because the share market has recently crashed.

Status Quo Bias: The Comfort of the Known

Status quo bias is closely related to familiarity bias and is our tendency to maintain our current investment portfolio or strategy, even in the face of new information or changing circumstances.

Investors may resist making changes to their portfolios, preferring the comfort of the familiar, even if it means missing out on potentially higher returns or better risk management opportunities.

As a very relevant example: You’re an investor who invested all your money into the Australian Stock Exchange (ASX). You just read about home bias, but despite this new evidence you don’t want to act on what you’re reading because you’re comfortable remaining with all of your money in the ASX.

Anchoring Bias: Fixating on Familiar Reference Points

Anchoring bias occurs when investors rely too heavily on familiar reference points or past experiences when making investment decisions. An investor suffering from anchoring bias will experience tunnel vision and often look to reaffirm their already-held beliefs. This is known as confirmation bias.

For example, investors may anchor their expectations for future returns based on historical performance or market trends, failing to adjust their outlook in response to new information or changing market conditions.

Overcoming Familiarity Bias: Diversification and Education

To mitigate the impact of familiarity bias and its related biases, Australian investors should consider the following strategies:

  1. Diversification: Diversifying your investment portfolio across different asset classes, industries, and geographic regions can help reduce the influence of familiarity bias and home bias. By spreading your investments globally, you can access a broader range of opportunities and better manage risk.
  2. Education and Awareness: Educating yourself about cognitive biases, including familiarity bias, can help you recognise when you may be making biased investment decisions.
  3. Seek Professional Advice: Consulting with a financial advisor can provide valuable guidance and perspective, helping you avoid the pitfalls of familiarity bias and develop a well-rounded investment strategy tailored to your goals and risk tolerance.

By acknowledging the influence of familiarity bias and taking proactive steps to overcome it, Australian investors can enhance their investment outcomes and build more resilient portfolios for the future.

Don’t let familiarity dictate your investment decisions – embrace diversification and education to unlock greater financial potential.

Secure your financial future today!