The Familiarity Heuristic: Why Most Investors Make This One Mistake
Our comfort zones have the word “comfort” in them for a reason: it can be daunting to enter uncharted territory. However, whether it’s though public speaking or trying an exotic dish, venturing into the unfamiliar can eventually yield very positive results.
Of course, despite the glaringly obvious potential rewards, leaving one’s comfort zone is a lot easier said than done. And we have a cognitive bias largely to thank for that unease.
The familiarity heuristic is a mental phenomenon first discovered by renowned psychologist Daniel Kahneman. It’s a well-documented shortcut our brains take that makes us feel calm with the familiar, and apprehensive about novel experiences – regardless of their advantages.
When it comes to investing, the familiarity heuristic can deceptively lull us into feeling hesitant about decisions that could lead to less risk and more returns.
US investors are mostly familiar with domestic equities. After all, they live in the US, largely encounter US products and companies, and mostly hear about American-based benchmarks (like the S&P 500) on the news. As a result, they almost solely invest in these stocks (particularly companies they’ve heard of before), and apprehensively ignore any foreign opportunities to grow their wealth through international investing.
Just because you live in the U.S., you don’t necessarily have enough knowledge to beat the stock market here, or that international investments aren’t any more attractive. The truth is that living in a country won’t give you enough knowledge to fully understand its’ incredibly complex market, or that you should discredit other countries because of it.
Despite investors’ apprehensions from the familiarity heuristic, nearly half the world’s investable opportunities are outside of it. Additionally, when the US stocks markets are doing poorly, international markets may still be growing. Between 1990 and 2014, international stocks outperformed domestic ones 11 out of 25 times in ten-year average returns.
A wise investor will realize that international investing can further diversify a portfolio to reduce risk. A globally diversified portfolio means investors can take advantage of a larger availability of investments, and enjoy the benefits of occasionally opposite performance.
At LexION Capital, we can focus on investments all across the globe as part of your portfolio. In fact, healthy diversification is so vital that it constitutes one of the five pillars that ground our approach. We are independent, customized, transparent, experienced and global. If you’d like to learn more, let’s have a conversation today.