Familiarity Bias is essentially confusing familiar with safe. Presented with two stocks, which one would a direct equity investor pick? More often than not, a software engineer would lean towards an IT stock while a banker may choose a banking stock. This tendency to invest in companies/sectors the person understands well is an example of familiarity bias.
Client suffering from familiarity bias may believe that it is safer to invest in it since he thinks he understands the risks well. He may not be comfortable investing in different sectors or asset classes because of lack of knowledge. However, this exposes his portfolio to concentration risk. Moreover, he will miss the benefits accruing to diversified portfolios. This will lead to a skewed portfolio and increase his chances of losses.
We spoke to a few advisors to understand how they deal with familiarity bias.
Dhruv Mehta of Sapient Wealth Mumbai and President FIFA
I had a client who had invested bulk of his corpus in the stock of a company where he had worked for almost 40 years. He wanted to continue to hold this investment. However, since most of his investible corpus was locked in just one company, he was exposed to concentration risk.
To convey the pitfalls of this bias, I used the power of storytelling. I told him how a few large companies had shut down their operations even after a successful run leaving many investors in the lurch. I asked him to evaluate if he was prepared for the contingency if anything went wrong with the company. Finally, I made him realize the importance of having a diversified investment portfolio.
In my view, we need to make the unfamiliar familiar so that they explore wider opportunities.
Swapnil Agarwal, VSRK Wealth Creators, Delhi
At times, familiarity bias can be multi-generational. I had a client who wanted to invest in a large cap scheme just because his father had made big money by investing in it.
However, over the years, the fund had undergone many fundamental changes like change in fund manager, investment strategy, key attributes and so on. The fund became multicap fund having high exposure to small cap stocks.
I used scheme offer documents and fund fact sheets to make him aware of these fundamental changes in the scheme. The idea was to get him to appreciate the risks had evolved. I also alerted him to the risks associated with funds having exposure to high small cap stocks.
