Familiarity and Finances

TOM HUDSON: Do you consider yourself a good investor? Do you follow the investment advice to buy stocks of companies you know? If so, you may be falling for the familiarity bias. Tonight in our series,”Your Mindand Your Money,” Dan Grech says its the same influence that leads some people t prefer the classics in music.

DOC RENO, Big 105.9: I want to send this out to a couple of buddies of mine, joe and mike calling from Miramar wanted to hear some Bob Dylan. So let’s throw out “Positively Fourth Street” on Miami’s classic rock station, Big 105.9.

GRECH: Though they play the same music over and over again, classic rock stations like Big 105.9 in Miami draw huge audiences why? Disc jockey Doc Reno says there’s an easy explanation.

RENO: I think people like to listen to music that they’re familiar with, really, because it takes them back to a time where they might be, I hate to even say this but maybe they were happier.

GRECH: And it’s not just familiar music that people prefer. Researchers have found that given the choice between, something familiar and something unfamiliar, the familiar one will win out almost every time. The power of familiarity was confirmed by an experiment first conducted more than 40 years ago. Participants were shown certain Chinese symbols at speeds their conscious minds couldn’t register. Later, they were shown a range of symbols, this time for a full second. When asked which symbols they liked most, the people picked the ones they had already been shown, even without knowing they had seen them before. The reason, these letters were now familiar. Familiarity may also impact how we buy stocks and make other investments. Something familiar is oftn perceived as less risky. Yale Professor Nicolas Barberis says that can lead investors to prefer local firms, sometimes too much.

NICHOLAS BARBERIS, PROFESSOR, YALE UNIVERSITY: One example is something we call local bias which is when people invest in equity, they invest in local stocks. Connecticut people invest in Connecticut stocks. Massachusetts people invest in Massachusetts stock, roughly speaking. Which is ignoring the benefits of broader diversification. Perhaps the most egregious example would be people voluntarily putting a lot of their retirement money into the stock of their own company which is really bad from the point of view diversification.

GRECH: Someting along those lines happened to Attorney Craig Savage, his holdings in three small banks were sold to Wachovia, that left him with a big block of Wachovia stock. But because Savage was familiar with Wachovia, he ignored advice to sell it.

CRAIG SAVAGE, ATTORNEY: My financial advisor, my accountant, even some friendstold me you shouldn’t have such a concentrated amount of shares. You should diversify. And the reason was even though Wachovia’s a great bank, if something happens, obviously the upside is great, but the downside is just as bad, so I didn’t listen to them.

GRECH: That decision cost Savage dearly. Wachovia’s stock tanked and he lost a ton of money.

SAVAGE: It probably took me six months to a year to get over it. It wasn’t something I thought about every day, but you get up in the morning, you look in the mirror and start shaving and go, why didn’t you sell?

GRECH: The tendency to favor the familiar may go back to early humans, who learned that something familiar was less likely to eat them. And today, University of Michigan Professor Norbert Schwartz, says the power of familitarity can make it very difficult to see something objectively.

NORBERT SCHWARTZ, PROFESSOR, UNIVERSITY OF MICHIGAN: When people feel that something is familiar it influences many ways of how they think about it. First of all they like it more they evaluate it more positively. They also find it more beautiful. They’re also more likely to find it true.

GRECH: So while it may feel good to stick with the familiar, that may not be the best way to invest. Just because you’ve never heard of something before, doesn’t automatically make it a bad choice. Remember even these golden oldies were once new and unfamiliar. Dan Grech, NIGHTLY BUSINESS REPORT, Miami.

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