Carl RichardsChange can be a scary thing. So it’s no wonder that we’re drawn to things we recognize — to things that are familiar — and stick with them. It’s why we go to a chain restaurant, buy clothes from the Gap and drive the same kind of car for big chunks of our lives.
It’s human to look for the familiar and to keep coming back. But when it comes to investing and money, this pattern creates some problematic biases. Let’s take a look at how they might be impacting your life.
1. Paying Every Month
Each month there are certain bills that we get in the habit of paying without really thinking about them. Some, like our utilities and mortgage, are a given. But what about that gym membership? We’re even more oblivious to the bills that get paid automatically.
Over time, we can end up spending more money than we’d like on things we don’t really want and maybe aren’t even using. But we do it because we always have, and we haven’t stopped to ask why.
A new month starts on Tuesday. I suggest you sit down and make a list of all your monthly bills. Then go through each one and ask the question: Do I really need this?
2. Believing in the Company
Secretaries becoming millionaires because they own a bunch of company stock are the exception, not the norm. So don’t kid yourself that working for a company, having a 401(k) with that company AND investing the rest of your money in that company’s stock makes a lot of sense.
For every Google, there’s plenty of Enrons. Don’t let familiarity with your company get in the way of you planning for the future. If you’ve made one company your sole source of income, what happens if it ceases to exist? You may know your company incredibly well, but that’s no guarantee of future success.
3. Inheriting an Opinion
Every so often, I’ll hear from someone who inherited some stock. Oddly enough it usually ends up being a utility. People rarely want to part with the stock. Whether from emotion (My grandma gave it to me!) or fear (What would I buy instead?), people will cling to the stock instead of honestly assessing if it makes more sense to sell it.
This becomes even more complicated when there are emotions connected to the decision.
A classic example involves the breakup of AT&T in 1984. When Ma Bell was split into the Baby Bells, shareholders received equal amounts of stock in each new company. However, by the time Gur Huberman studied the proportions of holdings for his 2001 paper “Familiarity Breeds Investment,” he found that investors tended to disproportionately hold shares in their local Bell.
Your goal is to invest in what makes sense for you, not what your grandparents thought was best.
4. Being Sold Life Insurance
Life insurance is almost always sold and rarely bought. What do I mean by that?
Few people wake up in the morning and say, “I’m going to buy life insurance today.” They’re usually approached by someone they know — a neighbor, an uncle, even the infamous “evil” brother-in-law — and sold on the idea.
The insurance that requires the most selling is variable or whole life, which comes with an investment component in addition to the death payout, because it’s generally not a good idea for most people. Because it’s not a good idea, it has to be pitched, and the people most likely to give in are those who know the person doing the selling. We do this even though our intuition tells us that it probably doesn’t make sense.
Then, even though we suspect we’re throwing good money after bad, we keep paying those annual premiums because we’re used to it (see above). Stop it! Don’t be afraid to admit that it might not be the best option for you. Continuing to pay the premiums doesn’t correct the mistake, it just compounds it.
5. Buying U.S.A.
We like what we know. So it makes a ton of sense that we have a bias towards owning United States stocks. And the research shows that investors tend to hold far more domestic stocks than the market would dictate.
In the book Behavioral Finance: Investors, Corporations and Markets, Hisham Foad noted that United States investors had 87.2 percent of their stock holdings in domestic stock in 2005, even though the country makes up only 43.1 percent of the global market. Investors in the United States aren’t the only ones with a bias.
Polish investors had 99.4 percent of their stock allocation in domestic stocks even though Poland’s stock market is only 0.2 percent of the world market. See the problem this can create? Your goal is to find the best mix of stocks, so don’t limit yourself to national borders.
Between looking for the familiar and finding comfort in the status quo, we can make financial mistakes that add up over time. I totally understand why it’s hard to ask the questions and to break the patterns. But don’t cheat yourself out of a more secure future because you’re comfortable today.
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