Fundamentals of behavioral finance: Home bias
Home bias is the tendency to stick with what feels comfortable.
For clients, home bias often results in too much exposure to U.S. stocks or shares of the company where they work.
These overweight exposures can mute the benefits of diversification and increase risk.
Advisors can potentially help clients address home bias by explaining the power of a well-diversified portfolio and reviewing the risks of over-concentration, or putting all your eggs in the same basket.
Educating clients about home bias may lead to better long-term results.
In this series, we explore some of the most common biases exhibited by investors and discuss how advisors can help their clients overcome them. This article focuses on home bias, an emotional bias that places unnecessary limitation on investor portfolios.
What is home bias?
Home bias is the tendency to stick with what feels comfortable. It can lead to personal experiences and allegiances playing an outsized role in the decisions we make. Home bias can be particularly strong in times of global economic uncertainty. With the ongoing war in Ukraine, wavering European stocks, and unreliable supply chains, clients can be tempted to overallocate to U.S. equities and assets.
In everyday life, home bias explains why we often stick with the same brands at the grocery store, even if another brand might be better, or why we might place a bet on our local sports team, even if that team is less talented than its opponent.
How powerful is home bias? A 2022 article in the Journal of Financial Economics found that as of 2018, U.S. residents held roughly $2.4 trillion in international equity mutual funds. That may sound like a lot, but it accounts for only 26% of all equity mutual fund assets under management.1
Why does it matter?
Home bias can concentrate clients’ assets too heavily in one area, undermining the well-established benefits of diversification and ratcheting up risk.
For example, U.S. and international stocks aren't perfectly correlated: volatility in the U.S. equity market may not be fully shared by international markets, and periods of U.S. outperformance may be followed by the dominance of international markets. Similarly, clients with heavy exposure to shares of their employer can suffer from a lack of diversification.
What can you do about it?
When clients demonstrate a home bias, advisors can discuss the rationale for diversification and how it can help them reach their long-term goals. Some clients might respond strongly to data. For these clients, you might compare the international allocation of their portfolio to international equities’ proportion of global market capitalization.
Older generations grew up during times when investing overseas often entailed a lack of transparency that brought greater risk. Times have changed, and the experience of investing internationally has become much more transparent and regulated. A little education about this evolution might help quell client fears.
Finally, some clients may benefit from a tighter media diet. The barrage of negative headlines from around the world can create a desire to keep investments close to home. But international markets—like domestic markets—are frequently weathering a seemingly constant flow of bad news. Reducing media consumption may help clients open up to the idea of investing beyond their traditional comfort zones.
Remaining in conversation with clients about home bias can strengthen the fundamental elements of the financial planning process. Not only does this potentially help clients achieve better outcomes, it may help advisors forge more durable client relationships.
Omar Aguilar, Ph.D.
Chief Executive Officer and Chief Investment Officer
About the author
Omar Aguilar, Ph.D.
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