Too Close to Home

Buying investments we know best hurts diversification.

If only familiarity did breed contempt, we might all be better investors. But the reality is just the opposite: Familiarity breeds contentment because human nature prompts us to feel comfortable with things we know. As a result, instead of buying investments that could yield superior results, we gravitate toward the ones we know best.

Consider an experiment in which a university student took four courses. In one she attended just a couple of classes, in the second she attended six sessions, in the third she showed up for ten, and in the fourth she made an appearance at every class. The student never talked to any faculty members or classmates. At the end of the semester, faculty and students were asked how attractive they thought she was. The student was rated more attractive by those in the classes she had attended more frequently "simply because people had been exposed to her more often," says Yale University finance professor Nicholas Barberis.

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Bob Frick
Senior Editor, Kiplinger's Personal Finance