Home Country Bias and Investing in What You Know

I was talking to someone very recently about general business topics, and and we ended up briefly delving into a discussion on international markets. As a part of this discussion, I mentioned that I have been wanting to increase my exposure to non-US markets, but am currently well under 10%.  My comments were that I thought I need to revisit this ratio.

The guy with whom I was talking paused for a second, furrowed his eyebrows, and then stated that he didn’t believe he had any direct international investment. He went on to comment that he’s fine with that, because how was he “supposed to know what consumers in China want?” He used China as a proxy for any market distant from the U.S. Essentially, he was saying that he didn’t understand foreign markets, so why invest in them? Right away, it seemed to me like he had a home country bias.

There’s an old maxim that you should “invest in what you know”. It’s a general philosophy that was a big part of Peter Lynch’s teachings. Lynch is probably best known for being the acclaimed manager of the Fidelity Magellan fund, as well as for authoring several popular investment books.  Lynch has probably forgotten much more about investing than many of us will ever know. In other words, he knowledgeable. Clearly, Lynch achieved quite a bit of success, so there’s obviously something to the the application of this principle of investing in what you know. Furthermore, he’s just an example to point to – there are scores of investors who take this approach. Yes, just like the guy with whom I was having the aforementioned discussion.

Now, I might not be someone to dispute this approach….but then again, I’ll do it anyway:)

My view on the idea of sticking to what you know is that it has merit, but it can be misapplied and taken too far.

If somebody asks me to make a big investment in a bauxite mining operation, as an example, I’d pass. Now, it just might be a great opportunity, but since I know absolutely nothing about that business, I wouldn’t make such an investment. In that case, I’d stick to what I now, or at least avoid what I don’t know.

However, there are other legitimate examples of when it’s good to ignore the “buy what you know” approach:

  1. Mutual Funds. If somebody asks me to make small investments across a representative set of companies traded in the stock market, I’ll think about it. Why? Well, isn’t that what index funds are, more or less? I might not know a lot about these companies, but I know enough to say that historically, stocks have earned a rate of return that well outpaces inflation.  That’s enough to get me to buy stocks in a ton of different companies, all through an index funds. Index funds are a great example of how taking the “invest in what you know” approach can go too far. If you follow that approach too closely, you’d miss out on all the advantages of investing in funds.  Including funds that hold positions in companies that you know nothing about.
  2. Investing in a Company other than Your Employer.  I’ve heard of several people who simply wanted to invest in the stock of their employer, because it’s what they know (or so they think). In post from the early days of the blog, I shared the story about a guy who invested everything in the company stock. He told a large gathering at a retirement party that he invested everything in the company stock over the years and that it worked for him, so we should consider doing it too. Surprisingly, he got an ovation for that. Meanwhile, I sat quiet thinking that he was so totally wrong. Maybe he got lucky with his investments, but it’s very risky to put all of one’s eggs in one basket. You already have employment risk in a company, why add investment risk too
  3. Investing in International Stocks. This applies to the guy I mentioned above, who might want to at least consider diversification. A prior post I wrote a while ago discussed the topic of international stocks and diversification. In that post, I referenced another article which stated that at the time, the U.S. held 43% of global stock value, yet American investors hold 70% of their stock portfolios in American companies. Frankly, I’m surprised it’s that low! What’s also interesting is that the United States’ share of the world stock market value was 90% back in 1945, and has since declined to the 43% figure I mentioned above. This phenomenon of home country bias is not exclusive to the U.S. either, as it’s been seen in even more drastic terms in some other countries, as I noted in the prior post. Yes, it seems like we all need to realize that’s there’s a world out there!

My Questions for You:

Do you prefer to strictly invest in what you know, or do you branch out?

If you do branch out, do you follow each of the 3 approaches above?

Do you know anybody who carries a home country bias with investments?

 

Comments

  1. says

    Real life example: during the dotcom boom, I thought I had figured out tech stocks since I was a gadget junkie and moved all my investments to tech stocks!

    I don’t have to tell you how that turned out! Turned out I didn’t know what I didn’t know.

    If you are indexing, then knowing a company is a moot point. China is clubbed under Emerging market, you allocate a percentage, buy an ETF or MF and rebalance.

    If you are picking individual stocks, China as a sector is moot again since you would pick a stock from china, do your research and decide whether to buy or not to buy.

    Ignoring an entire region would be foolish in my opinion.

    • Squirrelers says

      Moneycone – I agree than ignoring an entire region might not be the best idea. We’re in a world economy to some degree now, it would seem.

  2. says

    Warren Buffett only invests in what he understands and can value. How can I possibly value and company in a foreign country whose products I have never used? Buffett is very successful. Lynch was very successful. I wonder if there is a correlation?

    • Squirrelers says

      cashflowmantra – true, it’s harder to value an individual company with products you might not know much about in a country that you might not know as much about. But there are resources to help with that, such as funds. Presumably, some fund managesr should know enough. If not, there are indexes.

  3. says

    I agree with MoneyCone. Knowing the “product” and knowing the “company” are 2 different things. A lot depends on the Financials of the company as well.

    Amazon was one of the few companies that survived the dot com boom. But they never really made any profit for a very long time. So buying Amazon stock was not a very good idea at the time.

  4. says

    I agree with you (I don’t trust my foreign chops as much as my American, so most of my international investing is through funds), but I do want to point out a couple things:

    1) American companies make plenty of money overseas. Just buying an S&P fund will give you lots of foreign exposure… they just happen to be located in America, heh.
    2) A lot of people living now in the US will also retire here. Stocks located here will go through mostly the same business cycles and inflation as everything else – so at least you have some ‘certainty’ when it comes to the stocks.

    • Squirrelers says

      PKamp3 – you make good points. The first one, about US companies having a good deal of foreign exposure, is one I have considered – though it’s not quite the same thing. But that’s true, there’s exposure with many multinationals. The second point you made was a pretty interesting one, actually. There is some consistency in that regard, I can see that as a potential benefit.

  5. says

    I have about 30% in foreign and emerging market right now. These investments are doing terrible this year, but I think they are an essential part of my portfolio. All my investments in this sector are index fund/ETF. PK is right though, most of the big companies here in the US has quite a bit of foreign exposure.

    • Squirrelers says

      retirebyforty – frankly, this is an area where I can do a better job, there more I think of it. I do think it makes sense what you’re doing, in terms of focusing on index funds to a degree, with such investments.

  6. says

    I think it is impportant to invest in what you know or you should learn about it. My portfolio asset allocation includes some international funds. I have faith in the fund family and monitor its performance periodically.

    • Squirrelers says

      krantcents – of course, the investing in what you know part is hard to do with a fund – in the sense of knowing the details of individual companies in which a fund invests. At some point, the “what you know” part can only go to a certain level!

  7. says

    I own one international index fund but I also have international exposure through companies such as McDonalds and Coca Cola that do a lot of their business overseas.

  8. says

    I stick to what I know, mostly companies in the tech/e-commerce space. Failing that, I stick to things that are so simple that everyone can understand them. Health care services is an industry I love. On the other hand I won’t ever buy into biotechs or mining firms. I know nothing about diseases or their cures, and mining companies just seem like a crap shoot to me. I realize I throw out some really good performers, but I’m confident enough to say that I also throw out a ton of underperformers in doing that. Biotech leaves my head spinning. Mining companies scare me, because it seems like they’re almost always over-levered (or diluting their shares.)

    As for international exposure, I don’t really care for it. Probably 95%+ of my portfolio is made up of American firms. In thinking about it, my top 4 holdings do…IDK, probably 98% of their business in the US. Eh, maybe I shouldn’t have thought about it.

    But I still feel like there isn’t a single company in…say, China, that has squeaky clean books. If I can’t trust the numbers, then I just can’t trust the numbers. And there’s always the foreign exchange risk – dollar’s gotta get better one of these days, right?

    No mutual funds, investing in my employer (kinda an N/A deal here), or any real diversification overseas. Maybe it’s a mistake, maybe it isn’t – I have no way to know the future. When it boils down, though, I prefer the future that is systemically more predictable with less variables, so I stay in the US. I feel better about it, even if I shouldn’t.

  9. says

    I’ve committed to a couple of Brazilian stocks, but I’m not exactly a stranger to the place. Some of the mining companies that I hold shares in have international operations, but frankly, I have a bias towards ones that are more focused on north American and Mexico. As JT said, you tend to go with what you know.

  10. says

    Even though I don’t follow the international markets that much, I have about 30% invested in international funds in my 401k. I try to keep a diversified portfolio and don’t want all my money tied up in US equities. -Sydney

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