Why the “Familiarity Effect” Makes You Ignore 6,500 Stocks

Stop giving special preference to the stocks you already know.

In this article, we’ll cover the familiarity effect, which is one of the most common mistakes I see among both new and experienced investors.

Author’s Note: This article is part of my series on investing psychology:

The familiarity effect is when investors take a liking to something simply because they’ve been exposed to it.

Also called the “mere exposure effect,” it means that being familiar with something makes you favor it.

This is a very common bias among new investors and is one of their biggest pitfalls because it severely limits the number of stocks they’re willing to buy.

Many new investors rush immediately to stocks like General Electric (GE), Apple (AAPL), Netflix (NFLX), Tesla (TSLA), Google (GOOGL), Facebook (FB), Coca-Cola (KO), Johnson & Johnson (JNJ), and Bank of America (BAC).

Why? Is it because they’re the best stocks on the market?

No. It’s because they’re all very familiar to a new investor, whereas lesser-known companies are unfamiliar and therefore less attractive.

There are over 6,500 stocks that trade on the U.S. stock market. It’s a bit head-scratching to see new investors rush to a struggling company like General Electric when there are SO MANY other choices available.

By only buying companies that you’re already familiar with (or giving strong preference to them), you limit your investing universe from thousands of stocks down to just dozens, or maybe hundreds.

This is bound to hurt your investing profits over the long term.

Instead, keep an open mind and try to give equal weighting to stocks you’re familiar with and that are new to you.

Ask yourself:

“What do I like about the idea of investing in this well-known stock? Can I find that same theme, concept, or strength in lesser-known companies that are actually superior to the stock I happen to already be familiar with?”

For example, maybe you want to invest in a diversified industrial powerhouse and find yourself automatically thinking fondly of General Electric.

I’d suggest you also research Danaher (DHR), 3M (MMM), Toshiba (TOSYY), Siemens (SIEGY), Honeywell (HON), Raven Industries, (RAVN), CK Hutchison (CKHUY), and Roper Technologies (ROP).

Just because you’re more familiar with General Electric doesn’t mean it’s the best investment.

Finally, consider this question:

“Am I holding the stocks in my current portfolio because they’re the best possible place for my money? Or am I giving them unfair preference because I’m already familiar with them?”

When it comes to investing, playing favorites can cost you in the long run.

Disclaimer: This article is provided for informational or educational purposes only and is not any form of individualized advice. All information is obtained from sources believed to be reliable but cannot be guaranteed for accuracy or completeness. Use this information at your own risk.