One of the books that has had the most impact on my professional life is “Start With Why” by Simon Sinek. The central theme of the book is that people are often drawn to organizations, products, and leaders because of the identities and values they represent. Sinek uses Apple as an example, arguing that it has successfully transformed how people perceive the company. Rather than viewing Apple simply as an electronics manufacturer, consumers now associate it with innovation, simplicity, attractive design, and challenging the established ways of doing things.
I have often joked that they have done such a good job at their branding that people would line up to buy an Apple refrigerator despite the company having no history of building appliances, simply because of their confidence in the Apple name. That level of brand confidence is certainly valuable to a business, but it can also create a dangerous blind spot for investors.
People often assume familiar investments are better or safer simply because they recognize the company, use its products, are employed there, or see it active in their community. Familiarity can create confidence, but it does not necessarily reduce investment risk.
Just before SpaceX went public, I wrote about the potential danger of investing in the company based solely on name recognition and the excitement surrounding its initial public offering. Its early performance has proven my concerns to be valid. After an initial surge, the stock price has rapidly fallen. As I am writing this on Monday morning, it is down over 25% from its opening price on June 12 and over 50% below the high it reached four days later. This does not mean SpaceX is a bad company. However, familiarity with the brand and its founder may have encouraged some investors to pay a price that the market could not sustain.
This is by no means a new phenomenon. A 2001 study titled “Familiarity Breeds Investment,” finance professor Gur Huberman examined this behavior and found that shareholders of regional telephone companies tended to live in the areas those companies served. Customers were also more likely to own shares of their own regional provider than comparable telephone companies elsewhere. Huberman concluded that people often invest in what is familiar, even when doing so conflicts with basic diversification principles.
A similar study by finance professors Joshua Coval and Tobias Moskowitz found that even professional U.S. investment managers demonstrate a preference for companies headquartered near them. This shows that this kind of bias is not limited to inexperienced individual investors.
Bias is important to recognize when selecting investments because familiarity can create a false sense of safety. Investors may assume that a company they know, work for, or regularly interact with is less risky. This can lead to excessive concentration and greater potential losses, particularly when investors hold a substantial amount of stock in the company that also provides them with their income and benefits.
Before investing, ask whether you would still buy the stock if you did not recognize the name. Make sure you consider how much of your financial life is already tied to the company. Brand recognition may justify taking a closer look at its stock, but investment decisions should ultimately be based on valuation, risk, and diversification, not simply how you personally feel about the company.
(Past performance is no guarantee of future results. The advice is general in nature and not intended for specific situations)