By David Thomson
Home is a powerful psychological idea.
Whether it’s a childhood home, a new home, or the home ground of a football team; we all know how important home is.
And it is the same for investment. In pretty much every country around the globe, investors end up having far more of their portfolios in their ‘home’ equity market than anywhere else. It’s so common that it has a technical name, Home Bias. For example, according to the Investment Association, UK equity investors invested around 60% of their funds in the UK in 2022.
There are several reasons why home market bias exists, including familiarity.
Investors often feel more comfortable with assets they are familiar with or have better access to. They may have more information about their local market, companies, and economic conditions, which can make them more confident about their investment decisions.
Investing in foreign assets may involve currency risk, as fluctuations in exchange rates can impact the returns on foreign investments. Investors may prefer to avoid this risk by concentrating their investments in their home market. However, by not diversifying internationally, investors may miss out on potential currency gains.
READ MORE: The Big Read: What can we do to save Scotland's towns?
Some investors exhibit a form of patriotism or preference for their home country's assets. This bias can lead them to support local businesses and industries by investing in them.
There are often tax advantages or regulatory incentives for investing in domestic assets, which can influence an investor's decision to allocate more capital to their home market.
Access to information and investment opportunities may be more limited in foreign markets. Investors may find it easier to research and invest in assets that are closer to home.
While it is natural for investors to have some preference for familiar markets, this bias leads to several problems.
Overconcentration in the home market can lead to an insufficiently diversified investment portfolio.
Diversification is a fundamental risk management strategy that helps spread risk across different assets and regions. By favouring the home market, investors miss out on potential benefits from international diversification.
Home market bias can expose investors to increased risk because it can make them vulnerable to economic downturns, regulatory changes, and market-specific shocks that affect their home country. Diversifying globally mitigates these risks.
READ MORE: Scotland hotels: Apex reports profit surge as Covid fades
Restricting investments to the home market can mean missing out on attractive investment opportunities in other regions. Emerging markets, for example, might offer higher growth potential.
Home market bias can make investors more susceptible to regulatory and political risks associated with their home country. Changes in tax laws, regulations, or political events can have a more significant impact on their investments.
Many global markets offer different growth prospects, industries, and asset classes. Investors with a strong home market bias may miss opportunities in sectors or industries that are not well-represented in their home country for example the UK’s lack of technology stocks.
Some investors exhibit a home bias based on familiarity and comfort rather than rational analysis. This can lead to suboptimal decision-making, as investments should ideally be based on objective factors such as risk, return, and diversification benefits.
Over the long term, home market bias may result in suboptimal portfolio performance compared to a more globally diversified portfolio. Put simply, international diversification can provide better risk-adjusted returns.
To address these issues, investors should consider diversifying their portfolios across different asset classes and geographies, based on their financial goals, risk tolerance, and investment horizon.
While maintaining some home market exposure can be prudent, it should not come at the cost of ignoring the potential benefits of global diversification.
David Thomson is chief investment officer of VWM Wealth Planning
Why are you making commenting on The Herald only available to subscribers?
It should have been a safe space for informed debate, somewhere for readers to discuss issues around the biggest stories of the day, but all too often the below the line comments on most websites have become bogged down by off-topic discussions and abuse.
heraldscotland.com is tackling this problem by allowing only subscribers to comment.
We are doing this to improve the experience for our loyal readers and we believe it will reduce the ability of trolls and troublemakers, who occasionally find their way onto our site, to abuse our journalists and readers. We also hope it will help the comments section fulfil its promise as a part of Scotland's conversation with itself.
We are lucky at The Herald. We are read by an informed, educated readership who can add their knowledge and insights to our stories.
That is invaluable.
We are making the subscriber-only change to support our valued readers, who tell us they don't want the site cluttered up with irrelevant comments, untruths and abuse.
In the past, the journalist’s job was to collect and distribute information to the audience. Technology means that readers can shape a discussion. We look forward to hearing from you on heraldscotland.com
Comments & Moderation
Readers’ comments: You are personally liable for the content of any comments you upload to this website, so please act responsibly. We do not pre-moderate or monitor readers’ comments appearing on our websites, but we do post-moderate in response to complaints we receive or otherwise when a potential problem comes to our attention. You can make a complaint by using the ‘report this post’ link . We may then apply our discretion under the user terms to amend or delete comments.
Post moderation is undertaken full-time 9am-6pm on weekdays, and on a part-time basis outwith those hours.
Read the rules here