Solving home bias when investing isn't simple, but there are strategies to overcome it

Andrew Feindel: Examining the psychology behind home bias may help position a portfolio for success

By Andrew Feindel

All the attention-grabbing headlines out there these days make it more challenging than ever to separate valuable information from irrelevant distractions in order to make informed investment decisions without falling prey to emotional reactions.

This is particularly true with topics such as home bias, where an individual investor’s experiences heavily influence their perceptions, so emotions can cloud their judgment. This can lead to less-than-optimal long-term investment strategies that may impact their chances of achieving their financial goals.

Solving home bias is more complicated than it sounds, but examining the psychology behind it may help position a portfolio for success.

Why is there home bias?

The degree of home bias investors exhibit is frequently influenced by psychological factors instead of logical reasoning.

For example, an investor’s past experiences can significantly shape their risk tolerance and investment choices. If an investor made substantial investments in the Canadian market between 2000 and 2010 — when it outperformed many other market indexes — they would likely have a greater tilt towards home bias.

Conversely, an investor who began investing domestically after 2010, when the Canadian market underperformed, might be hesitant to seize domestic opportunities. Other factors that can reinforce these subconscious biases might include one’s political beliefs, view on foreign governments and/or occupation.

In order to create appropriate investment strategies suitable to each client’s unique circumstances, advisers should strive to understand these biases and help clients consider more pivotal investment variables.

Strategies to tackle home bias

It is crucial to take a step back when determining the right degree of diversification an investor needs, and look at markets from a broader perspective to strategically position a portfolio for different market cycles.

The last bull cycle from 2009 to 2021 was filled with quantitative easing, disinflation, low yields, growth and large-cap stock dominance, globalization and monetary excess. However, the next bull cycle is looking quite different, with quantitative tightening, inflation, normalized yields, onshoring and the resurgence of small-cap and value stocks potentially being the core drivers.

Whereas the last bull cycle did not favour home bias for Canadians, should the key variables of the next bull cycle diverge from those of the previous one, a strong argument could be made for favouring some form of home bias for Canadians.

Given the volatility of macroeconomic and geopolitical factors, it is important to not fixate on a single perspective and stress test portfolios by assigning probabilities to different scenarios.

Assuming best-case, base-case and worst-case scenarios — adjusting variables to see the effects on portfolio returns and volatility — will help capture a wide range of possible outcomes and avoid being caught off-guard by changing market conditions.

The right allocation

Personal circumstances are crucial considerations when determining the appropriate degree of diversification, often more so than strategic market factors. Elements such as age, risk tolerance, family situation, income and liabilities need to be considered alongside market factors to ensure a balanced portfolio.

For instance, as individuals approach retirement, they should consider holding more Canadian assets to avoid currency and liquidity risks. Those who need access to their money over the short term should be investing conservatively in havens such as guaranteed investment certificates, high-interest savings accounts or short-term bonds to avoid price risk. And individuals with a higher risk tolerance may want to hold more foreign assets over a longer-term horizon.

Specific allocations will vary depending on a mix of individual and market variables, but it’s generally advisable to avoid holding more than 80 per cent to 90 per cent in either foreign or domestic assets as a balanced approach is often more beneficial.

Luckily, Canadians have access to a variety of investment solutions that simplify the process of creating a balanced portfolio while offering tax advantages, whether investing domestically or internationally.

For example, Horizons Equal Weight Canada Banks Index exchange-traded fund provides exposure to the Big Six while deferring taxable distributions until you sell the ETF, making it tax efficient compared to buying the six banks individually. The Purpose Tactical Asset Allocation ETF is another tax-efficient fund that automatically adjusts asset allocation between equities and bonds to generate absolute returns. For those seeking equity exposure with enhanced yield, the Evolve S&P 500 Enhanced Yield Fund provides exposure to the S&P 500 with an option strategy that provides additional income.

Keep in mind that there are rarely, if ever, times of complete certainty in markets. Every day, new developments throw into question the viability of investment strategies. In this ever-changing environment, an adviser can help clear the fog of financial complexities and shed light on timeless, fundamental investment principles that help you achieve your financial goals.

By clarifying misconceptions and educating clients on security selection, portfolio allocation and macroeconomic conditions, advisers can provide clients the confidence to adhere to their investment strategies and base decisions on understanding and logic instead of emotional impulses.

Andrew Feindel, CFA, CFP, CSWP, CIM, FMA, CPCA, FCSI, HBA, is a portfolio manager and investment adviser for Richie-Feindel Wealth Management at Richardson Wealth Ltd. and the author of Kickstart Your Corporation (2020) and Kickstart: How Successful Canadians Got Started (2008)