The Geographical Bias
Geographical bias refers to when a specific location or region has a significant impact on an investment decision. For example, US investors may choose to only invest in the US stock market, and Indian investors may only invest in Indian equities. However, if an investor has a bias towards investing in their home country, they may miss out on potential higher returns in other countries. The global market has become highly integrated, and technology has created global connections, making global information easily accessible. Nevertheless, investors find it challenging to overcome geographical bias.
In the current low return market environment, this inability to overcome geographical bias can harm investors in multiple ways. Firstly, by limiting investments to a particular region or industry, investors may be taking on more risk than they realize. For example, if US markets continue to stagnate or fall and emerging markets catch up, a pure US equity portfolio may turn out to be riskier than a portfolio with US and emerging markets. Secondly, it is hard to determine the average returns an investor loses due to geographical bias, but research has shown that investors who have a home bias may miss out on potential returns by not diversifying their investments internationally. According to a study by Vanguard, a US investor who invested only in US companies would have earned an annualized return of 9.5% between 1970 and 2019, whereas an investor who invested globally would have earned an annualized return of 2% more at 11.5%. Lastly, inflation is a reality, and alternatives like commodities are important asset classes for an investor to understand and own.
To overcome this bias, investors should actively seek out investment opportunities in different regions and asset classes. This will not only reduce overall risk but also enhance returns in low return or recession times. Investors should seek professional assistance and ask their advisors for more research on the effect of geographical biases on long-term wealth.
Bibliography
- “Home Bias in Equity Portfolios, Consumption, and Exchange Rates” by Markus K. Brunnermeier and Stefan Nagel, The American Economic Review, 2005.
- “Home Bias at Home: Local Equity Preference in Domestic Portfolios” by Joshua D. Coval and Tobias J. Moskowitz, The Journal of Finance, 1999.
- “The Determinants of Individual Investment in Foreign Financial Assets” by S. Borağan Aruoba and Francisco J. Gomes, Journal of International Economics, 2010.
- “Geographic Diversification and the Role of Home Bias: Evidence from Mutual Fund Investors” by Jennifer L. Blouin and others, Journal of Financial and Quantitative Analysis, 2010.
- “Home Bias and High Turnover” by Nicholas Barberis and Andrei Shleifer, Journal of Financial Economics, 2000.
- “The Geography of Investment: How to Invest Globally in a Domestic Asset Allocator” by Mark C. Kritzman, The Journal of Portfolio Management, 2001.
- “Home Bias in International Equity Markets” by Richard J. Herring and Luc Laeven, Journal of International Money and Finance, 2003.
- “Geographic Diversification and the Role of Home Bias: Evidence from Mutual Fund Investors” by Jennifer L. Blouin and others, Journal of Financial and Quantitative Analysis, 2010.
- “The Home Bias Puzzle” by R. Glenn Hubbard, Journal of Economic Literature, 1998.
- “Home Bias in International Portfolio Choice” by Avanidhar Subrahmanyam and S. Viswanathan, Journal of Financial Economics, 1996.
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