Familiarity breeds contempt. And investor bias

In the late 90s, Rahul Roy (name changed to protect identity) invested in his bank’s public issue.

He told DNA, “The management had requested us to buy shares worth Rs500 at least. Perhaps, I could have bought those shares in the secondary market at comparatively cheaper rates, but it was my company’s first initiative and I wanted to be a part of it.”

It might seem silly of Roy to have bought shares in a company simply because he works there — and without due diligence — but his is not an isolated case.

Many-a-times, employees buy the stock of the company they work for. And if the company is a financial institution, they may also buy a mutual fund or insurance product.

Such behaviour, wherein we buy products/ services from a company because we are “familiar” with it — which brings about a sense of security — is called “familiarity bias”.

Market experts and HR people say employees buying into a company is usually a positive sign.

“Usually, employees have a better idea of the company they work for, and would invest only if the company is expected to give better returns,” says Ambareesh Baliga, vice-president at Karvy Stock Broking.

Nihar Ranjan Ghosh, senior vice-president, HR, at RPG Retail Sector, told DNA, “An employee investing in a stock of his own company is a combination of strong emotional connect and wise investment decisions, because employees have deep understanding and strong insights on how the company will fare in future towards its long-term success.”

Roy’s investment has performed well. He followed it up with another investment in 2004, a decision based on more rational factors.

But such investments can prove costly, for this familiarity can blindside you to the risks involved. Consider the following cases:
“I am working with TV18 and have developed a bonding with the company. Thinking that the media industry was performing well, I bought 200-odd shares of the company in January 2009, when the price was hovering around `500. But I sold off a part of my holdings in mid-November 2010, suffering a loss of almost 20%,” said an employee of the company. The person requested anonymity as he still works there.

“In September 2009, at a price of Rs138, I invested Rs2 lakh in my company. Now, the stock price has come down to Rs82 and since I am getting only half of my invested principal, I am still holding them. If I’d invested the same amount in gold, I would have made a profit of almost 22% as compared to this loss suffered,” says a senior employee working with a leading broking house.

A former employee of Reliance Communication told DNA he had purchased 100 shares of RCom at around Rs265 in July 2009, thinking the company would benefit from its GSM foray. “The stock price too had corrected from around Rs350 levels a month ago,” he said. “But within 4-5 months of my purchase, the stock price crashed to around Rs170 levels. I held on to the stock, averaging out at lower levels. Finally, I sold 300 shares at an average price of Rs180, making a loss of over Rs8,000,” said the person, who requested anonymity.

What happened in these above cases? Familiarity bias played a role in at least the first two cases. The third case saw a more rational approach, wherein the individual bought the stock because it had ‘corrected’. Unfortunately, the stock corrected further.

Why does this happen? It is difficult for insiders to judge the company as an outsider. We are often emotionally attached to our companies, making it difficult for us to judge our companies objectively.

To avoid falling into the familiarity bias trap, ask yourself a fundamental question — would you buy this stock if you were working for a rival?

So be careful and avoid thinking of your company as “our” company when making investment decisions.