Let us consider, for a moment, the story of former Enron employee Charles Prestwood. A long-time worker for Enron and Houston Natural Gas (as the company was previously known), Prestwood was optimistic when he retired in 2001. “I thought I had all my t’s crossed and all my i’s dotted,” he said while telling his story several years ago, but things would soon take a dreadful turn. His retirement savings, consisting almost entirely of company stock, went from being worth over a million dollars to being nearly worthless, leaving the man to survive on Social Security and a small monthly pension. Prestwood’s tale was an extreme case of the dangers facing investors when they fail to diversify properly. Investors face similar perils of varying degrees when tailoring their investments too narrowly in other ways, such as investing heavily in the same country – especially their home country.

Of course, problems associated with home-country bias are different from Prestwood’s situation in several key ways. The first relates to pressures against diversification: Although the Canadian government (like other governments) has incentivized domestic investment, this pales when compared to Enron’s practices, where the leadership pushed its anti-diversification philosophy on employees with a cult-like fervour, insisting that they keep only Enron stock. Another major difference is severity of risk: The average Canadian investor, even if her portfolio exhibits extreme home-country bias, is unlikely to face the devastating consequences that Prestwood did – assuming, of course, that her investments are diversified in other important ways. In other words, the danger here is not immediate financial ruin, but foregoing potentially high returns (less urgent but nonetheless very real).

Canada’s government has made it easier over time for investors, particularly those planning for retirement, to diversify globally. Things were once much stricter, especially after the Foreign Property Rule (FPR) was instituted in 1971. This regulation placed a 10% cap on the foreign content of investments by Canadian parties, imposing a small penalty on those who exceeded it. The ceiling was eventually raised to 20% and then to 30%, and was finally eliminated in 2005.

It seemed that Canadian investors would celebrate their newfound freedom by greatly increasing their foreign holdings – not so, however.  In 2011 HSBC Bank Canada polled Canadians with investable assets of $100,000 or more and found considerable evidence of persistent home-country bias even in the wake of the FPR’s removal. Nearly three-fourths of their holdings (74%) were invested in Canada, with the United States receiving the next largest share.

Why does such a large home-country bias persist even in the face of increased financial freedom? Several factors likely contribute to it, each with different implications on how soundly (or unsoundly) Canadians are managing their investments. The first relates to practical concerns. A strong majority of Canadians (67%) stated their willingness to invest wherever they found promising opportunities, while a stronger majority (71%) indicated they would be unwilling to invest in a market unless they felt well-informed about it. Greater familiarity with domestic markets (and US markets, to a lesser but still significant extent) would therefore bias them towards investing there, even if they had no inherent desire to do so. Only 8% of their investments went to emerging markets, a number likely influenced by lack of familiarity with foreign economies. Other practical matters that may tip the balance toward domestic portfolios include various costs and complications of investing across borders, such as taxes, currencies and the ever-present hassle of dealing with more regulations.

Another key aspect, often overlooked, is that “home” bias may not mean the same in today’s increasingly globalized world as it did a century ago. In a report published while the FPR was in effect (with a 20% cap), the Fraser Institute noted that “Canadian” and “foreign” often meant something quite different than what the words implied. They cited examples of organizations such as Seagram Company and Thompson Corporation, which were classified as “Canadian” even though the bulk of their sales came from abroad. However, while the Fraser Institute’s stance was generally against the FPR, they did not consider this aspect to be one of its flaws, stating that “On the contrary, this type of indirect foreign exposure increases the level of diversification in an investor’s portfolio.”

One likely component of home-country bias should genuinely concern investors. Psychologist Daniel Kahneman, who is also a Nobel laureate in Economics, wrote about several quirks in human reasoning in his 2011 book Thinking, Fast and Slow. Of particular note is one quirk termed the “affect heuristic,” which results in one’s assessments being guided by “feelings of liking and disliking, with little deliberation or reasoning.” This means that instead of making a careful determination regarding a company’s stock (underpriced, etc.), an investor bases his purchasing decision on whether or not he personally likes the company. This mental substitution often occurs without the person realizing it, so even experienced investors are vulnerable. The affect heuristic is particularly relevant to this discussion since people will generally have positive feelings about their home country, potentially resulting in undue optimism about domestic investments.

Home-country bias is a very real phenomenon that exists throughout the entire world. As noted earlier, this bias may be partially justified by practical concerns such as unfamiliarity with foreign markets, and the costs and constraints associated with investing abroad. Additionally, as the Fraser Institute noted, investors with “home” bias may have diversity in their portfolios without even realizing it. However, investors who desire the best possible returns should  see home-country bias as a problem and take steps to address it. An obvious move is to learn about foreign markets (particularly emerging markets), ensuring that investors will be able to seize attractive foreign investment opportunities when they arise. All investors (inexperienced and veterans alike) should carefully examine the way they make investment decisions, to ensure those decisions are based on sound financial strategy rather than merely feelings about their home country.