The familiarity bias or heuristic (rule of thumb) makes you invest in the familiar even though a less well-known alternative would produce a better return.
In simple terms this might mean investing in the shares of companies whose brands you know, rather than in better performing shares of companies you have not heard of. The result is likely to be lower returns, or even losses.
To counter the familiarity bias educate, yourself about the alternatives, compare the data on the different options and put in place a double-check reminder before investing in anything that sounds familiar. Take your time to decide based on full facts, rather than rushed choices.
Science of the familiar
A heuristic is a psychological term for a methodology used to make quick decisions. Humans use heuristics all the time to judge people and events, to form beliefs and to make decisions.
They are used to make fast choices in familiar situation but where there is uncertainty. Often heuristics are useful short-cuts to the right decision, quickly. If we hear gunfire, we duck. If it’s not gunfire we might look silly but, in general, ducking under fire is a good move.
But some heuristics lead to prejudice and to bad decisions, which is why they are often referred to as biases. A decision made too fast based on a preconception is not always the right decision.
Kahneman and Tversky
Israeli psychologists Daniel Kahneman and Amos Tversky worked together from the late 1960s. In 1973 they were the first to produce the idea of the availability heuristic or bias.
Their work between 1971 and 1979 eventually won Kahneman the Nobel Prize in Economics in 2002 (Tversky had died by then).
Between them they went on to develop prospect theory, which became vital in understanding how irrational decisions affect economics.
The premise of the availability bias is that people believe that if they can remember something easily, it must be more important than something they struggle to recall.