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Conventional wisdom says that you should invest not only in what you know, but in products that you buy. Now a pair of University of Illinois professors have taken that notion one step further.
Using a detailed data set of investments made through a large discount broker by 78,000 U.S. retail investors over six years, Zoran Ivkovich and Scott Weisbenner took a look at what economists call local bias: the inclusion of hometown stocks in individual portfolios. Granted, their definition of “local” is probably broader than yours: the area within 250 miles of investors’ primary homes. But it’s still fair to say that most people would be more familiar with companies within that radius than with firms farther away. And what the researchers found was that the average household generates an additional 3.7 percent per year from its local holdings compared to non-local holdings.
The results are even more dramatic for small companies. Stocks of local firms that are not in the large-cap S&P 500 saw average annual returns that were 6.1 percent better than non-local small stocks, which suggests that investors are taking advantage of market inefficiencies. Investors may buy their local stocks not just because of hometown familiarity and a feeling of civic duty, but because they know something that non-locals don’t -- the availability of information sets local preference and performance apart from the pack.
Compare two stocks, Microsoft and Corvis, for example.
Microsoft certainly is a hometown company for people living near Redmond, Wash., but for all practical purposes, it’s a local stock to all investors because of its inclusion in the Dow Jones Industrial Average and the S&P 500. With 28 analysts on Wall Street covering the stock, information on the company is deep, readily available and easily accessible. There is no local advantage to ownership of the stock.
Meanwhile, Corvis, a Maryland fiber optics company whose small-cap stock shot higher in mid-May, is not part of the S&P 500. Only three brokers follow this stock and give investment recommendations. But serious local investors can uncover companies such as Corvis by talking to people that work for the company, reading articles about it published in the newspaper or following local radio and television news.
Make sure you verify facts. Basic investment information such as price-earnings ratio and how it compares to its peers can go a long way to verifying those stories and tips.
As with all investing, keep emotions out of buying hometown stocks. Trouble can surface when you think you have to own the stock just because it’s local, and on the other side, sometimes familiarity can breed contempt. And make sure you’re using the information wisely. What may be perceived as bad news, such as layoffs, may be good news for the stock price, as it signals management’s efforts to cut costs and thereby boost profits.
So in your search for investment opportunities to increase the return of your portfolio, keep an open mind and remember to remain diversified with a combination of cash, stocks and bonds. But also remember that sometimes, you may only have to look as far as your own backyard.
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