Certified Financial Management Specialist Practice Exam

Familiarity bias in investing primarily leads to what outcome?

1. Increased Portfolio Diversification

2. Higher Investment Returns

3. Reduced Diversification

4. Enhanced Market Knowledge

The correct answer is: Reduced Diversification

Familiarity bias occurs when investors favor investments with which they are more familiar, typically leading them to concentrate their portfolios in a limited number of assets or sectors. This bias can stem from personal experiences, local knowledge, or simply preference for companies that are well-known or commonly discussed in their immediate social environment. As a result, investors often underweight or entirely ignore opportunities that lie outside their familiarity zone. This behavior is significant because it can limit exposure to a diverse array of investments, leading to a portfolio that is less balanced and more prone to risks associated with specific sectors or the companies they choose to invest in. Therefore, the outcome of familiarity bias tends to result in reduced diversification, making the portfolio more vulnerable to market fluctuations.