Illusion of knowledge
Once you’ve decided to invest, the question of where to put your money needs to be answered. Economist Chris Dillow blogs for eZonomics that it can be tempting to invest in the sector in which you work because of “illusory knowledge” – or the tendency to buy shares in businesses they think they know. Dillow explains that investors might feel they know businesses because they are local or because they work in the same sector. But in their paper The Behaviour of Individual Investors, academics Brad Barber and Terrance Odean from the University of California highlight illusory knowledge as one of the traps that investors fall into and that can lead to poor performance. Analysing the market in detail might require an examination of fundamentals not encountered in day-to-day work in a sector, hence the term the illusion of knowledge.
Get ready to change
Investing in the sector in which you work can throw up another problem – one to do with diversification. Investing and working in the same industry can leave people over-exposed to one sector. Research from Norway referenced in an earlier eZonomics poll investors often buy shares in firms in industries that they work in. Even excluding shares in their company the investors worked for, the study found high ownership of “professionally close” shares. From a diversification point-of-view, it could be dangerous to “put all your eggs” in one sector. If it takes a hit, an investor might find themselves out of a job and with shares that have dramatically fallen in value.