Affinity Bias: Why You Invest in Things You Like Instead of Things That Make Money

This is the last emotional bias in Pompian’s book, and it is an interesting one because it touches on identity. Affinity bias is about investing based on who you think you are (or who you want to be), rather than what actually makes financial sense.

The opening quote is from Paul Getty: “My yachts were, I suppose, outstanding status symbols.” That sets the tone perfectly.

Expressive vs. Utilitarian Value

Pompian introduces a useful framework here: the difference between expressive value and utilitarian value.

Utilitarian value is what something actually does for you. A car gets you from point A to point B. A phone lets you make calls and check email.

Expressive value is what something says about you. A Range Rover says “I am outdoorsy and successful.” An expensive watch says “I have arrived.” A particular wine at dinner says “I have refined taste.”

Here’s the thing: there is nothing inherently wrong with buying things for their expressive value. If you enjoy a nice car, go for it. But when this thinking leaks into your investment decisions, it can cause real problems.

Some people invest in companies because they like the products those companies make. You love your blue jeans, so you buy stock in the jeans company. You admire the brand, so you invest in the brand. But liking a product and evaluating a company as an investment are two completely different skills. The jeans might be great. The company might be a financial disaster.

Patriotism in Your Portfolio

The most fascinating application of affinity bias that Pompian discusses is the “home country bias.” Researchers Adair Morse and Sophie Shive from the University of Chicago and Notre Dame studied how patriotism affects investment behavior.

Their findings are striking:

• U.S. investors hold 92% of their equity portfolio in domestic stocks, even though portfolio theory suggests the optimal diversified portfolio should only be about one-third domestic
• More patriotic countries invest less in foreign stocks
• Within the U.S., investors in patriotic regions like Texas, Oklahoma, Louisiana, and Arkansas invest less in international equities than investors in New England
• A 10% decrease in patriotism is associated with a 29-48% increase in foreign equity holdings

They even found that when France opposed the Iraq war, American demand for French stocks traded in the U.S. declined. People sold their French stock holdings as a form of political protest. The proportion of French ADRs (American Depositary Receipts) sold increased by 15-18% during the period of anti-French sentiment.

This is affinity bias at its most visible. People are making investment decisions based on national pride, not financial analysis. And it costs them real diversification benefits.

Morse and Shive point out that patriotism creates a “winner’s curse” effect. Citizens of a country will tend to be the highest bidders for their own country’s assets. This can drive up domestic prices and reduce returns, while leaving perfectly good international investments on the table.

ESG and Values-Based Investing

Pompian also touches on something very relevant today: ESG (Environmental, Social, and Governance) investing. Some investors want their money to reflect their values. They want to invest in companies that are environmentally responsible, socially conscious, and well-governed.

Here is where it gets nuanced. Pompian is not saying ESG investing is bad. Some studies show it can work as a strategy. Others show it underperforms. The point is that if you are making investment decisions primarily based on values rather than financials, you need to be aware that you are introducing a non-financial factor into a financial decision.

If you invest in a “green” company because it makes you feel good about yourself, but you do not check whether the company is actually well-managed and financially sound, you are letting affinity bias drive your portfolio. The company might be saving the planet while also going bankrupt. Those two things are not mutually exclusive.

The Status Trap

There is another angle to affinity bias that I find particularly interesting: investing for status. Some people invest in hedge funds, private equity, or other “sophisticated” investment products not because they understand them, but because they want to be seen as the kind of person who invests in hedge funds.

“Oh, you are in an index fund? How… basic. I am in a private equity fund. Very exclusive.” Meanwhile, the hedge fund charges 2% management fees and 20% of profits, and the index fund just quietly outperforms it year after year.

Pompian warns that investing in things you do not understand, just because they make you look sophisticated, is “hazardous to your wealth.” If you cannot explain how your investment works to a friend over coffee, you probably should not be in it.

Liberalism and Home Bias

The research review section covers an interesting study by Evangelos Benos and Marek Jochec, who found that countries with more liberal social values tend to have less home country bias. Both economic liberalism (trust in open markets) and social liberalism (openness to change) correlate with holding more foreign equities.

The researchers suggest that social liberalism is a proxy for a society’s willingness to accept change in general. Since international investing is historically relatively new, socially liberal societies are more willing to pioneer it.

This is interesting because it connects investment behavior to something much deeper: cultural attitudes about change, openness, and trust. Your investment portfolio is not just a reflection of your financial knowledge. It is a reflection of your worldview.

The Four Mistakes

Pompian summarizes four ways affinity bias leads to poor outcomes:

1. Investing in companies you like. You love the product, so you buy the stock. But a great product does not guarantee a great investment. The company could have terrible management, massive debt, or no path to profitability.

2. Investing based on values alone. ESG investing can work, but it needs to be combined with solid financial analysis. Do not buy a stock just because the company plants trees. Check the balance sheet too.

3. Home country bias. Keeping 90%+ of your investments in domestic stocks means you are missing out on diversification and currency benefits that come from international investing. The world is bigger than one country.

4. Investing for status. Putting money into “sophisticated” products you do not understand because you want to impress people is a recipe for disaster. The smartest investors often use the simplest tools.

What To Do About It

Ask yourself why. Before making any investment, ask: “Am I investing in this because of sound financial analysis, or because this investment reflects who I want to be?” If it is the latter, pause.

Separate products from investments. You can love Apple products and still recognize that Apple stock might be overvalued. You can hate a company’s products and still acknowledge that its stock is a good deal. Consumers and investors need different evaluation criteria.

Check your international allocation. Look at what percentage of your portfolio is in domestic versus international investments. If it is heavily skewed domestic, ask yourself honestly: is that because of analysis, or because of comfort and familiarity?

Do not invest in what you do not understand. If someone is pitching you a “sophisticated” investment product and you cannot explain how it makes money, do not invest. The most successful long-term investors typically use straightforward, transparent strategies.

If you want values-based investing, do it carefully. There is nothing wrong with wanting your portfolio to reflect your values. But apply the same financial rigor to ESG investments as you would to any other. Check the fundamentals. Look at the track record. Make sure the company is actually a sound investment, not just a feel-good story.

My Take

This chapter resonated with me because I have seen affinity bias play out in so many contexts. In the tech world, people invest in companies whose technology they admire, without checking whether the business model makes sense. In post-Soviet countries, people heavily favor domestic investments even when their own country’s market is tiny and volatile compared to global options.

The patriotism angle is especially interesting. I grew up in a country where patriotism was mandatory. You did not question the homeland. And that kind of thinking can absolutely leak into financial decisions. “Our companies are the best.” “Why would I invest abroad when we have perfectly good companies here?”

But your portfolio does not care about your national pride. It only cares about risk-adjusted returns. And in a globally connected world, limiting yourself to one country’s investments is like going to a buffet and only eating from one station.

With this chapter, we have now covered all the emotional biases in Pompian’s framework. Next, we will look at how to actually apply all of this behavioral finance knowledge to real asset allocation decisions.

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This is part of a series retelling “Behavioral Finance and Wealth Management” by Michael M. Pompian. Start from the beginning.