Mental Model: Mere Exposure Effect or the Familiarity Principle
The mere exposure effect, also known as the familiarity principle, describes a phenomenon that causes humans to rate or feel positively about things to which they are frequently and consistently exposed, including other people. All else equal, you will buy products, invest in stocks, frequent establishments, and engage in behaviors that are familiar to you based on past exposure. This can lead to suboptimal decisions and results and has no basis in rationality. It can also pin you in to situations that repeat past outcomes, which may not be desirable.
An example of how the mere exposure effect influences your behavior: Imagine you live in New York City. You are in Central Park and spot a drowning child, splashing in a lake after having fallen off one of the small pedestrian bridges. There are two people standing next to you on the bank as you chuck aside your shoes and rip off your shirt. You have a split second to make a decision about which of the two people you will entrust with your wallet, cash, phone, and keys. One of the two is a man you see a few times a month on the jogging trail. You don’t know his name. You have no idea if he is trustworthy. You don’t know where he lives. There is no logical reason for you to trust him more than the other person. He could steal your stuff and change jogging trails. Odds are, you’d never see him again.
Yet, the probability is overwhelming that the mere exposure effect is going to cause your subconscious brain to rate the jogger “good”, or at least “better” than the stranger, simply because you are already familiar with his face. He is going to be handed your valuables, even though he could be a con artist or identity thief.
How the Mere Exposure Effect Can Hurt Your Investments
This mere exposure effect can influence your investment portfolio strategy, as well. Many stock traders tend to invest in companies that are familiar and popular, due in part to social proof and in part to the mere exposure effect. They will give up an extra 3% or 4% per year, which is an enormous amount of lost wealth over long periods of time, because they rank a familiar company better than an unfamiliar one.
If you are excellent at analyzing banks, for example, and you are like most people, you might find yourself gravitating to very large bank holding companies instead of to the best bargains, which might include banks that trade only a few shares of stock a day on the over-the-counter markets. There is a part of your primitive brain that feels better if you own shares of companies that your grandmother would recognize instantly even though, as an expert in bank valuation that understands the financial statements far better than most, they don’t represent the best bargains.