Investment starts at home

"Buy what you know." Invest in companies that have products you love or in industries that you're familiar with, and you're less likely to get in over your head. Or so the theory -- championed by longtime Fidelity Magellan Fund manager Peter Lynch -- goes.

But have you ever heard this piece of Wall Street wisdom: "Buy where you live?"

Probably not, but chances are that you may be doing just that. Americans tend to be domestically biased investors. And research discovered that we're also locally biased investors, opting for a larger proportion of our portfolios in shares of hometown companies.

"Everyone thinks of us as one monolithic country," said Alok Kumar, an assistant professor of finance at the University of Texas at Austin. Kumar conducted the research with George Korniotis, a staff economist with the Federal Reserve. "Given that it's such a huge country and so much diversity, to say that it behaves just as one market didn't seem right to us."

So they combed through data from 1980 through 2004 and found that, indeed, Minnesotans tend to buy more Minnesota companies, that folks in Florida prefer companies in the Sunshine State and that residents of Ohio buy -- well, you get the picture.

The research didn't uncover why we like to own General Mills, U.S. Bank and Pentair. Or why Minnesotans tend to own more local companies and reap higher returns than the majority of other states as well. Kumar says he believes the phenomenon is mostly subconscious. Perhaps we want to own shares of the companies we work for (although owning too much stock in your employer is risky).

Maybe we like supporting companies that have direct links to the health of our home state. Or we can't resist that tip we got from a friend about her company at last week's barbecue. Kumar may further investigate the why, after he's done looking into whether tall people are better investors. (The answer: Yes, if you're tall -- but not too tall.)

"We've got a remarkably diverse local economy of many different industries that's almost unprecedented throughout the U.S.," he explained.

Henneman also puts weight in our good schools and amenities that attract top employees, as well as a strong work ethic.

Minnesota also has a lot of large public companies, more per capita than most other states, points out Joe Barsky of the Carlson School of Management.

Keep tabs on local economy

Whatever the reason for our penchant for local stocks, paying attention to the ebbs and flows of the local economy may boost your returns. That's the second part of Kumar's and Korniotis' research. Local economic conditions will affect the behavior of local investors. If unemployment is higher than the national average and the housing market is one of the worst in the country, local investors "might get risk-averse, meaning they start selling their financial assets," Kumar said. They sell to make ends meet or stuff money under the mattress, which in turn drives down the price of local shares for a spell. The reverse is true in a good local economy.

The researchers tested it by buying stocks in the states that have companies expecting to grow and selling short companies in areas poised for decline, hoping to profit on the drop. Doing so earned the researchers a 6 to 8 percent risk-adjusted annualized return. Hedge fund managers and other purveyors of leveraged strategies have been showing interest in bottling the duo's work, Kumar said.

But is there anything for the average investor to take away from the study? For instance, is the uptick in Minnesota's unemployment rate a signal to buy? Kumar thinks so. It could also prompt you to broaden your horizons a bit if your investments are highly concentrated in Minnesota.

"Even realizing that a phenomenon like this takes place would be a step forward," Kumar said. Then again, "If everybody starts to do this, then the pattern will disappear."