Unless you are a CPA who audits public companies, you’ve probably never heard of familiarity risk. Familiarity risk are risks that you may be incurring that are easily masked by something or someone that you simply become used to. Being too familiar with any situation may cause your guard to become lower than it should be and not allow you to perceive the actual risks that you may be facing.
There are several examples of familiarity risk common in many peoples’ day to day lives. Take a look at your rental property. Are there issues such as large potholes in the driveway or poor lighting in a stairway that could cause one of your tenants to injure themselves? Don’t wait to fix or address the issue once you see it in clearer light. In fact, if this is an issue that you were personally familiar with or knew in advance that it may be problematic, your LLC or other protected entity may not protect you from liability. Even your insurer can hold up your claim if this is something where you knew there was a deficiency.
What about that investment you inherited from your parents? Very often I find investors who insist on holding onto a particular investment because their grandmother owned it, their mother owned it and now they own it. It wasn’t a problem for them and you’ve become so familiar with the company that your risk meter has been attenuated and isn’t really flashing the warning sign of how risky this particular company holding may be. Just ask those who held onto once stalwart companies who have faded into oblivion due to competition or mismanagement.
The same situation often happens to those with the same team of professionals for extended periods. It is not uncommon to meet someone who has had the same accountant, attorney, insurance agent and financial advisor for decades. Just because you are familiar with these professionals doesn’t mean that they aren’t causing you harm. While it may be unlikely that they would intentionally cause you harm, you may be in harm’s way because of the services that they are not delivering to you.
Familiarity risk is common in the financial services world. Some clients get to know their financial professionals very well; maybe even developing a personal relationship side by side with the professional relationship. I see familiarity risk in action nearly every day and the proof lies in these simple observations. Why does your CPA see your investment accounts have excessive trading activity generating higher fees and commissions, and not say anything? Why does your investment advisor see that your investment accounts are either in joint or individual names and not ask why you aren’t using trusts? Why does your insurance agent sell you a life policy naming minor children as the contingent beneficiary?
The only answers that I can give are either incompetence or familiarity risk on everyone’s part.
John P. Napolitano CFP®, CPA, PFS, MST is Founder and Chairman of Napier Financial in Braintree, MA. Visit napierfinancial.com for more information. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investment and financial planning advice offered through US Financial Advisors, a Registered Investment Advisor.
