Home country investment bias is easy to understand, in part because so many of us relate to it personally. It is the tendency among investors to overweight their investment portfolios in domestic securities: stocks and bonds issued by companies and governments close to home, and mutual funds containing those stocks and bonds.

Investors experience a false sense of security from this decision. Their optimism about their home country may be well-founded over any given timeframe, but in the long term, modern portfolio theory calls for a balanced mix of investments. Diversification across geographic regions and across asset classes is one of the foundations of sound financial planning.

It might feel less risky to invest the bulk of your savings in companies you know and see close to home. But in fact, an overemphasis on one country is the financial equivalent of having all your eggs in one basket.

This is particularly true in Canada

Our economy is heavily based on commodities like oil and other natural resources. Our stock markets — including Canada’s main index, the S&P/TSX Composite — reflect this. Investments in these companies have done well because commodity prices have risen as a result of significant economic growth in developing economies like India and China. Those countries are growing huge middle classes, and their consumers all want the same comforts of middle-class life that Canadians enjoy. So raw materials like copper and lumber have grown increasingly expensive.

This has led some investors to view Canadian companies in these industries as a way to invest (indirectly) in continued emerging market economic development. These Canadian stocks, oddly, became a way to gain emerging market exposure.

But as everyone knows, the global recovery has been hit hard by political and economic developments globally. So expectations for continued growth in the emerging economies have plummeted. That’s driven commodity prices down, and taken the Canadian stock market along with it.

It’s been a painful lesson for investors overexposed to Canada. The fact that some of them made those investments believing they were gaining a degree of international exposure adds a bit of irony to the situation. But in the final analysis, it’s still not much more than a simple illustration of what can happen when you fail to diversify.

Find out more about diversification: