One of the age old pieces of advice for stock investors (including icons such as Warren Buffet), is to invest only in things that you know. No one ever explains to you why though, so we’ll take a look at some of the reasons for this particular saying.
1) You know what’s going on - A big part of the success of your investment depends on you knowing exactly what you’re investing in. It sounds obvious, but many people make the mistake of investing in something they don’t understand. How do you know what’s going on if you’re not into cars and invested in GM and they tell you that the turnover is getting long and maybe only the new hybrid electric car can increase sales?
If that sounds like gibberish to you, then you might as well have put your money with some random guy. After all, how do you expect to have an edge without knowing what’s going on? If you don’t know, then you can bet that someone else does. Since trading in itself is somewhat zero sum, where do you think the money will come from?
2) You have an edge - Investing is a competition of information. While everyone technically have access to the same amount of information in theory, it’s not actually true in practice. If you’re a new college student with a finance degree analyzing a garbage company, you may know all the expected outcomes and projections and statistics, but a garbage man who’s been working for many years can probably accurately see that the company is going to get sued soon or something.
Your experience in a particular field gives you an insight into the company that other people may not be able to see. You can guage the reactions of the CEO and see that he’s nervous about a possible new regulatory law. You can sense the concerns of the workers and know that they are becoming unmotivated. You can see innovative solutions in the company based on past experience.
It’s like you have inside knowledge while the other less experienced people only have paper knowledge and statistics to go by.
3) There are more opportunities - Because you have inside knowledge about that industry, you naturally can spot more opportunities. For example, you may be able to understand why a particular stock plunged or why certain parts of the stock are undervalued. You know it’s just a temporary downturn and things just seem worse on paper than they actually are. You put in your money and get cheap shares with ease from people scared and not knowing what’s going on.
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Overall, even if those reasons aren’t convincing enough for you, do you really want to look in your portfolio a year from now and wonder what company all your money is invested in does? Isn’t that kind of like putting all your money on black?