Why you shouldn’t buy an investment you know

Legendary investor Warren Buffett and others are known for telling investors to buy what they know. Basically, Buffett and his enthusiastic followers recommend investing in companies you really know-or at least know them enough to be able to explain how they make money (ie, the company’s business model).

Although it is certainly not without advantages, buying what you know is not necessarily an investment strategy that can produce the greatest investment success. This strategy has some limitations. In fact, investors can get better service by buying what they can learn.

Key points

  • Buy relevant and practical investment advice you know.
  • However, buying only what you know will put your portfolio at risk, because many of the greatest returns will come from companies you have never heard of and don’t know yet.
  • One pitfall of investing only in companies you are satisfied with is the opportunity cost of not owning a company that is not yet well-known.

It takes time to fully understand a company

For some obvious reasons, many new investors will find it difficult to thoroughly study the business models or 10-K statements of listed companies. The most important thing is the lack of time and knowledge. Not many of us can listen to the company’s earnings conference call consistently, and even if we can, we may not really understand what is being discussed.

A true understanding of a company’s balance sheet and overall financial direction requires expertise that most investors cannot immediately have. However, there are many online resources that can help shorten the learning curve for knowing the company you own or companies that are interested in buying.

This type of website allows you to quickly understand the company and its future prospects. Of course, there are limits to the services that can be provided without payment, but the amount of free information that can be collected over time must not be ignored. The idea is to familiarize yourself with your potential investment options, not necessarily professional knowledge.

You might miss fast-rising companies

One pitfall of investing only in companies you are satisfied with is the opportunity cost of not owning a company that is not yet well-known. Most investors know that ExxonMobil sells gasoline, Johnson & Johnson produces pharmaceuticals (including one of the Covid-19 vaccines developed in 2020 and widely distributed in 2021), and health and beauty products.A valid argument can be made that these companies bring predictability and help reduce the risk of one’s investment portfolio. However, the fact remains that the greatest return on stocks usually comes from Earlier growth phase.

Often, large, well-known companies cannot grow at the same rate they did when they first went public. Therefore, our idea is to understand these companies before they experience the greatest growth, so that their stock prices rise most explosively.

Cisco Systems and Microsoft are the two most recognized technology companies on the planet. Microsoft went public in the 1980s. At that time, not many people had heard of “Windows” or “e-mail”, they are now an important part of the business world. In the early 90s, few people knew what the Internet was, let alone it would eventually be accessed wirelessly. Cisco did it, and understanding the company conceptually and pulling the trigger will get a huge return on investment.

There are also some online sites that can help browse some of the latest companies and potential high-growth stocks. No one should go out and invest only in small, growth companies or recent IPOs, but understanding these companies can make you a more balanced investor.

Don’t just focus on the future

Another creed of investment purists is to attach great importance to fundamental analysis. Indicators such as forward price-to-earnings ratio, book value, price-to-earnings ratio, and free cash flow are just a few of the many data points used to determine whether a stock is worth owning. Most analyses are based on assumptions for at least the next year. Using these indicators, fundamentalists and analysts try to determine the “target” price for the next year.

Rather than trying to figure out the true meaning of all these jargons, look at a picture owned by a company Actually Finish instead of what it is Expected To do it? The chart of the stock will tell you its value when you pull it higher. Many stock technologists, those who pay close attention to stock prices, might agree with the old adage that a picture is really worth a thousand words.

Investors should consider conducting technical analysis of companies that they do not know or do not have the time or desire to learn. Doing some homework and learning basic stock chart trends and terms such as moving averages, breakouts, and candlesticks can open new doors for stock analysis.

Bottom line

Buying what you know is of course relevant and practical investment advice. However, if only Buying what you know brings risks to your investment portfolio: many of the greatest returns will come from companies you have never heard of and don’t know. Investors may wisely invest in companies they can know about, rather than just insisting on what they call “knowing” the verified truth.

Exploring alternative methods, such as learning basic technical analysis and focusing on recent initial public offerings (IPOs), will help broaden investors’ horizons.

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