Buying What You Know

by Mr. Cheap

In my recent review of “Rule #1″ I talked a bit about people taking Buffett quotes and twisting them. A while ago during a conversation about “Rich Dad, Poor Dad” a similar idea came up that people can use aphorisms to mean whatever they want. One Peter Lynch quote that I think gets bent beyond recognition is “invest in what you know“.

Years ago I was working in San Francisco at the tail end of the dot-com boom (I think I may have caused the bust after I arrived). RIGHT at the height I got into buying tech stocks with a NY stock broker (JDS Uniphase and all the usual suspects). I liked to talk to people and say it was ok for me to be buying tech stocks since I worked in the field and had a deeper understanding of the technology than the man on the street (I was investing in what I knew, dontcha know!). This didn’t stop me from losing 75% when the bubble burst (and forced me to realize that I was just being greedy chasing the trend like everyone else).

During the boom, I was talking to one man who called me on my foolishness. He looked me in the eye and said “You may have a computer science degree and be working at a startup, but that has nothing to do with tech stocks. You don’t understand global demand for the various technologies being developed, you don’t understand the financing behind the companies, you don’t understand the coming economic cycles, etc, etc”. I was a bit annoyed at the time (who likes being called on their foolishness?), but if I’d listened to him and got out I could have avoided a pretty good shearing.

A psychologist I know gets a newsletter about pharmaceutical and biotech stocks and buys based on information from it because “it was his field, so he had a deeper understanding of it.” He isn’t someone who’d be particularly responsive to warnings so I just nodded and smiled.

My brother wanted to buy Lululemon’s IPO because his girlfriend shopped there and he saw so many new stores opening up. He quoted Lynch’s idea that he was seeing a trend before it hit Wall Street. I cautioned him that he wasn’t the only one who saw all the expensive yoga-wear being sold and that IPOs were notoriously volatile. Tim Horton‘s IPO got quite a bit of attention, mostly because people like their coffee I think.

In “Your Money and Your Brain” Jason Zweig talks about how investors, including professionals, tend to over-buy geographically nearby companies. I think its possible if you’re a domain expert or if you have extensive experience with a local company that you might be able to shave a small amount of time off of you company research (if that’s your investing strategy). However, I suspect just buying things just because they’re familiar is a very dangerous practice.

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