Buy What You Know: An Update on a Classic Investing Strategy

Let’s flash back to 1989. The Simpsons became our favorite primetime family, handheld gaming took off with the launch of Nintendo’s Game Boy, and the World Wide Web was born. It was also the year that one of the most important investing books was published by legendary Fidelity Magellan fund manager Peter Lynch, One Up on Wall Street: How to Use What You Already Know to Make Money in the Market. One of his strongest pieces of advice from the book was to buy what you know.

There has been a good debate recently in the media about the validity of this mantra to today’s investors. Put simply: Should an individual use their own local or personal knowledge of companies and products to influence how they might invest their money? The depth and breadth of information available to the individual investor in the 1970s and 80s (while Lynch was managing his fund at Fidelity) looked nothing like it does today. Does this strategy still have a place today in your own investment portfolio? Let’s take a look.

Back then, where you lived, worked or went to school played a big role in the information you had access to that maybe others didn’t. I attended a private high school in the mid 1980s and remember distinctly the opening of our new computer lab. About a dozen boxes with small black and white screens stood on the tables. They were Apple Macintosh computers, and the students clamored to use them. The interfaces were like nothing we had ever seen before, and we patiently waited for them to boot up while stuffing in floppy disks of Microsoft Word to write our term papers. Apple and Microsoft were not yet household names, but somehow I knew this would be a game changer. Some people who also experienced those magic moments became early investors and the rest is history.

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A Trend Versus a Sound Investment Idea

Having a magical experience or gut feeling doesn’t always produce a positive outcome on Wall Street. There are legendary tales of fads that have left many a destroyed company in their wake. This is why, after you discover that good idea, you should not just invest blindly, but begin to research the company. Follow the stock for a few weeks or even longer. Read the company press releases, visit its website, and follow its posts on social media. Take advantage of the breadth of information that was once only available to Wall Street. Then determine if that company deserves a place in your portfolio.

Today’s ubiquitous access to information has also greatly changed the game of knowing something before someone else does because of where you live or work. Anyone can see the lines at a popular barbecue joint or hamburger stand via webcams, read blog posts or check reviews on social media to get a real understanding if a business is popular, or listen to any of a dozen podcasts about “the next big thing”. Just having a crowded store or a large queue for dining isn’t the sole reason to put some of your investment dollars behind that company. And with today’s multinational companies, a local trend may not be reflected in their overall performance. Your advantage as a small investor with regional knowledge of a company has basically disappeared.

Fundamentally there is also too much risk in putting a significant share of your assets in only one or more companies. If you work for a company remember it pays your salary, and perhaps contributes to your retirement account. Why would you also want to own additional shares outside that? A single negative event for that company would affect your livelihood in too many ways.

The best way to avoid trends and limit your exposure to one company or region is to consider owning broader market mutual funds or ETFs. Look into the core holdings of some of these funds and you may discover they own a few of the companies you follow or feel like you want to own. Research their managers or investment philosophy before committing your dollars. The real advantage to the small investor now is through this diversification of your portfolio. You will also be exposed to the trends or regions that are far beyond your local knowledge or personal experiences and that just might allow you to participate in something magical.

Kevin Kaplan is a partner at Silicon Hills Wealth Management (opens in new tab) in Austin, Texas. He is passionate about photography, travel, pizza and live music.