"Buy what you know", the famous phrase coined by Peter Lynch is a well used quotee but what does it really entail and how can it make you a better investor?
In simplistic terms, buying what you know takes advantage of your familiarity with a product or market and translates that knowledge into potential earnings.
Think of it this way; good investors understand opportunity and risk. They weigh the opportunity against the risk in order to determine the value of a potential investment. Without knowledge of the industry you don't have a method of ascertaining the reliability of information, ratios or reports associated with any company or stock. Warren Buffet calls it the "circle of competence" but more often than not, the "circle of incompetence" may better describe the majority of lay investors.
Use these quick steps to identify potential sectors that would allow you to buy what you know:
- Jot down areas of expertise and interest. This might consist of formal education and training or simply a hobby.
- Narrow your list by selecting those items you enjoy learning more about. Buying what you know also requires diligent research to stay abreast of changing markets.
- Research the industry.
- Research individual stocks.
- Try before you actually buy. If you are new to investing then spend time learning the ropes by setting up a virtual portfolio at wallstreetsurvivor.com. It's a risk free way to test your skill and knowledge.