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.