“Why not invest your assets in the companies you really like? As Mae West said, ‘Too much of a good thing can be wonderful.'”
— Warren Buffett
Warren Buffett is considered one of the best investors that the modern world has ever known. He started out as a financial analyst in the 50s when he was younger and has now accumulated a fortune worth more than $68 billion. When people ask for investing advice from Buffett, he typically suggests that investors buy stock in businesses that they know and understand. This is a key principle to Buffett’s own investing strategy.
Buffett only buys stock in what he knows and understands, which is why the Berkshire Hathaway portfolio is very low in tech and it doesn’t have any Internet companies or biotech companies as well. As part of his stock holdings, the companies all have familiar names that you will recognize, and include businesses like IBM, Coca-Cola, Wells Fargo and American Express. His private companies are also quite traditional and include Fruit of the Loom, Heinz and GEICO among others.
This might not seem like the most exciting way to invest in the stock market, but as you can tell from the wealth that Warren Buffett has accumulated, it definitely does work. In the last five years, shares of Berkshire Hathaway have more than doubled in price. This is a reflection of Berkshire Hathaway’s strength and the businesses that they have purchased, including Dairy Queen, Benjamin Moore, See’s Candies and Burlington Northern Santa Fe railroad among others.
Buffett pays much more attention to long-term holdings, and he is most famous for being resistant to investing in “the next big thing.” During the late 1990s, Buffett completely avoided the technology stocks that were booming because he did not have any experience or knowledge about those industries. His overall attraction is to slow growth companies, old technology stocks and businesses that he is willing to invest in for the long term that will withstand even the worst economic downturns.
Why It Makes Sense to Invest in What You Understand
For most people, it’s a lot easier to understand a product or business that we encounter at some point on a regular day-to-day basis. Investing in the things that you know makes it easier to place value on a stock and understand industry trends and stay informed about a company. If you have no idea what the company does or how it earns its money, it will be very difficult for you to properly manage the investment.
Buffett often talks about the “circle of competence” concept, which is the smart way for investors to begin focusing on areas that they know and understand the best. It’s the reason why Buffett himself does not invest in technology and biotech stocks because he’s really unfamiliar with these industries, they change much too frequently and have very short or nonexistent track records. By staying inside of his circle of competence, Buffett does not need to worry about buying on speculation.
We all have areas of expertise in our lives, whether we live them or have learned them through our education. We need to use this knowledge in order to improve our investing. Nobody expects you to understand each and every company in every industry, but you must have the ability to evaluate companies within your particular circle of competence.
As an example, an investor that spent 10 years working in a garment factory would have a real advantage when analyzing strengths in the clothing manufacturing business.
Stick to your circle of competence, invest for the long-term and improve your chances at investing success.