Own What You Know

Although I’m a stockbroker, I don’t think everyone should invest in the stock market. There is no “one size fits all” solution to invest for the future. But I have noticed one thing in common among successful investors: they own what they know.

An entrepreneur owns her business. She works in her business, she understands her business and she has control over her business. If she wants a better return, she can change her strategy, hire different people or increase her offerings. She will have a reasonably good idea of the value of her business and she’ll be willing to sell only for a fair price. Otherwise, she won’t worry about the price people are willing to pay to buy her business, because she’ll be focused on earning a profit.

A stock market investor owns stocks. He knows how to read companies’ financial reports, he knows what common indicators to look for and he knows how to question management. He is comfortable owning a variety of businesses and he probably has a good idea of the value of each. He is unlikely to panic and sell his shares during a crash and unlikely to overpay during a bubble, because he understands each one.

A real estate investor owns real property. Whether she’s a real estate agent or a landlord or a developer, she is familiar with the local market for real estate. She understands what people value and what they don’t, she understands the difficulties of buying, selling and renting and she’s willing to borrow large amounts of money to make a profit in the real estate market. She’ll have clear ideas about the value of her properties, and she will only be willing to make a deal that seems reasonable to her.

A collector has knowledge about certain items. Whether it’s sports cards, coins, stamps, old cars, art or anything else, he understands the rarity and value of certain objects. He also knows who else is in the market and is able to buy and sell profitably.

It is possible to profit by buying, owning and selling a variety of things. People who have little or no knowledge are less likely to profit. People who have no knowledge at all should “invest” in safe vehicles such as GICs, savings accounts and savings bonds. This way, they are guaranteed a return with certainty and don’t risk losing money by making a mistake. Then, little by little, the saver can learn about and start investing in one area. As their knowledge and confidence grow, it makes sense to allocate more and more capital away from savings toward investment.

What do you know about? How does it affect your investing?

9 thoughts on “Own What You Know”

  1. “A stock market investor owns stocks. He knows how to read companies’ financial reports, he knows what common indicators to look for and he knows how to question management.”

    Robert: You seem to be thinking only of active investors. Passive investors just buy the market through indexes. No need to know the companies. Also keeps cost down and helps outperform the majority of active investors.

  2. larry brings up an interesting point in that a true passive investor won’t even trade their index funds as they believe market timing doesn’t work. Hoping that the stock market index provides you an unknown or unquantifiable return is too close to gambling (past history does not guarantee future performance, thus you have the “lost decade”).

    And so I’d advise the true passive investor go with Robert’s statement: “People who have no knowledge at all should “invest” in safe vehicles such as GICs, savings accounts and savings bonds.”

    Myself? I’m an active investor and blend gambling (horse race odds-making) and statistical techniques with the traditional financial techniques for picking stocks and setting trades. In this sideways market environment, I like high yielding companies and trading price swings.

  3. Larry, I don’t believe there is such thing as a passive investor. Those people are actually either saving (more likely) or speculating. Just to make the point: what are you buying when you buy the index? Do passive investors understand how the index is constructed, and how derivatives are used to track its performance? There’s nothing wrong with passive “investing”, but it’s riskier and less certain than owning what you know.

    George, your approach sounds very well-suited to the current economy. How did you develop your strategy?

  4. @Robert – oh my, the answer to how I developed my strategy could easily be book-length! A shorter answer is that I kept my monthly brokerage statements from the ’90s (back when a monkey throwing darts could pick a winning stock), shoved all the data into a spreadsheet, and compared my performance to the indexes.

    What became evident was that when I pay attention to the individual stocks, trading when the time was judged right, my performance was better than if I buy & hold. This put me firmly in the traders camp.

    I also noticed I was trying to budget too tightly, as money was going into the brokerage account and then some would come back out a month later. Relaxing the strings on how big the deposits had to be made for steadier growth.

    In the mid-90s I sought an education on gambling which made me comfortable with the ups & downs of making bets (poker, blackjack, horse racing, etc.). My original reason for getting that education was so I wouldn’t fear the occasional social gambling occasion. Along the way, I found the parallels between paramutual betting and the stock market are uncanny, so applying the principles made sense! A good couple of books that explain paramutual betting are “Commonsense Betting” and “Commonsense Handicapping”.

    Like most folks in the 90’s, I eschewed the dividend payers and solely went for capital gains. If there were dividends, it was a nice bonus. As the Dotcom bubble formed around 2000, I started picking up the dividend payers, particularly for my IRA and Roth IRA where I wasn’t planning on trading. Sep 11, 2001 came and went, causing a very small temporary blip in my progress.

    In 2004, we traded up in homes. For the next 3 years, money was tight, so I didn’t really reenter the market until 2007. I could see the 2008 train wreck coming and screwed up handling only one stock in my portfolio. That one, however, cost me much more than I expected.

    First half of 2009 was spent worrying and fretting over whether we had any recovery, but by July I had confidence. My trading strategy was still working well and I formalized (wrote down) my rules so I wouldn’t stray. I also studied which high yield securities in my portfolio survived through 2008 without cutting dividends (some even increased them!).

    The only things left were trying to figure out how to capitalize on the absurdly low mortgage rates and increasing my cashflow so that a job loss could be survived. It wasn’t until November that I discovered switching to a 10/1 ARM from a fixed 15-year mortgage was a worthwhile endeavor and taking cash out to increase liquidity would satisfy both goals.

    About 40% of my takehome pay is now deposited in my brokerage account and the total there would meet 2 years of expenses if I lost my job tomorrow. Prior to the start of the year, only 20% of takehome pay was being deposited and there was only 6 months of living expenses available.

  5. George – any good sources of information on horse betting you could provide? I enjoy it and do okay at it, but would like to know more.

    I’m interested where you got your education on gambling?

  6. @Dave – Try “Commonsense Betting” and “Commonsense Handicapping”.

    A sizeable chunk of the education from the father of a gal I was dating. Then more came through reading various books and trying out the games at home, with occasional trips to the casinos.

  7. I agree that you should know what you own, and have a decent understanding of it. But if you do not understand something the answer may not be to not buy it, but to educate yourself about it. Understanding how a GIC works, and how the banks are really using the funds behind the scenes is just as complex as understanding an index fund and how it works.
    Unless you have a good pension (something else most people do not truely understand the details of how it works)you need to invest in something to retire in comfort. If the only thing you know about is beenie babies, I would not recomend trying to save for retirement investing in them.

  8. Atlas, you raise some good points. I will have to trust you that the inner workings of a GIC or a pension are complex. But it doesn’t matter, since they carry (reliable) guarantees. I fully agree that (self-)education is better than avoidance. And I believe that many people learn by doing. The more I buy and sell stocks, the better I understand how it works. But I didn’t jump into all stocks all at once, either. Finally, allow me to suggest that someone who truly understands beenie babies already knows whether or not they will grow in value.

    Off topic, what is the average return of stocks?

  9. @Robert. I think the best thing to do is work with someone who actually takes the time to explain things to you. Trust does become an issue, because if you do not know about something it is hard to know if what you are being told is true, and unforturnetly the investment industry has not acted in a way to warrent trust.

    About the question about what the average return of stocks is. Which marekt over which time period?
    Here is a link to a chart that shows the returns of various investments since 1950 along with many other things, that I find a handy reference.

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