🔒 “Invest in what you know” may be terrible advice for small investors

By Felicity Duncan

Investors often hear that they should invest in what they know — after all, Warren Buffett adheres to that adage and sticks to his own “circle of competence.” However, what works for Buffett may not work for us.

The issue is that, for most of us, there is a difference between our general understanding of what a business does and a detailed grasp of the risks of investing in that business. Studies show that investors usually think that a business they understand — say, a small, local restaurant chain that they know and like — is a safer investment than one they don’t understand. Unfortunately, they fail to grasp that the restaurant business is volatile, complex, and risky, and that small restaurant chains make for dangerous investments. 
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As amateur investors (and compared to someone like Buffett), our “circles of competence” are essentially dots. Rather than relying on “what we know” about individual stocks, we’re probably better off investing in a diversified portfolio of index-linked products and leaving the stock picking to the Buffetts of this world. 

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