"Invest only in what you know."
POSTED ON January 30, 2020
This popular belief says people should invest only in what they know or are familiar with. It is based on the fact that you need full knowledge and understanding of an investment tool before you consider it, but it does not allow room for learning new things.
For people who have already tried investing, it is tempting to stick to what they already know or have tried. This is especially true if the experience was a positive one.
But when you invest only in familiar products, your risk is higher. This is because you end up with an undiversified portfolio, which can be severely affected by just one industry-specific crisis. Of course, this is something that you should avoid.
Why do people believe it?
Trying something new can be scary, especially when it comes to investing money (given that there is a certain amount of risk in any type of investment). Choosing something familiar is much easier to do.
Another consideration is the amount of time and effort you put in when learning about a new investment product. However, it is necessary before deciding if it is an option for your portfolio.
Risks of believing this myth
If you invest only in what you know, there is more chance that you may run into investing trouble as opposed to when your portfolio is diversified. This is because of diversifiable (also known as unsystematic) risk, which affects certain industries strongly while having negligible or no impact on others.
For example, a portfolio that only had power company stocks would be hit harder than one that also had government bonds, in case the power industry suddenly encountered a crisis.
While familiarity with an investment product is good, you should still try to learn about other types to see if they fit your goals, budget and risk appetite. This will help you achieve a diversified portfolio, which is a good way to minimize diversifiable/unsystematic risk.