1) You Tend To Be More Competent In Things You Understand
- There are things you know and there are things you think you know
- There are things we understand and there are things that somehow always seemed so Greek to us
- One thing for sure is that we can only be competent in things that we understand
By buying stocks of business’s we do not understand, it would come under the category of speculation. And in speculating in stocks, there is the tendency of human behaviour to try to “time the market” and “focusing on the price of the stock instead of the price of the business” and make a profit out of it– they are the traders– and most traders lose money.
We need to only put our hard earned money on things we understand– because we tend to be more competent at it.
2) You Will Be Able To Make Better Decision
In reason 1 above, I am assuming that we are more competent in things that we understand. And by focusing on things that we are more competent in, I assume that we are able to make a better investing decision on what and when to buy or sell our stocks.
It is almost impossible to time the market but we can forecast to a higher degree– assuming that we understand the underlying business behind the stock and are competent in how their business operates– on how the business’ earnings are going to be years down the road.
For example, if let’s say you understand the business that Coca-Cola is in and are competent in understanding their business model, you would be able to judge whether we can safely assume that people will still drink Coca-Cola 5-10 years from now and therefore, if their earnings will be stable– due to the nature of their business?
If the answer is yes to the above question, do you have a clear concept of the differences between Coca-Cola market price and its underlying value?
The point is this– if you understand the Coca-Cola business, you will be more competent in evaluating the stock and therefore able to make a more competent investing decision in relation to the buying or selling of the stock.
3) You Will Be Able To Look Back On Why You Bought It In The First Place
I have always wondered that people can spend so much time doing their homework before deciding what bags or shoes to buy but the exact same people might not do their homework in buying stocks. They understand which bags are in trend and therefore they buy it. They do not understand which stock is undervalued but they still invest in it.
If you do not understand the underlying business behind the stock in the first place, even if you lose or win money, you would not be able to learn anything because you do not know what specific action and mindset you used to make the decision in the first place.
On the contrary, if you know why you bought the stocks, you would be able to look back and evaluate in hindsight, if the thought process and strategy you used are correct or wrong.
From there, if you were wrong, you can learn your lesson by taking corrective action and deciding to never repeat the same mistake again. If you were right, you would know what investing philosophy is suited for your character and that is great!
Benjamin Graham, the father of value investing said that sound investment principles produced generally sound investment results.
The question is what is sound investment principles? How do you have a sound investment principles?
The answer is pretty simple– you just have to understand who you are as an individual and what investing philosophy suits you. And as long as you stick to doing things you understand and therefore are more competent in, you tend to make better investing decision– and you will do just fine.
Sources: Graham, B. (2005). The intelligent investor: The classic text on value investing. New York: HarperBusiness.
Disclaimer: The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.
Important: Please read my full disclaimer.
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CHRIS LEE SUSANTO
Hi, my name is Chris and I am the founder of Re-ThinkWealth. A blog that focuses on personal finance self-improvement, investments, and investor psychology.
Since early 2015, I manage money for my family and invests it in Singapore and United States equities and options achieving above market return.
I use Value Investing and Options Selling strategies used by Warren Buffett (World’s richest investor) coupled with the core theory of inversion. Inversion meaning that in every investing idea, we have to scrutinise on why it would fail.
This will result in us being more conservative, and being conservative is the key to protecting and growing wealth in the long run.
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