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Question:


I’ve been told to never invest in what you don’t understand. Agree?
-JimW


Answer:


This, or some variation of it, is the mantra of some very successful investors, including Peter Lynch, who built up a lot of wealth for a lot of people as manager of the Fidelity Magellan Fund, and Warren Buffett, the brains behind Berkshire Hathaway. If you don’t understand what you’re investing in, then you’ll be depending on others to whom you entrust your assets to do the understanding for you. Some of them do – you could have increased the value of your portfolio many times over by investing in Magellan or Berkshire – but many others do not.

The knowledge gap and the damage it causes can be exacerbated by a tendency toward groupthink on Wall Street that leads money managers to crowd into or out of particular investments at the same time – which often turns out to be the wrong time – and to attract others who are ignorant and only following the money. That is especially likely to occur when next big things come along, like Internet stocks in the late 1990s. Professionals who were supposed to know better bid them up to unprecedented valuations and cost many people a fortune because they invested in what they didn’t understand, and neither did those who thought the smart money was smarter than it really was.
-Conrad de Aenlle



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