"Investing In What You Know", Volatility, and Conviction
Everyone has heard of Peter Lynch's "invest in what you know" mantra. Applying this principle in a vacuum (excluding many other important variables) can be dangerous, but it can also function as a useful heuristic. Of course, there are unlimited nuances to successful investing, but the mantra logically makes sense, which is on reason it has held such staying power.

Throughout my personal investing journey (~3.5 years now), the principle has guided much of my decision-making. I have mostly invested in companies whose products or services I interact with or where I clearly understand the customer value proposition. However, this is not the case for every investment.

Observing the evolution of my portfolio since inception, it's clear one key factor determines the longevity of a position (which is a key factor in overall returns): how well do I know the business? Companies I don't truly understand have tended to be short-term losers: I would react emotionally to a drawdown and panic sell, thinking of all the variables of which I could be unaware. Companies I understand well, however, have tended to be long-term winners. One of the reasons behind this? An ability to withstand volatility.

Perhaps the most difficult aspect of being a long-term investor is dealing with drawdowns. The trick is to understand the source of the drawdown. If you are unfamiliar with the business, however, this is likely an impossibility. How do you determine the reason for a change in public opinion if you don't understand fundamental changes within the business? If there are no major changes, how do you have the conviction to hold when the market is saying, "you're wrong"? The answer is you have to understand what you own.

To understand what you own, you have to invest in what you know. Investing in what you know fuels conviction, a necessary ingredient to deal with volatility successfully. Conviction is often the difference between acting rationally and acting emotionally during a drawdown.

Limiting my investments to those businesses I understand well has improved the quality of my investing activity, as well as my state of mind.

This is an observation I've made from my own experiences, which may or may not hold true for others. Please share your own experiences in the comments, especially if you disagree!
The Hippie Investor's avatar
I agree wholeheartedly. The one caveat I would add though is sometimes you can know a company really well and still sell it bc you know it well enough to know when to sell. Either it gets way overpriced or you see something in the business has gone wrong, hopefully you notice before the market does but sometimes it could be worth cutting the cord anyway if something doesn’t sit right in an earnings call or financial report or business changing news. Unless you’re the CEO, there’s no way to know everything about a company. Getting too comfortable with owning a stock can blindside you.
Invested Thought's avatar
@the_hippie_investor well said! Great point to add
Joey Hirendernath's avatar
Your post mirrored my thoughts exactly. I tend to stick with businesses that fall within my circle of competence. I find that when I understand the company I have the conviction to hold during challenging times even when the narrative is bleak but my thesis is still intact.
Rihard Jarc's avatar
100% true. You need to understand the company very well so you have conviction, without it you will lose money most of the time. I also like to focus more on my current positions in a bear market than look for new ones.
Invested Thought's avatar
@rihardjarc Without having much experience in bear markets, I think monitoring current positions vs. searching for new ones is a constant balancing act. Logically, it seems looking for new positions in a bear market could be advantageous due to relatively lower valuations. But, at the same time, monitoring the existing portfolio is vital to preserve conviction and prevent impulsive actions.
Rihard Jarc's avatar
@investedthought I think everyone should have a "target list" of business that they find interesting and set some valuation levels where they find them interesting.
Joshua Simka's avatar
I don't disagree and love Lynch's general sentiment but would ADD, as a person who loves learning and the excitement of a bit of additional risk, that I think it can be enriching on multiple levels for investors to take baby steps outside their circle of competence--as long as they have interest in learning and keeping up with the investments--with small buys here and there of companies that seem particularly intriguing.
Invested Thought's avatar
@tomato thanks for sharing. I agree there’s nothing like “skin in the game.” I think allocation / position sizing is key though. Don’t want to over-allocate to this area and risk significantly harming the portfolios returns. And don’t want one individual position to dominate the portion of the portfolio.

I allocate a bit of my portfolio to more “VC-like” investments where it may lie somewhat outside my circle of competence but will almost never sell.

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