Based on Fisher Investments UK’s reviews of financial commentary, a common investing rule of thumb is to buy what you know. Whilst this may seem sensible, we think there are issues with this stemming from overconfidence – a common investing pitfall to beware. Focussing solely on companies you have great familiarity with can impede diversification, limit your opportunity set and inadvertently increase risk.
According to Fisher Investments UK’s reviews of conventional interpretations of buy what you know – popularised by well-known, former US fund manager Peter Lynch – investors should buy equity in companies they are familiar with so they can set expectations accordingly.[i] Now, we think there is wisdom to this. At a fundamental level, investors benefit from understanding what they are buying. For example, if you purchase common equity in a multinational pharmaceutical maker, your slice of ownership entitles you to a share of that company’s future earnings (which will depend on the company’s prospects as well as industry-level trends and the broader economic environment). Understanding the company’s products and financials can be beneficial. Likewise, if someone is selling you an investment product, it behooves you to understand what you are actually buying – not just the product pitch.
But in Fisher Investments UK’s experience, some take this thinking too far. Consider a worker whose compensation includes the option to buy employer equity – a more common practice in the United States (especially amongst startup technology firms), though it is gaining traction in Europe.[ii] An employee may choose to hold those shares or build a very large position on the belief they are familiar with their company’s prospects, leadership and strategy – making them quite qualified to assess their company’s risk.
Similarly, someone’s professional experience may influence how they view their broader industry, believing their experience provides an edge. A customer may even think they have special insight about a company based on personal experience (e.g., their favourite store is frequently crowded with people, so business must be healthy). Relatedly, this type of thinking could also discourage investors from pursuing opportunities – e.g., avoiding certain industries or companies because of the lack of intimate familiarity.
We think that familiarity can build bias and overconfidence – damaging in investing. Regardless of experience, we have found it risky for investors to load up solely on assets they are familiar with. The reason is due to another investing reality, in our experience: you could always be wrong. Based on Fisher Investments UK’s reviews of market history, no forecaster or investor has reliably and repeatedly forecasted what a given equity will do. This is because predicting the future is impossible – too many variables can change, leading to unforeseen outcomes.
For instance, what if a high-performing company’s chief executive officer unexpectedly retires early, and the successor doesn’t possess the same skill or vision? That uncertainty and weaker leadership could undermine the company’s advantages, dampening future profitability. Or, what if the company is sound, but the industry undergoes major transformation? For example, the rise of digital media and technology transformed how readers consume their news, hitting traditional print media hard.[iii] A macro-level development can sink a company’s prospects, too. The COVID-19 pandemic hammered the travel industry, disproportionately roiling companies in tourism-dependent economies.[iv]
Restricting yourself to companies you are familiar with may also mean sticking with business approaches that are slow to adapt to a dynamic economic environment. It may also lead to omitting a whole sector or industry with bright prospects simply because of your own lack of deep knowledge or familiarity. What if a new company challenges the status quo by taking a risk (e.g., by marketing to an overlooked demographic or utilising technology in an innovative manner to improve productivity)? Avoiding the upstart could end up being a big missed opportunity.
In Fisher Investments UK’s experience, a remedy to the overconfidence of buying what you know is to diversify. Diversification is an effective way to practise humility in investing, though diversifying doesn’t mean owning every type of asset available. The right mix will depend on your personal investment goals, objectives, time horizon and risk tolerance. Generally speaking, we think diversifying means your portfolio has broad sector and geographic exposure, with no single position having an outsized weighting. This spreads investment risk, mitigating the risk a single equity, geography or industry upends your portfolio. Moreover, diversification widens your opportunity set, i.e., expands the amount of companies available for you to own and reap profits from. The comfort of buying what you know is understandable, but applying that rule of thumb can limit your portfolio’s ability to grow and provide for your future needs.
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This document constitutes the general views of Fisher Investments UK and should not be regarded as personalised investment or tax advice or a reflection of client performance. No assurances are made that Fisher Investments UK will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Nothing herein is intended to be a recommendation or forecast of market conditions. Rather, it is intended to illustrate a point. Current and future markets may differ significantly from those illustrated here. In addition, no assurances are made regarding the accuracy of any assumptions made in any illustrations herein. Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom. Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
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[i] “Fidelity Legend Peter Lynch: ‘I Never Said to Invest in the Stock Market,’” Kerry Hannon, Yahoo! Finance, 20/6/2023.
[ii] “Seven European Countries Match US in Startup-Friendly Laws, Report Says,” Staff, Reuters, 27/10/2024. Accessed via Investing.com
[iii] “Service Annual Survey Shows Continuing Decline in Print Publishing Revenue,” Adam Grundy, US Census Bureau, 7/6/2022.
[iv] “Tourism-Dependent Economies Are Among Those Harmed the Most by the Pandemic,” Adam Behsudi, International Monetary Fund, December 2020.