Invest In What You Know

Warren Buffett famously shies away from investing in technology companies like Twitter and Facebook.

His company owns shares in Apple but Apple isn’t your typical technology company like Twitter or Facebook that haven’t been around long enough to establish their long-term prospects or staying power.

Apple has been around since the late ’70s and has more in common with a consumer goods company like Tesla and Ford than it does with Silicon Valley tech companies.

“Never invest in a business you cannot understand.” – Warren Buffett  

Warren Buffett doesn’t invest in technology because it’s a sector that would take too much of his energy in order to understand.

Why is this important?

Because Warren Buffett doesn’t speculate. He seeks out established companies with intrinsic value that pay dividends. 

He’s more interested in long-term value and returns than trying to hit home runs by buying low and selling high. He would rather win by consistently getting on base than hitting the occasional home run but losing.

With tech companies, he believes it’s difficult to reliably pick winners. He knows how to evaluate businesses he understands. Tech companies are too unpredictable to reliably predict future performance.

For investors considering investing in the private markets to avoid Wall Street volatility, it pays to take a page out of the Warren Buffett playbook by investing in what you know.  

Why invest in what you know?

The most important factor pushing investors to private markets is the allure of above-market cash flow insulated from Wall Street volatility. And since cash flow and returns are vital in evaluating an opportunity in private markets, understanding the financial engine behind these opportunities is vital to separate the winners from losers.

Also, because private investments are largely illiquid, getting it right up front is more vital than when investing in public equities because a private investment can lock up capital for a minimum of five years plus. That is why investing in what you know is so important.

It’s easier to evaluate opportunities and predict future success in industries you understand than in ones that you don’t.

One of the biggest mistakes investors who are new to private markets make is getting involved in overly complex businesses or industries.

Not only will it be harder for you as an investor to evaluate financial projections in something you know nothing about, but you will have no idea whether the promoters of an opportunity know what they’re talking about or whether they’re trying to sell you a pie in the sky.

Here’s why investing in what you know is to your advantage:

  • By investing in something you know, you are in an ideal position to analyze deals. Whether you’ve worked in agriculture, lending, a particular segment of manufacturing, or whatever other market segments you’ve gained particular knowledge or expertise in, having the knowledge allows you to understand and evaluate business plans and financial projections better in a familiar market than in an unfamiliar one.
  • Investing in something you know allows you to understand the language of the promoters of an opportunity. This allows you to align your investment goals and objectives with those of the company’s.
  • Having a specific understanding of a particular market or industry allows you to assess risk better than investing in something you know nothing about.
  • Familiarity also allows you to gauge the business cycles of particular industries to establish realistic financial and operational expectations.
  • Knowledge also allows you to assess the competitive landscape associated with the company you’ve targeted for investment and the viability of the company’s business plan.

Investing in what you know is an essential rule to live by when investing in the private markets because your capital will be tied up for years and not days like in the public markets.

That’s why it’s important to get it right upfront and the more you’re familiar with a particular market or industry, the greater the likelihood of separating the winners from the losers through the information advantages you hold from familiarity.

Before even taking the plunge in the private markets, take a personal inventory:

  • What’s your educational and professional background?
  • In what industries or markets have you gained intimate knowledge of personal or professional exposure?
  • What are you passionate about?
  • What do you find yourself reading about on a regular basis?
  • What do you use?

Why invest in businesses you don’t understand?

Why not invest in what you know in markets and industries in which you have a reasonably strong grasp to maximize your chances of success and minimize your risks?