How to invest in what you know

By Abi Tyas Tunggal 02 October 2019 3 min read

Key points:

  • Leverage your own knowledge to gain investment ideas.
  • Take some tips from Peter Lynch's Magellan fund.
  • You have plenty of time to make decisions!

We live in a world full of information and distraction.

Doing the work required to uncover a great stock can be pretty hard. You could spend thousands of hours trawling through newspapers, YouTube videos, discussion boards and everything in between.

And while you’re likely to find someone saying every stock is a buy, it just can’t be true.

Everyone is searching for the next Amazon or Google but very few people find them. And the introduction of the Internet and distractions like Facebook or YouTube hasn’t made it any easier.

How can we sort the signal from the noise, if we can’t even stay off Facebook for five minutes?

Peter Lynch, an investor who managed the Magellan Fund at Fidelity, which returned an average of 29.2% annual return from 1977 to 1990, suggests that you should “invest in what you know.”

The idea is you use your knowledge to see opportunities the average person would miss. Then you study them to decide if they’re worth owning. So, instead of combing through newspapers and discussion boards, you use what you already know as a base.

Think about it like this, if you work at Coca Cola, you probably know the companies that are becoming competition. So why not look to see if those are good investments, rather than trying to comb the entire investable universe.

Magellan Fund

While we might not hear much about Lynch since his retirement in 1990, the Magellan Fund remains one of the most famous actively managed funds. The fund was so popular, Lynch saw the assets under management balloon from $US18 million to $US14 billion during his tenure.

The Magellan Fund managed to beat the S&P 500 Index 11 out of the 13 years Lynch was at the helm, with an average annual return of 29.2%.

This was the best 20-year return rate of any mutual fund ever. Lynch mentioned in "Beating the Street" how good the market was in the early 80s.

“The stock market fell apart. As is so often the case, just when people began to feel it was safe to return to stocks, stocks suffered a correction. But Magellan managed to post a 16.5% gain for the year in spite of it.”

Lynch’s Investment Ethos

Lynch has written three books about his investment ethos, “One Up On Wall Street,” “Beating The Street” and “Learn To Earn.” The general tenets are:

  • Know what you own.
  • It’s futile to predict the economy and interest rates.
  • You have plenty of time to identify and recognise exceptional companies.
  • Avoid long shots.
  • Good management is very important — buy good businesses.
  • Be flexible, humble and learn from your mistakes.
  • Before you make a purchase, you should be able to explain why you are buying.
  • There’s always something to worry about

A lot of these remind me of the maxims of Warren Buffett and Charlie Munger (Berkshire Hathaway):

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” — Warren Buffett on buying good businesses

“There are huge advantages for an individual to get into a position where you make a few great investments and just sit back, you’re paying less to brokers, you’re listening to less nonsense.” — Charlie Munger on taking the time to recognise exceptional companies

“Stick within your circle of competence.” — Warren Buffett on investing in what you know.

Ending thoughts

We aren’t Buffett, Munger or Lynch. But investing in what we know seems to be a good start.

Remember, getting the best return isn't the only goal of an investment portfolio, it's also about getting the best return for the lowest amount of risk.

It’s just as important to not pick losers, as it is to pick winners. If you can build a portfolio that has a few winners and the rest up is made up of non-losers, it’s likely you’ll be happy with your returns.

As Howard Marks wrote in “The Most Important Thing,” “Most investors’ results will be determined more by how many losers they have, and how bad they are, than by the greatness of their winners.”

By investing in what you know, you’ll have an idea of what a winner and a loser looks like. Then you can dive deeper and decide if it’s a business that you would want to own. After all, a lot of investing is just a proxy for buying part ownership in a company.

How to invest in what you know