Only Invest in What You Know

The Ripoff Alert is a new series appearing once each week on Fridays. It alerts you to the latest scams and ripoffs trying to get between you and your money, and gives you information you need to stay safe. This is #20 in the series. 

Investing is a topic that makes many of us squirm. It can be incredibly simple or mind-numbingly complex. What gets us in trouble so often is that we try to invest in something we don’t understand.

Warren Buffet, the billionaire investor, is famous for his practice of investing only within his “circle of competence”. To us common folk that means we should only invest in what we know.

During the big run up of tech stocks in the late ’90s, Buffet sat out of the game because technology wasn’t an area he was familiar with. Instead, he continued his tradition of buying undervalued stocks. As others were picking up the pieces after the bubble burst, Buffet maintained his strategy and limited his losses.

Think about the various types of investments available to us. Stock options, derivatives, commodities, exchange traded funds and so on. The reality is, these investments are very complex and aren’t suitable for most people.

Investment opportunities presented to us by friends, family, neighbors or people at church can likewise be difficult to understand. For every big Ponzi scheme reported in the news there are a hundred smaller ones that don’t make headlines. I’m not saying your pastor is going to approach you about earning 2% per day on your money, but the people who run these scams rely on trust and familiarity you may have with them. They know your guard is down.

Before doing any type of investing, understand how the company operates, how they earn money and who their main competitors are. Take a look at their financial statements. Is the business growing or is the customer base shrinking? What are the risks and opportunities in the industry? This knowledge helps you make an informed decision about whether you should invest.

Investment scams have been around since we started using money to pay for things. But never before have we seen the range and complexity of investment scams that exist today. The recession and the resulting loss of individual wealth have created a perfect opportunity for scam artists to craft false promises of oversized returns on your money. Because of their complexity, the new scams are more difficult to detect.

Remember Warren Buffet’s simple rule, and know that there are no shortcuts to building wealth. It comes little by little over many years and decades. The best way to avoid these scams is to do your research and stick with investments you understand.

4 thoughts on “Only Invest in What You Know

  1. Pingback: Friends of the Family: Busy Week Edition - The Family Finances

  2. This used to be called the Peter Lynch way of investing (he was the star fund manager of Fidelity Magellan in the 1980’s). Kick the tires, understand the product. I loved investing in PCAR, as they make big trucks, for use all over the world. Even toddlers understand the lure of bug trucks…

  3. Pingback: Mr.CBB’s Weekly Blog Post Picks September 28,2012 « Canadian Budget Binder

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