Wednesday, May 14, 2008

Stick to what you know

One thing alot of people do in life,especially when they get bored, are particularly ambitious(or turn 40!) is to go outside one's comfort zone to challenge their personal or professional skills, this can be quite rewarding in many ways, a sense of achievement comes from trying new things and the risk of failure can often be forgotten in the heat of excitement.

While this approach to life in general is much to be admired, this sort of approach to investing is probably one of the easiest ways to lose your hard earned bucks.

When deciding to buy a business or part of a business, as stocks are, one of the most important aspects you must consider is if you understand what it is the company does and how it does it.

Look for either a good business that you yourself may have industry experience in or is simple enough to understand with a minimum of interpretation of company reports.

Food companies, retailing, steel making and strong brands like, Coca Cola and McDonald's are easily understood even by the most green of investors.

This basic investment tenant can also be applied to the management of any business or enterprise. Watch closely at management of any company who also want to go out of their comfort zone or level of experience and therefore competence.

A successful toilet paper company that suddenly decides to use their excellent profits to expand into the new car business is one that you don't want to invest in and if you are already invested you should roll yourself right out of there.

Coca Cola tried to mess with the formula to their main product in 1985, they didn't need to, they were still number one, but the CEO decided to go outside his level of expertise and change their simple successful 100 year old product. It would have meant the end of the company had the decision to recall the old formula not been made.

The formula of sticking to what you know clearly goes across all asset classes as well.

Be it bonds, of either the Sub-prime or "prime" variety, stocks, real estate, gold, oil, pork bellies or carbon trading, you must stick to what you know first. If you want to get into something you don't know, either you don't, or you do your homework and become as competent as you can.

It is very easy to look at glowing company reports, prospectus' or advisor recommendations of companies but when those businesses are more complex than a real estate agent's patter on explaining why the view in the advertising looks nothing like the view from the house itself, don't go along with the hype.

K.I.S.S. keep it simple stupid!

Who in their right mind would get into a company like Blue Chip New Zealand, their company was structured like a pyramid within a maze, but people looked past the complexity and "invested" anyway.

While of course good management, good company history and growing revenue and profit are also essential ingredients in the investing cake, removing complexity from the mix is going to make one's decision a more profitable one in the long run.

Understanding a business or investment is a really good start along the road of success and the new challenges will lie in continuing to keep the business/investment simple. Keep the challenges for the weekend and bungee jumping in Queenstown.

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