A few months ago, a friend of mine, who had never invested before, told me that he wanted to take all his savings, buy a lot of Facebook (NASDAQ:FB) shares during the IPO, and sell before the market closed. His only reason for telling me was to ask what online broker I used, knowing that I'd been investing for some time. On hearing his strategy, I immediately told him to pump the brakes and I explained to him why I thought it was a very risky move, and not worth taking.
Over the course of the next few days, we started texting each other back and forth, with me explaining why he should follow a strategy of dividend growth investing. With the small sum of money he had, I said that he should invest in some blue chips like Wal-Mart (NYSE:WMT) or Chevron (NYSE:CVX).
After all my careful teaching (I even typed up a page of some of my lessons learned and just good overall practices), here's the exchange we had the next afternoon, verbatim:
Friend: I rearranged my portfolio this morning to buy dow when it was low and then also bought jbl and trh because they have been down recently but are growing overall, also their dividends are coming up which will be. Jbl might have been silly but tnh looks like a good move.
May 10, 12:24 PM
Me: Jabil circuit? Terra nitrogen company? Do you know anything about these companies?
May 10, 1:44 PM
Friend: Yup, did research on both this morning.
May 10, 2:00 PM
After reading that, I said some more stuff, using some inappropriate words. I had never heard of these companies until he dropped the stock symbols on me. My friend hadn't either. Neither of us was too knowledgeable about what kinds of electronics Jabil Circuits (NYSE:JBL) dealt with or how the outlook for nitrogen fertilizer would affect Terra Nitrogen Company (NYSE:TNH). Were these bad companies to invest in? I have no idea. They could be great or they could be horrible. It's irrelevant.
My anger in his investing choices wasn't completely that he ignored my advice. It was that he chose two companies that he'd never heard of, in industries that he wasn't knowledgeable about, and after reading maybe an article or two about how they're going to be hot stocks in 2012, threw his money into them.
I should have given him this great Peter Lynch quote in my page of investing tips:
"The worst thing you can do is invest in companies you know nothing about. Unfortunately, buying stocks on ignorance is still a popular American pastime."
In the spirit of my friend's poor decisions and popular American pastimes, I decided to come up with a quick activity, the goal of which is to convince new investors to pick stocks they know.
The premise is simple; if instead of investing in companies, you invested in professional athletes, who would you choose? Allow some leeway with age and retirement. Your choices are:
- Peyton Manning
- Joe Montana
- Marcus Stroman
- Kent Emanuel
I'm going to take a shot in the dark here and say that, if you're American, you chose either Peyton Manning or Joe Montana (or both). These quarterbacks have solid stats, and at least one Super Bowl victory. Any football fan would tell you that they're great choices. I understand how great they are, and I'd bet my money on them.
In case you aren't aware, Marcus Stroman (Duke) and Kent Emanuel (North Carolina) are two of the highest rated college baseball pitchers. Are they bad choices? Probably not. I had never heard of them until I Googled, "top college baseball pitchers 2012", so clearly I know nothing about them. In fact, I know almost nothing about baseball, other than the rules. I'm 26 years old. I went to my first and only MLB game at the ripe age of 26. I was focused more on the bottle of gin my friends and I snuck in than the game itself. Clearly, putting my money on Marcus Stroman and Kent Emanuel, two players whom I know nothing about, in a sport I know nothing about, would amount to little more than gambling for me.
If you had chosen Marcus or Kent as your investment, chances are you follow college baseball and know a lot more about the sport than I do. With that in mind, someone who understands baseball and chooses those players is making an informed decision. Someone like me, knowing very little about the players and the sports, is taking a complete guess.
So why would I gamble on Marcus or Kent, when I know just how good Peyton and Joe are, and that I'll make a lot of money on them? Let's call Marcus and Kent "JBL" and "TNH", and Peyton and Joe "WMT" and "CVX", respectively. Not understanding the industries behind JBL and TNH, I'm not going to understand the factors that affect those companies. Likewise, I'm very in-touch with Wal-Mart. Every time I go out shopping, I'm directly affected by the retail industry. I shop at both Wal-Mart and its competitor, Target (NYSE:TGT) so I see first hand how their decisions affect their bottom line, the consumer.
Perhaps the problem is that inexperienced investors think of investing as gambling, and therefore invest in a manner similar to gambling. When sports fans bet on games however, they don't bet make complete guesses. They bet in sports they watch, with teams they know, and to them, they're making an informed decision, not gambling. If they make money, they think it's because they were smart. If you bet in industries you follow, with companies you know, you're making an informed decision, and you'll end up ahead.
I hope you enjoyed this article because I really enjoyed writing it! Please leave a comment below to tell me what you think. If you're new to the investing game, I suggest you take this article seriously. If you're a seasoned investor, I hope this isn't all brand new information. It's very easy to make mistakes when first starting out, so maybe you can relate with an experience of your own.
Disclosure: I am long WMT, CVX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.