Investing in companies that you know

In beginner investing, you can often get carried away by the pronouncements of major investment gurus without fully understanding the ramifications of what you are doing. For instance, Warren Buffet, the legendary investor, never tires of saying that you should only invest in companies that you know. This means that you should at least know enough to be able to understand their business models and how and why they make money. This approach has its merits but you should also understand the limitations of restricting your investment options. A proper level of understanding may take time and effort and require technical knowledge that you do not possess. There are a number of Web sites that will bring you up to speed on the performance and prospects of your potential investment but there is a limit to the free information that you can obtain.

In beginner investing, an approach such as this may be comforting because of the ease of applying it. For instance, you will know that Exxon is in the gasoline business or that Johnson and Johnson is a very successful pharmaceutical company. It is true that this knowledge will help you to reduce risk on your investment. However, these well-established companies have already gone through their growth phase and you may miss out on companies that are just entering their growth phase and can provide superior returns. You should therefore balance your investment portfolio between known companies which are relatively low-risk and little known companies that can provide you with much higher returns.

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