The risks of only investing in what you know

TORONTO – It’s something financial planner Mark Coutts sees from time to time.

Clients comes into his Toronto office and tell him they want to invest in a company’s stock based solely on its brand-name recognition.

Often, it’s an investment strategy he cautions against.

“Just because you own an iPhone doesn’t necessarily mean that Apple is the right stock for you. Just because you get a coffee every morning at Tim Hortons doesn’t mean that’s the right investment for you,” said Coutts, an adviser at Sun Life Financial.

“It means you understand the product, but do you understand all the other factors you would normally consider when making any investment decision: the strength of the management, their competitive advantage, the maturity of the industry, the economic factors that impact that sector. Those are all factors you should bake into the equation.”

The idea of investing in what you know has been touted by many, including legendary investor Warren Buffett.

The reasoning behind it is that people have a better grasp on what they’re investing in if they understand the products or services of the company.

While owning a piece of large, well-known companies may be attractive to many, one of the risks investors can run into is missing out on the potential for faster or bigger growth if they only stick to the tried-and-true brands.

With Apple, for instance, investors may want to buy the company’s shares because they see the huge lineups out the door every time it launches a new product.

But getting in on the company now may be expensive, and there may be more growth opportunities if investors looks at smaller firms that may have a connection to Apple, such as its chip maker.

Coutts says buying into big, brand-name stocks also doesn’t guarantee perpetuity, such as the cases of Bombardier and the now bankrupt Canadian tech firm Nortel Networks, which both saw their shares plummet.

But on the flip side, HollisWealth senior adviser Allan Small says that although investors may be drawn to new, emerging startups because they have more potential to grow — their longevity and returns are also not guaranteed.

“You have to be really careful. Just because a young company has promise and potential doesn’t mean it will shoot up and continue to go on forever,” he said.

“Sometimes owning a company like that makes sense if you’re an investor who can handle the risks associated with it. But for those who want steady and slow because they believe that’s what wins the race — these bigger names may fit the bill.”

Small says investors need to evaluate their risk tolerance, time horizon and goals with any investment strategy.

Avoiding home bias is another consideration, adds portfolio manager Adrian Mastracci.

For instance, some investors only want to invest in Canadian stocks and don’t even consider American or international stocks.

Instead, he suggests diversification as a better guideline to follow for sound investment plans.

“Just because you’re a foodie, you shouldn’t just pick A&W (restaurant) stocks because you won’t have enough diversification,” said Mastracci, president at KCM Wealth Management in Vancouver.

“I like putting all the sectors in a portfolio because I don’t know which ones are going to be good ones.”

He advocates buying shares when times are bad and selling shares when times are good — in other words, buying low and selling high.

“That’s the better approach as opposed to loading up on a particular stock because you think it’s big,” Mastracci said. “Size is great but it’s not always going to save you.”

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