Why we’re bad at investing part 3: We seek comfort in the familiar

Often, those who have built significant wealth believe they have special expertise in certain industries, especially in the areas where the money was made.

I’ve seen the executive with expertise in a particular growth industry insist on restricting their portfolios to that industry, based on the belief that they have special insights. And although they might understand the nuances better than almost anyone, there’s no guarantee that will translate into investment success, because prices are driven by other factors—and this is where an understanding of business valuation comes in. It can take an outsider’s view of an industry to truly understand whether the companies in it are fairly valued - not just relative to each other, but to all of the other investments available around the world.

Your own section of the forest might be thriving and pleasant, but you are completely unaware that several miles away a fire has been sparked. Or that there’s a more lush, more promising area far away.

Worse, whether it’s software or the oil patch, entrepreneurs often don’t realize how much they are exposed to the fortunes of that single industry, and how little they are actually diversified.

I can build a pretty well-diversified portfolio of 10 stocks, provided they are in different industries and have different geographic exposures. But if I buy 10 medical device stocks, or 10 wireless infrastructure companies, my diversification is an illusion.

Remember that a key reason for building a portfolio is to diversify your wealth, and so sticking close to home, whether industrial or geographic exposure, is often a mistake.

In the context of today’s market, this might mean that you need to look at industries and companies that have lagged the market leaders, and that might be well beyond your circle of competence. If you’ve made a fortune on Nvidia stock, or bravely stepped into Meta at the lows, or have been faithfully holding Google and Microsoft for the better part of the last decade, it may be uncomfortable to look at industries like industrials and pharma, which have historically done better in inflationary environments, and appear more reasonably valued. It really does feel like the market is reaching an inflection point, as investors come to terms with a “higher for longer” interest rate regime, and that will require new ways of thinking. 

In order to diversify our investment portfolio successfully, we need to venture beyond the familiar.