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This article is part of our Better Investor series, in which The Motley Fool goes back to basics to help you improve your returns and be more successful with your investing.
Think about this for a minute: When you invest in stocks, in some ways you're competing with other investors. That "bargain" you just bought was something that someone else was happy to sell -- at the same price you paid.
In that situation, who's right? Sure, the seller's circumstances and goals may be very different from yours. But when you buy a stock, you're (hopefully) doing it because you've done some research and think it'll go up. Because you think you know something that others don't, in other words.
But do you?
Finding your secret advantage
Outsmarting -- or out-knowledge-ing -- Wall Street analysts seems like it should be a fool's game. After all, those folks have degrees from elite schools, tremendous resources, more time than you and I do to spend on this stuff, and the kind of easy access to executives that most of us can only dream about.
But is it really? Most of us have something, some little corner of the investable universe, that we know better than most people, even (maybe especially) people with MBAs from Wharton. Think about it: What has your job, your spouse, or your hobby taught you that could be applicable to investing?
To be clear, I'm not talking about inside information. I'm thinking more of the perspective you get from spending years learning about a product or industry. Maybe your employer is somehow connected to the food business, and after seeing PepsiCo's (NYSE: PEP ) terrific distribution system up close, you have a deep understanding of why that system is a huge competitive advantage for the company. Or maybe you fix jet engines for a living, and you think that the new engine from General Electric (NYSE: GE ) is likely to be a winner -- and maybe a big source of profits for the company.
How your informed perspective can make you money
For me, it's cars. I've never worked in Detroit, never had a job with an automaker. But ever since I was a little kid, I've been interested in cars. As a teen reading magazines like Road & Track, I got interested in the business of cars -- which companies are strong and which are weak, and why. Why did the Ford (NYSE: F ) products that my dad loyally bought for years seem kind of lousy by the late 1970s? Why did Honda (NYSE: HMC ) end up eating Ford's lunch -- and how did the new Honda my dad bought in 1980 seem so much nicer in comparison to his old Ford? What drove these changes?
I was fascinated. I read, and learned. After college, I read and learned more, met some people in the auto business and talked to them, and learned more still. And since I had started working in the investment business, I started looking at automakers' stocks. Not for my job, but because I was interested.
After hearing a portfolio manager at Fidelity talk about the ins and outs of cyclical stocks, I bought Chrysler at the bottom of a cycle and made a bunch of money when I sold it a couple of years later. Over the years I repeated that trick with General Motors (NYSE: GM ) and Toyota (NYSE: TM ) , but never more successfully than when I bought Ford in the dark days of early 2009.
That was a moment when the smart guys on Wall Street were sure that Ford would go bust -- but as someone who had acquired a detailed understanding of the business, I was able to both see and understand the implications of the remarkable product transformation that was happening at the company. I knew Ford had a good chance to survive, and I knew that if it did, it was a steal.
As it turned out, that was a once-in-a-generation opportunity. But somewhere, in some field, you probably have that same kind of knowledge. How can you put it to work in your portfolio?
But before you start making trades, there's one big caveat.
"Buy what you know," not "Buy what you love"
"Buy what you know" isn't a new idea -- it was a catchphrase made popular by superstar investment manager Peter Lynch over 20 years ago. Lynch argued, as I do above, that using your unique perspective on a business could give you an investing advantage.
That idea, though, has come in for a lot of criticism over the years -- but I'd argue that that's because people misapply it. You might love the big chrome-laden Harley you ride on weekends, but does that mean that Harley-Davidson (NYSE: HOG ) is a good buy right now? Profits are up, but the stock's valuation is pretty high. Can you trust yourself to make an objective decision?
If you want this to work, you have to be able to separate your understanding of the industry from your feelings of loyalty to a particular business and its products. That can be a hard thing to do. Back when I was thinking about buying Ford in early 2009, I wrote an article questioning whether this was a sentimental idea rather than a rational one. (In retrospect, it was probably a bit of both.)
This is an extremely important exercise to go through when you're looking at buying a favorite company (or, for that matter, when you're thinking of buying or selling that company's chief rival), and services like Motley Fool CAPS can be a helpful sanity check before you trade.
But don't let worries about objectivity stop you from putting your unique perspective to work in your portfolio. It could turn out to be your biggest investing advantage.
Stay tuned throughout our Better Investor series and get the advice you need to succeed with your investments. Click back to the series intro for links to the entire series.