It's always dogged me. No matter how hard I try, I just can't sing. (Damn, I hate admitting that!) Sure, there are times when we go to church and I nail the occasional gospel note. But then minutes, if not seconds, later I'm back to being about as off-key as Celine Dion at a burping contest. Except I'm louder.
Frequently, I just push through these embarrassing moments, pretending there's nothing wrong -- that my voice is a nice, robust bass. Yeah, that's right. I simply ignore reality. And you know what? It works for me. My pride isn't hurt, and I end up getting more enjoyment from church, or karaoke, or whatever it was that involved me croaking in the first place.
Too bad this same philosophy just doesn't work in investing. Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ) Chairman and superinvestor Warren Buffett calls it understanding your circle of competence. Peter Lynch in One Up On Wall Street summed up that same advice by advocating that you buy what you know. But that's not reality, is it? Haven't we all invested in a business we didn't understand, hoping against hope for big returns?
I sure as heck have. And that's why I won't invest in biotech stocks today.
The price of intellectual risk
Don't get me wrong. I'm no sadist. I'm very much for drugs and technology that help people live longer and better. Heck, I expect to start benefiting from this stuff in the next 20 years. The problem is that biotech investing is an intellectual risk for me.
What's intellectual risk? Think of it this way: Every time you wade into some new venture that requires brainpower, you're guessing that your approach is correct. Investing in a stock without understanding the business behind it is a massive intellectual risk in the same way that it was a risk for you to skip studying calculus before your big 11th-grade final. (Yeah, I know, that was a cheap shot. Sorry, I needed to make a point.)
Sure, stock investing is always a guess at some level. But some guesses are better than others. Building an investment thesis around a deep understanding of a company, its business, and its industry is inherently less risky than simply following a chart. Or, for that matter, buying on a tip from Uncle Joey after he's had one too many at the family picnic.
I've had all kinds of people tell me I'm nuts for not investing at least a portion of my portfolio in biotechs. They tell me that I'm missing out on profiting from the best medical science has to offer. And the ones who know me really well, who know that I come from a family of doctors, can't comprehend my total lack of interest in the space.
Well, let's settle it all right here, once and for all, so you can stop bugging me: I don't invest in biotechs because I don't understand them. The intellectual risk is too high, and I'd expect to pay a dear price for taking the plunge. Why? Because I've paid at the altar of ignorance before.
Back in 1998, my wife became self-employed to help us dig out of debt. At the time, we rolled over her 401k assets into a retirement plan called a SEP-IRA. We weren't investment savvy then, so we followed the now-defunct Foolish Four strategy, buying equal stakes in Caterpillar (NYSE: CAT ) , Eastman Kodak (NYSE: EK ) , International Paper (NYSE: IP ) , and SBC Communications (NYSE: SBC ) . (To learn why we no longer follow this strategy, read our research results.) We held the stocks all the way through mid-2002. Our returns after dividends were what you'd expect: pretty much even. We missed the big bull run but avoided most of the crash. Not bad, overall.
The luck didn't last, though. I sold right before Caterpillar was about to rally like crazy on rising global demand for construction equipment. Why? Because I had no other frame of reference. I paid attention only to the Foolish Four strategy, which had been languishing, not the stocks or the companies behind them. The fact is that I knew almost nothing about Caterpillar, other than that it paid a good dividend and was part of the Dow Jones Industrial Average. My intellectual carelessness cost us a lot of money then. I won't repeat that mistake.
My adventures as a bubble boy
When Buffett famously said in 1998 that he wouldn't invest in tech stocks such as Intel (Nasdaq: INTC ) and Microsoft (Nasdaq: MSFT ) , I thought he was positively nuts. After all, I had been in the tech industry for the better part of a decade and was seeing firsthand how much money was flowing into Silicon Valley. But after my Foolish Four debacle, the comment made perfect sense.
Buffett was making the point that tech wasn't part of his circle of competence. There were other industries he knew better. And me? Well, I'm a bubble boy. My competence was, and still is, tech and tech stocks. That's why I invested in Sun Microsystems (Nasdaq: SUNW ) as an employee in the late '90s and then bought shares of Akamai (Nasdaq: AKAM ) after researching its business late last year. And after digging through Oracle's (Nasdaq: ORCL ) financials for last week's duel with fellow Fool W.D. Crotty, I'll probably plunk down some of our spare change for shares in the database king.
Are these investments risky? It depends on how you define risk. In terms of valuation, Akamai is hugely risky, while Oracle is less so. But intellectually, there's zero risk, because I understand each business, and the industries they participate in, intimately. As an owner, I should.
It just ain't me
What it really boils down to is this: Ignorance kills investment returns. And when it comes to biotech, I'm ignorant. I can't hold a candle to fellow Fools Zeke Ashton and Charly Travers. They're the experts on the subject. They know how to assess the sector's risks and how to value biotech bottle rockets such as Motley Fool Hidden Gems pick TranskaryoticTherapies (Nasdaq: TKTX ) .
But even if I did spend the time to learn how to research biotech stocks, I couldn't buy them because they're easily as risky as the tech stocks I already own. There's simply no place for them in my portfolio, which I strive to keep Foolishly diversified.
Yeah, I might miss an unbelievable rally in biotechs and probably a few 10-baggers, but it's like Clint Eastwood's Dirty Harry said in The Enforcer, "A man has got to know his limitations."
Well, Clint, I can't sing, and I don't do biotech.
Motley Fool Hidden Gems members get more than just two recommendations of undiscovered small caps with explosive profit potential every month. They also join a community of thousands who pool their research to find additional gems. Join in the fun, join in the profits, join Hidden Gems now with a free trial.
Fool contributorTim Beyerscan't remember the last time he did karaoke, but he's certain it wasn't a pleasant experience for the audience. Tim owns shares of Akamai, and you can view his Fool profilehere. The Motley Fool has adisclosure policy.