Many investors consider that they should stick to the industry the work in and have experience of when picking stocks, and not dabble into anything unknown. Apparently, IT specialists should invest in software firms and surgeons in drug companies etc. They assume that their knowledge of the industry will lead to better foresight of the investment risks involved and to pick stocks which bring them greater returns.
To many, this sounds like a natural thing to do and an effective investment strategy. However, as I will explain below things are not quite how they seem..
Lets look at investment risk. When you invest in the stock market, the stocks could go down or even crash. The money that you could lose is the exposure to that company. Risks can be minimalized by diversifying, so that you have a small amount of exposure to many companies, rather that a large exposure to one of two companies.
The job that you do, the career that you are in, these are also an investment in a way. You have invested money to study, and years of your time to get to where you are. In terms of risk, you are very exposed to the industry. If new technologies take over, or changing economic fortunes ruin your industry, you lose your job and your salary. If you also have your savings invested in shares in your own industry, then in the event of an industry meltdown, you lose everything.
Of-course this is a worst-case scenario that might never happen, depending on your industry. However, a slump in your industry at some point is likely to occur, and in such an event you would most likely need to sell some shares to keep going, for which you would get a low price.
As an investor looking to diversify, you should not focus just on your industry, even if you know it inside out. Of-course, no one is telling you that you shouldn’t invest a certain amount of your savings in the field you know most about, but at healthy percent of it should be strictly invested into other industries.
Watch out for overexposure of other kinds. You might, for instance, be overly exposed to your regional economy. You might know a lot about companies that operate with your city, but if you are too heavily invested in them, then a local economy slump would affect your stocks, as well as the price of your house, and potentially your job all at once.
Your should invest in a wide range of industries that are located in a wide range of places. A good way to do this is by putting some of your money into an exchange traded index fund. These funds purchase small quantities of practically everything the market has to offer. Diversify away your risks, and you can be more confident about your financial future.
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