Kevin O’Leary says “Don’t invest in what you don’t understand” – 3 signs you’re in way over your head

Kevin O’Leary, Canadian businessman and “shark” on hit show Shark Tank, advocates for not investing in what you don’t understand. Undoubtedly, if you’ve watched Shark Tank or Dragon’s Den, if you’re from Canada, you’re probably well aware that he has no problem with not partaking in an investment he doesn’t get.

Indeed, O’Leary shows us all that it’s okay to say “I’m out” for a particular investment opportunity thrown one’s way with a market opportunity, business model, or product one does not understand or care to understand.

Though O’Leary has made some fantastic investments on the show, the bad ones he’s avoided should also be applauded. Indeed, when it comes to the heightened risk of betting on startups and venture capital, perhaps it’s the investments that one does not make that are just as important.

Many new investors may unintentionally invest in what they don’t quite get.

In any case, O’Leary isn’t the only big-name investor who cautions against investing in what one does not understand.

For instance, many excited young investors may be inclined to buy a stock on a tip from a friend without even understanding (or caring) about the company that stands behind the stock. If you start treating stocks like pieces of paper rather than pieces of businesses to be held for the long haul, you’ll be likelier to play the trader’s game. And if you’re starting out, being a trader, especially with companies you do not have a remote understanding of, can be like heading over to the local casino.

At the end of the day, you become a better investor when you learn from your mistakes as well as the mistakes of others. If you take only “investing in what you know” to heart sooner rather than later, though, perhaps you can avoid a painful hit before it has a chance to happen.

In this piece, we’ll look at three potential signs that, in my opinion, suggest you may have broken a golden rule by investing in what you do not understand. Even if you’ve done such and lost money, there’s no reason to feel shame if you’ve treated the whole experience as a learning opportunity.

You’re chasing momentum.

The desire to get rich quickly may lead many new investors to chase high-momentum stocks. For them, it’s more about share price momentum than what the company actually does, valuation, or anything related to the fundamentals.

Indeed, this is speculation that could get many investors into deep trouble once momentum reverses. It can also be hard to tell what to do when one effectively “guesses” which direction a stock will head in the near-term based on recent action in a stock.

While it’s fine to have some high-priced, high-growth stocks in your portfolio, do understand the actual business and attempt to value it before punching your ticket to shares. Otherwise, you may be speculating rather than investing.

You can’t explain, in simple terms, what a company does.

If you can’t explain what a company does, you’re probably not investing in a stock for the right reasons, at least in my humble opinion. If you’re in Applovin (NASDAQ:APP), can you tell me what the firm does and what the market opportunity is?

If not, it’s hard to know what to do when the trade turns south. How do you know when to buy more or sell if you can’t value a company? The once-red-hot momentum stock is now off 47% from its all-time highs, but is still up close to 346% in the past year. It’s tough to know what to do if you can’t pin the valuation down.

Your portfolio isn’t diversified.

AI is an exciting trend to invest in. But does your entire portfolio need to be invested in tech stocks? Unless you’re comfortable with the heightened sector-specific risks, I’d argue that diversifying into other sectors could do you a lot of good as the tech trades sink faster than the rest of the market on the way down.

Of course, heaviness in tech doesn’t necessarily mean you’re investing in what you don’t know if you’re a disruptive innovation investor who’s fine with the wilder waves. However, if you’re new at investing and your portfolio is comprised of the hot names you heard around the water cooler, your portfolio may be at risk.

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