What Does it Mean to “Invest in What You Know?”

The Johari Window  is an extremely useful tool for investors wanting to invest in what they know. The window is a map of who knows what information, and knowing what quadrant a piece of information fits in when it comes to the investment analysis you’re doing is a large step toward investing efficiently and minimizing cognitive bias-driven decisions.

There are 4 quadrants of the Johari window:

1. Things that you know that everyone else knows, too.
2. Things that you know that others do not know.
3. Things that others know that you don’t know.
4. Things that no one knows.

The Johari window predicts that people who have a lot of segment 2 knowledge- that is, they know a lot that others don’t- might have the upper hand in at least being an informed investor, if not having higher returns (though higher returns are certainly half of the goal here). That makes sense and as I described in the ACME Conglomerate example, the quantitative side here is somewhat restrictive. It’s the qualitative stuff that you know that others don’t that gives you an edge as an investor.

There’s a big pit-fall that I see investors fall into here, however. Imagine that these quadrants are gradients of red and green (where green is good and red is bad) for a second. An investor that has a bright green section 2 knowledge; they know a lot about how their business works. But imagine that the “stuff everyone knows” is barely green (they don’t know a lot of the common knowledge) and there’s a bright red quadrant for section 3; most people know more than the investor in this example about most things. This investor could be in serious trouble and over-confidence is a high risk for this investor.

In this example, the investor knows a lot about how good of a company their firm is, that the bosses are nice and that people love working there, and that as far as they can see, they make more money all of the time. They don’t know the publicly available information about the company, however. They don’t pay attention to the Cash Flow statements, the Annual Statements to the investor public, can’t read a Balance Sheet, and don’t realize that in fact the company may be in poor financial health because of low return on assets, high amounts of debt, and diminishing profit margins. When they see the stock of their company drop, they might think the market is wrong and invest heavily because it’s a good company in all of the ways that matter to someone who works there. In this case, the odds are that the market is actually right and the investor is wrong but the investor may not realize it until it’s too late.

The optimal “invest in what you know” investor doesn’t just focus on what they know; they balance that information with all of the data that everyone else knows, too. Not only do they know the officers named on various Annual & Quarterly Reports personally, know what their company is up to enough to feel optimistic about the competitive edge, and know that it’s a good company overall; they also read the Balance, Income, and Cash Flow statements and know how to gauge the stock against the rest of the market. They know if today’s price sounds about right, whether it’s probably over priced, or whether it’s a good buy.

Returning to the gradient metaphor with the Johari Window, in this instance the left side of the window is bright green, the “what others know that you don’t know” section is light pink, and of course what no one knows stays the same. If this investor also understands Asset Allocation, tax efficiency, and financial wellness, they’re probably a very good investor that should feel confident in their investment decisions.

This is where an investor’s financial team comes in. There are people, of course, that you can get assistance from that minimizes the things that you don’t know. I know a lot about taxes, for instance, but I am not a CPA or a tax preparer. I always have professionals help with my taxes. I know a lot about Estate Planning, but I will still have Estate Planner deal with the things that I don’t even know that I don’t know.

Using the Johari window to think about your investments, you don’t actually have to know everything. You just need to properly sort information. If there are tax implications that are knowable but you don’t want to learn them all before making a decision, the good news is that there are numerous competent people who do know those things and you can hire them to inform and act on your behalf. I say this to highlight the fact that the optimal investment approach doesn’t involve needing all of the information in the world- it just means that you should shrink the areas that you could know but don’t by one means or another- learning it all or hiring folks that already know.

I also say this to highlight the fact that a lot of people who know a lot about their companies and have large exposures to single stocks hire us to fill them in on the things that are outside of their window of knowledge and make informed decisions. I’ve worked with folks in various degrees of employment, leadership, and ownership at many firms over the years, and one of the things I find rewarding about working with people who know a lot that I will never be able to know is helping fill in some of the blanks to create optimal strategies.

I think that it’s good to invest in what you know. Peter Lynch wrote about it and brought a unique perspective to the topic in his books (i.e. One Up on Wall St.). I’ve seen people take this approach to the bank, so to speak, over the years. I’ve also seen people get incredibly lucky without realizing how much danger they were in all the while, and people that thought that investing in what you know means investing safely only to suffer massive losses that permanently harmed their finances.

As an investor, I always use the Johari window to organize information. I’m just as interested in knowing what other people know that I don’t (or knowing who knows that information) as knowing specialized info that others don’t know. In my experience, it’s the investors that use this approach to sorting information (whether they’re aware of the Johari theory or not) that apply this concept the best. I like to say “invest in what you know as long as you know what everyone else knows, too.”