We're Thinking About Risk and Research All Wrong

Let's just get this out of the way: Investing can be baffling at first. Somewhere between "do your research" and "follow your gut" is the chance to help your money grow, but before any of that, you need a basic idea of what you're working with. A forthcoming study has some startling news for us — namely, that we need to recalibrate how we think about investing fundamentals.

Three analysts have just previewed their research on how we think about risk in MarketWatch. When you choose a stock or a company to invest in, it's likely that you draw from your experience or understanding of that product or business. The researchers use a small fried chicken franchise looking to expand nationally as an example. A typical novice investor may believe that because the restaurant's recipes are delicious, there's no way growing the company could fail. But that's not what risk means in the context of investing, and you'd need to do a very different kind of research than testing out the menu.

This new study reexamines the philosophy of "invest in what you know." "[W]e often think we understand things when we do not," the analysts write in MarketWatch; "for instance, when we focus on a restaurant's delicious chicken but neglect the complexities of the business. That error will cause us to take on more risk than we intend and can lead to major trouble."

Until you have experience in understanding business risk versus instinctual risk, it may be worth leaning on a financial advisor for help choosing your investments. That doesn't mean accepting everything they tell you, but it is a good way to learn about the mindset before going all in.