Why does Naval emphasize 'investing in what you understand'?

Okay, let's discuss this fascinating perspective from Naval.

Why Does Naval Emphasize "Invest in What You Understand"?

Imagine you're a mechanic who really knows cars. One day, a friend asks you to check out two used cars: one is a brand and model you're very familiar with, the other is a brand-new, structurally complex electric vehicle you've never worked on.

Which car would you feel more confident giving buying advice for?

The answer is obvious: the familiar one. Because you know its common issues, which parts are prone to failure, whether the engine sound is normal, and its fair value. For that new electric car, you can only assess the surface—you have no idea about its battery degradation or potential hidden issues with its electronic control system.

Naval's advice, "Invest in what you understand," embodies this exact principle. He's telling us a remarkably simple yet profoundly important truth.

At its core, there are several key reasons:

1. You Possess an "Informational Edge" Others Lack

The investment market is like a vast battlefield of information. If you invest in a field you know nothing about—say, biotech—but can't even tell DNA from RNA, how can you expect to make money? The information you see is public, processed, and often what others want you to see.

But if you are a programmer yourself, when you analyze a software company's financial statements and products, you can gain real insights:

"Their tech architecture sounds impressive, but it's actually outdated and hard to scale."
"This new feature they launched solves a major industry pain point that competitors haven't addressed."
"User reviews show the product has many bugs; their technical team might be struggling."

See? This is the advantage your understanding provides. You're not gambling; you're making judgments based on your expertise. You can identify the company's true value or hidden significant risks long before others even realize it.

2. You Can Truly "Understand" Risk

For an investment you don't understand, the only risk you perceive is: the price going down.

But for an investment you do understand, you can discern different types of risk:

Is this a temporary setback or a fatal flaw? For example, a great company you know well suffers a sharp stock drop because of one missed quarterly earnings target. Understanding its business, you might judge, "This is just a short-term production issue; the long-term moat is intact," making it a potential buying opportunity.
Is this market sentiment or deteriorating fundamentals? Many people invest as if opening a "black box"—they put money in and hope for the best. But if you understand it, that "black box" becomes a "glass box"—you can see exactly how it works internally. When market panic strikes, you don't succumb to fear because you can see that everything inside is functioning normally.

3. You Can Hold On During Market Volatility

This is the most crucial point. Making money from investments often depends less on picking the perfect entry point and more on how long you can hold on.

When you invest in something you don't understand, like buying a hot stock on hype, any dip in price makes you panic: "Is it going to zero? Was I scammed? Better sell now!" The result is often selling at the absolute bottom.
When you invest in something you deeply understand, perhaps a company whose products you use and admire, knowing its strong competitive moat, a market-panic-driven price drop will likely make you think: "Great, it's on sale! This excellent company is even cheaper now—time to buy more."

This strong conviction doesn't come from wishful thinking; it stems from deep understanding. Without understanding, your confidence is like a sandcastle—washed away by the first wave.

4. You Can Identify True "Long-Term Value"

Naval is a proponent of "long-termism." He believes true wealth comes from long-term compounding, not short-term speculation.

If you don't understand something, you can only focus on short-term price fluctuations and news headlines, easily falling into the cycle of buying high and selling low.

When you genuinely understand an industry or a company, however, you can assess its long-term potential. You start thinking:

What will this industry look like in ten years?
Can this company continue to create value?
Where are its competitors? Can it win against them?

This way of thinking helps filter out the vast majority of market noise and focus on truly high-quality assets that can withstand the test of time.

To Summarize:

This advice from Naval is essentially urging us to abandon illusions of "getting rich quick" and "overnight wealth," returning to common sense.

Don't try to be an expert in every field.
Find your own "Circle of Competence"—the specific domain you truly understand. This could come from your profession, a hobby, or a subject you've studied deeply over time.
Only make significant investments and decisions within your Circle of Competence.

This isn't just a rule for investing in stocks; it applies equally to investing in yourself (e.g., learning skills), choosing a career, or deciding on a business venture. Focus your most precious resources—your time, money, and energy—on the areas you understand best and have the strongest conviction about. This is the most reliable path to long-term success.