The thought of investing in tech stocks or new technologies can be appealing for those who'd like to quickly achieve major gains.
It's a booming business on the rise, right?
Well, technology has historically been a feast-or-famine sector for investors, with historic slumps - like the dot-com crash of 2000 - wiping out entire companies.
As Warren Buffett has often said, "Risk comes from not knowing what you are doing," and many of the factors that make tech investments so attractive are the same ones that can lead to their downfall.
I’ve got 3 reasons why investing in tech stocks can be an uncompensated risk for most investors.
1. The Technology Industry is Tough to Understand
Warren Buffett has advised investors to "Never invest in a business you cannot understand."
Although it's not necessary to be able to explain the dynamics of the internal combustion engine in order to invest in an auto manufacturer, it is important to have at least a basic understanding of the product, service, or value the company in which you're investing offers to its consumers.
For many tech companies, the question "what creates your value?" is a tough one to answer.
During the dot-com boom, many investors poured their entire life savings into companies whose business models were fairly amorphous and who lacked a clear path to future profits.
Sadly, when these companies failed to adapt to market or regulatory changes, those who invested in them saw the value of their shares dwindle to zero.
Generally speaking, you should be able to easily explain why a certain company provides a useful service or product, and show that the stock price accurately reflects the company’s value and isn’t based on buzz or “bubble” hysteria.
If you can’t, it may be wisest to avoid this investment.
2. Planned Obsolescence Means a Loss of Competitive Advantages
If you've ever noticed that electronics and appliances aren't lasting as long as they once did, or that your smartphone or laptop computer seems extra "glitchy" just after the new model is released, you're likely observing planned obsolescence in action.
This phenomenon involves designing products, particularly tech products, to become effectively obsolete after a certain period of time, spurring users to rush out to buy the latest and greatest version of a product once their older one stops functioning.
While this can be frustrating from a consumer perspective, it also makes tech companies especially vulnerable to their competition.
Companies that fail to anticipate their customers' desires or who are a few months behind in releasing a new product or feature can lose their competitive advantage. Regaining this user trust and loyalty can be a steep uphill battle.
One only has to look at former titans of the smartphone industry, like BlackBerry, Palm, and Nokia, to see how quickly tech companies can go from the top of the world to a nostalgic footnote in history.
Predicting which of these companies will thrive and which will wither is all but impossible, even for world-class investors like Warren Buffett, and attempting to do so can be a major gamble with your hard-earned investment funds.
3. Most Tech Companies are Too New and Unproven
While well-established companies aren't exempt from market forces that can leave them struggling to maintain profits or asset value, tech companies are even more vulnerable to these fluctuations because of their relative newness.
Most tech companies haven't been around long enough to prove themselves to investors, making it tough for experts to predict how they'll fare (or even whether they'll pull through) during a market slump.
In general, you'll want to focus your investment funds on established companies that have made it through a few recessions relatively unscathed, as this shows the type of adaptability and staying power that can make these businesses strong long-term investments.
However, none of these factors mean that technology is entirely off-limits to investors; after all, even Warren Buffett recently broke his no-tech streak by investing in Apple.
So, what are the best types of tech stocks to buy?
If you're interested in buying a few shares of a technology company, apply the Rules that you would apply to any other investment.
Do you understand the company?
Does it have a definitive competitive advantage?
Can you trust the management?
Is it on sale?
If you can answer yes to all of these things you may have just found a wonderful company. To learn how to fully understand determine if a tech stock meets the Rule#1 standards use my 5-Step Checklist for Picking Stocks that will help you find and evaluate any company with confidence.
Do you think tech companies are risky investments? I'd love to hear your thoughts in the comments.
How to Pick Rule #1 Stocks
5 simple steps to find, evaluate, and invest in wonderful companies.