Almost all investing heartbreak can be avoided if you stick to one simple rule of thumb: only invest in the stocks of companies that you understand. It is amazing how many people stray from this principle. I recently heard from a brand new income investor who told me that he has over 50% of his investable assets in Linn Energy (LNCO), and he was glad that he came across my blog so that he could learn about “defensive” investments.
No, no, no.
Look, I don’t own any Linn Energy, because there are a lot of things I don’t understand about the company, and there are some things I understand about the company but don’t like (for instance, right now, the LNCO distributions roughly mirror the LINE distributions because LNCO isn’t realizing GAAP income—if LNCO starts realizing GAAP income, it will have to pay a 35% tax, causing LNCO distributions to substantially lag LINE distributions. Shares would likely fall, triggering an option for Linn management to swap out LNCO shares and replace them with LINE. I doubt this new investor is aware of risks like that with the company).