There’s something to be said for this very literal interpretation for that old adage. If you live in Seattle and have not left the state of Washington your whole life, your stories set in Seattle, Washington are bound to read more authentic than your stories set in New York City or Munich, Germany. You’ve experienced Seattle and you have the nuanced, day-to-day details to draw from as you write.
But we’re talking fiction here, right? Sara Gruen didn’t join a circus during the Great Depression, but her character Jacob Jankowski did in Water for Elephants. Robert Olen Butler isn’t a female auctioneer, like his main character in Fair Warning. Those stories don’t suffer for that lack of direct, literal experience. Think of all the books we wouldn’t have if authors stuck to their own personal lives.
There’s a less literal interpretation of this phrase that allows you to use your powers of imagination to their full potential to achieve a convincing authenticity. Perhaps you want to write a story about a woman coping with her husband’s death. Your challenge in writing this, however, may be that you haven’t experienced the death of a spouse. Does this mean you're not capable of writing this story? Of course not!
So how can you “know” something without experiencing it directly? You’ve likely had some kind of loss. That very human, relatable emotion—loss—is a point of connection. Work with that emotional core to imagine your way into the specific situation of your character’s loss. Starting with that solid foundation you can imaginatively reach toward new circumstances.
And don’t forget about the power of research as a way to reach toward what you haven’t experienced. You may not have worked on Wall Street, but if you talk to people who have, perhaps tag along for a day, and read books about the topic, you can gain the kind of information that will help you write about it with more authenticity. No matter what your subject, you’re bound to find plenty of information to give you the kind of detail you need in order to “know” what you’re writing about.