Murrdox said:2) YOU and ALL objects you pick up are invisible. If you pick up a knife and wave it around, people see the knife vanish from the table as soon as you pick it up.
D&D seems to subscribe to method #2 when it comes to invisibility.
Reread the PHB entry for Invisibility. The knife is fully visible until and unless you can tuck it under your clothes. Mud on your boots would make them visible (unless you rinsed them off). Similar to how Glitterdust works, really. Heck, a sackful of FLOUR woud present problems (though the invisible creature taking time (a full round action?) to brush the dust OFF, would get rid of most, and render the rest invisible (form being briefly concealed by heir own hand, kinda).