All that random life knowledge you’ve built up? It’s time to use it to find investments that are the right fit for you.
Focusing on areas that you have experience and interest is one of the four principles of value investing. It’s called the Circle of Competence and it centers around making sure you understand the companies you’re looking at buying.
As we discuss in the podcast and previous blog posts, learning the four core principles is the start of our educational foundation in value investing. I look at these as the vital steps you should take before you consider investing in a company. So far we’ve covered a broad overview of all four: the circle of competence, economic moat, management, and price. These are the original principles defined by Charlie Munger, one of the most respected investors of all time.
In our next Stocks4Docs episodes, we take a deep dive to explore each principle. Let’s start with the Circle of Competence…
What does Circle of Competence mean and why is it important?
Each of us, through our own life experience, studies, careers, and family time, build up useful knowledge and skills. When you’re passionate about something, it’s a great place to start thinking about your investment research. The most important thing here is having first hand experience or knowledge to work with.
One of the best ways to choose companies to invest in is to operate within your circle of expertise. While you can’t gain a deep and total understanding of every single available company, you can build specific areas of competence based on your existing knowledge, interests, and skills. This allows you to have focus and insight into companies that make the most sense for you to invest in. Basically, you’re creating an advantage for yourself by knowing more than other people.
As Warren Buffett’s been quoted as saying, the size of the circle is not what’s important, but knowing its boundaries is vital. Stay with what you know in order to create successful investments.
Another way to think about it is that you should want to buy into a company because you’d like to truly become a part owner. Base decisions on your own values, not just on wanting the stock to go up.
What’s on your list?
Start by identifying products and companies you experience on a daily basis. It’s not that you should automatically invest in these, but it’s a good place to begin brainstorming. Then broaden the list to include other interests, hobbies, knowledge, and skills from your career…
Remember that one thing you want to avoid is jumping into something just because other people think it sounds good. If you don’t understand or have any knowledge about it, it might not be the right investment for you. And yes, you can overcome this lack of knowledge by studying and researching, but the way I look at it is that there are so many wonderful companies already in my Circle of Competence. Why not start with things I’m already interested in? This investment journey we’re on should be enjoyable. Look at it as building new life-long skills that you want to remain passionate about.
Stay tuned for in-depth descriptions of the next three principles in upcoming Stocks4Docs episodes and articles.
In the meantime, if you missed any episodes, you can catch up here.