Two sides to the coin if you stick to your circle of competence
• Warren Buffett stayed away from the tech bubble, but he regrets not getting into Google
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees,” said Warren Buffett in his 1996 letter to Berkshire shareholders.
“Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering.
“Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word ‘selected’. You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
Buffett goes on to say in this year’s letter to shareholders: “I’d like you to know that almost all of the directors I have met over the years have been decent, likable and intelligent. They dressed well, made good neighbours and were fine citizens. I’ve enjoyed their company. Among the group are some men and women I would not have met except for our mutual board service and who have become close friends. Nevertheless, many of these good souls are people whom I would never have chosen to handle money or business matters.
“It simply was not their game. They, in turn, would never have asked me for help in removing a tooth, decorating their home or improving their golf swing. Moreover, if I were ever scheduled to appear on Dancing With
the Stars, I would immediately seek refuge in the witness protection programme. We are all duds at one thing or another. For most of us, the list is long.
“The important point to recognise is that if you are Bobby Fischer, you must play only chess for money.”
Pat Dorsey, founder of Dorsey Asset Management, says: “It always amazes me how few investors — and sometimes fund managers — can articulate their investment philosophy.”
He adds: “Without an investing framework, a way of thinking about the world, you’re going to have a very tough time doing well in the market. If you do your homework, stay patient and insulate yourself from popular opinion, you’re likely to do well.
“It’s when you get frustrated, move outside your circle of competence and start deviating from your personal investment philosophy that you’re likely to get into trouble.”
What could be simpler? And yet most of us can’t seem to resist stepping outside our circle of competence when it comes to investing. That includes really smart people, who you’d think would know better.
Stanley Druckenmiller could not bear to see others make money in the technology sector — and got killed.
“I bought billions worth of tech stocks, and in six weeks I had lost billions in that one play,” he later explained. “You ask me what I learnt. I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was just an emotional basket case and couldn’t help myself. So, maybe I learnt not to do it again, but I already knew that.”
Druckenmiller wasn’t alone. During the tech bubble, the socalled old money became so upset at the nouveau riche boasting about their gains and newly acquired possessions that many jumped into the market at the worst possible time, with disastrous results.
At the time, Buffett was heavily criticised in the media for refusing to invest in high-flying tech stocks. But when the tech bubble burst his critics were silenced: he had, it was said, shown the wisdom of sticking to his circle of competence. “If we can’t find things within our circle of competence, we won’t expand the circle. We’ll wait,” Buffett was quoted as saying.
Not too much later, however, he surprised the markets with a giant bet on Apple stock. Apple has since been a major contributor to the Berkshire coffers, boosting the portfolio by about $2bn in 2017 alone.
Buffett is reportedly kicking himself for not taking advantage of the opportunity to buy into Google when it went public. The founders came to see him shortly after the initial public offering with an investment prospectus.
“I knew the guys,” says Buffett. “And I had plenty of ways to educate myself, but I blew it.”
Buffett’s partner, Charlie Munger, seems to regret their earlier decision to stay out of tech stocks even more. “If you asked me in retrospect what was our worst mistake, it’s the tech field,” he’s quoted as saying.
Which raises some doubt as to the wisdom of not expanding your circle of competence. Apparently, sticking to what you know can just as easily work against you as for you.
Perhaps the takeaway is something American journalist and author Kathryn Schulz stressed when she wrote: “If we can add the idea that all of our theories are fundamentally provisional and quite possibly wrong to our cognitive toolkit, we will be better able to listen with curiosity and empathy to those whose theories contradict our own.
“We will be better able to pay attention to counter-evidence.”
THE IMPORTANT POINT TO RECOGNISE IS THAT IF YOU ARE BOBBY FISCHER, YOU MUST PLAY ONLY CHESS FOR MONEY
APPARENTLY, STICKING TO WHAT YOU KNOW CAN JUST AS EASILY WORK AGAINST YOU AS FOR YOU