Warren Buffet defined "Circle of Competence" as knowing what you buy and only investing in companies in which you understand how they operate and earn money. For me, I am still trying to rapidly expand my circle of competence in order to understand how companies in different industry operates and the measures thah they use to achieve growth.
My investing journey has been short but there are many times in which I am tempted to stray outside of my circle of competence; trying to invest in technological/biomedical companies because of their high growth potential. However, I have always failed to understand their valuations and the ways these companies generate revenue. Fortunately/Unfortunately for myself, because of my inability to understand their valuation, I have not invested in any of these companies yet. Nonetheless, I'm not saying that nobody should invest in technology/biomedical companies but rather, this is up to individuals. It depends on how comfortable you are with the industries and whether you're able to comfortably establish what will the industries be like in a couple of years.
Everyone's circle of competence will be slightly different and in my opinion, it does not matter what or how big your circle is. Rather, I believe it's how well we understand the industries/companies that are within our circle in order to avoid investing mistakes. As what Peter Lynch mentioned, if you cannot explain the business model of the company within two minutes, you should not invest in it.
Writing this post serves as a reminder for myself to only invest in companies that I know well and to stop looking at speculative companies that I do not even understand!
Journey to Financial Freedom,
SGInvestingSuccess
My investing journey has been short but there are many times in which I am tempted to stray outside of my circle of competence; trying to invest in technological/biomedical companies because of their high growth potential. However, I have always failed to understand their valuations and the ways these companies generate revenue. Fortunately/Unfortunately for myself, because of my inability to understand their valuation, I have not invested in any of these companies yet. Nonetheless, I'm not saying that nobody should invest in technology/biomedical companies but rather, this is up to individuals. It depends on how comfortable you are with the industries and whether you're able to comfortably establish what will the industries be like in a couple of years.
Everyone's circle of competence will be slightly different and in my opinion, it does not matter what or how big your circle is. Rather, I believe it's how well we understand the industries/companies that are within our circle in order to avoid investing mistakes. As what Peter Lynch mentioned, if you cannot explain the business model of the company within two minutes, you should not invest in it.
Writing this post serves as a reminder for myself to only invest in companies that I know well and to stop looking at speculative companies that I do not even understand!
Journey to Financial Freedom,
SGInvestingSuccess
Hi
ReplyDeleteI feel that understanding the circle of competence is important but one should look beyond and take effort to understand the different business complex that might be a value buy in the future.
I'm saying this because I feel like if a person only understand fashion industry for instance, then they will only be subjected to selected fashion industry stocks to consider and all other things will be irrelevant to them, unless they start brushing up their understanding on other industries.
Just my 2 cents opinion :)
Hi B,
DeleteThank you for your honest feedback.
That is what I feel exactly as well. My understanding of business models is mediocre at best and I'm still trying very to be good at at least three different industries. After which, I'll definitely look into expanding my circle. (: