Understand Your Circle Of Competence

Professional investors do not invest in things they don’t know. They understand their inner circle of competence and they are not anxious to risk their hard-earned capital on something that sounds cool. Taking passes is just as important when it comes to investing. This is also the very mental model that Charlie Munger and Warren Buffett have and limit to what they invest in.

What is your circle of competence?

Our circle of competence is where one has the greatest familiarity. It is the subject area that matches one’s skills and expertise. Just like every businessmen, they should concentrate most of their time and attention to the one business that they are specialized in. That is where they have their competitive advantage and will give them the best chance of succeeding. Similarly in TJI, we deal with stocks and options but we do not touch areas such as forex or commodities because that is not our forte. 

Not everyone knows everything

Sometimes we must learn to accept the fact that we are not necessarily familiar with everything there is that makes money. Tiger Woods doesn’t try to play soccer, neither does Lionel Messi compete in the PGA. All of these can make money, but the question is, can they win it? Too many people feel embarrassed to take a pass.

As an investor you must be willing to say, “Nope I am not familiar with this and I should not be touching it for now. Or that some things are genuinely too hard for me to understand for now. I should learn more about it before diving into it.” Everyone’s got to know his own limitations at the stage that he is at. You can only play your A game in what you are competent at. That is of course, not an excuse not to learn anything further, but the message we are trying to drill across is to not risk your hard-earned money on things that you are not familiar with.

In the context of investing, so let’s say if you don’t quite understand how fundamental analysis works, perhaps you should just buy a market ETF. If you don’t quite understand how technical analysis works, you should just do dollar cost averaging. If you don’t quite understand how options work, you should not even get started with them at all. 

This is nothing different just as in our lives. If we have not been trained on how to pilot a plane, then don’t think about sitting in the cockpit. Or if you have not even learned how to drive a car, then just take the public transport. And if that means that you will reach your destination much later, so be it, because at least you will still reach there safely, though taking a longer time. The wrong thing would be that you want to reach your destination fast yet not willing to learn how to drive properly and attempt to do so.

But don’t let that be an excuse not to learn new skills

A lot of people dispensing investing advice are missing the whole point altogether. Just because they can’t drive they insist that taking public transport is the only way to go. And for those who can drive but can’t fly, they claim that driving is safer than flying a plane. But there are actually more car accidents than plane accidents. It is about how competent you are as an investor that determines what choices you have that are safe. 

You may not be qualified now, but if you have the will to learn something, don’t let anyone tell you that it cannot be done. Yes, perhaps more people are going to fail to get a pilot license as opposed to a car license, but that doesn’t mean that it cannot be done. And just because fewer people can really fly a plane or understand how to fly a plane, it is not equivalent to the fact that the act of doing so is going to be more dangerous! So to tell someone not to trade options because it is dangerous is akin to telling someone not to attempt how to fly because flying a plane is dangerous.

Recognize that to become a successful investor is a marathon, not a journey of a few weeks. Learn the foundations and slowly move up to higher levels when you feel comfortable. While we are comfortable at what we are doing now with both stocks and options, we didn’t start off with options initially until we have a firm grasp at investing itself. Everyone who got to where he is had to start from where he was. As long as you understand your own circle of competence, you will eventually arrive at your destination.

Leave a Reply