One of Warren Buffett’s most oft-repeated pieces of advice is to invest in what you know. But, unfortunately, that’s something that is a little harder in this day and age than it used to be. With the internet at your fingertips and endless learning possibilities, as well as pressure to always be in the know, it can be hard to acknowledge that there are things at which you just don’t excel.
Here are some tips for learning how to develop your circle of competence so you can invest like Warren Buffett.
1. Start simple
It’s best to start with companies that you are familiar with and that you can easily understand. Your circle of competence generally will start with companies or areas that you’ve studied or worked in, because you’ll have a better understanding of them than those you haven’t. You don’t have to know everything, but you have to have an understanding of what you’re getting into.
2. Look five years down the road
If you can’t picture what the company will look like five years down the road, then you should move on. And that doesn’t mean picturing success, that means understanding where the market is going, what the competition looks like, and what challenges and risks the company will face. Then, decide from there whether it’s a good investment or not.
3. Know the edges of your knowledge
You can’t consider yourself competent if you don’t know the edges of your knowledge. What are the things that you know about, but not enough to confidently invest in? What confuses you? How do you separate out those degrees? That’s the edges of your circle of competence, and you should tread carefully in those areas.
4. Understand knowledge is cumulative
With every business that you invest in (or purchase) you’re going to learn more. It’s important to realize that your circle of competence will eventually grow with time. It shouldn’t be static, and as you continue to buy more stocks in more and more similar companies, you’ll better understand each individual market. The exposure will help provide you with an advantage, so use it!