Rusmin Ang: 3 Reasons To Stay Within Your Circle Of Competence

The concept ‘Circle of Competence’ is termed and popularised by Warren Buffett. Three years ago, I bought into Courage Marine, a shipping company with its primary business in transporting commodities such as coal. I had no in-depth knowledge of the shipping industry, and it cycles, but I invested anyway solely based on someone else’s analysis.

Last year, I was abandoned in the middle of the sea for being too “courageous”, and I sold off my stake in Courage Marine at a 30% loss. I had no one to blame except myself for straying too far from what I knew and understood. This unfortunate event of mine carries an important lesson – always stay within your circle of competence.

How do you identify your circle of competence?

For most people, it starts with your very own job or profession. Your profession gives you an innate understanding and behind-the-scenes knowledge of how your industry and the companies in it operate and function.

That can be highly valuable when it comes to investing within your industry; you know which companies are the best to pick out of the bunch and you know which ones are dead-in-the-water and you simply must avoid.

Another way to identify your circle of competence is how you spend your money. If you are an informed consumer of any product/service you frequently use, you might possess some in-depth knowledge of which companies are more likely to succeed with consumers and thrive in any given marketplace.

Here is an excerpt from my book, Value Investing in Growth Companies published by Wiley:

Here are 3 reasons why you should always stay within your circle of competence:

1. You possess an unfair information advantage over others

If you are a property agent, your area of expertise is in the property industry. You are more likely to know how market sentiments affect property prices, where the best locations are for investments or how much a piece of land is really worth.

For example, you could capitalise on the information you know and invest in a company that owns multiple pieces of valuable real estate.

The stock market could have underpriced the company’s stock and may be selling it below its net tangible assets. With more knowledge and experience over others in your given area of expertise, you should focus and concentrate your efforts on it. Your odds of success will be higher!

2. It narrows down your stock selections

According to World Federation of Exchanges, there are over 46,332 companies listed worldwide. In Singapore alone, I’m spoilt for choice with over 700 stocks to choose from.

If I took a month to analyse each one deeply, it would take me over 58 years just to finish the entire Singapore stock exchange! I specialised in the aerospace engineering field, and so I promptly looked at those publicly listed companies that fell within my area of expertise.

I shortlisted two companies, SIA Engineering and ST Engineering and I was able to analyse these businesses and get up to speed immediately quickly.

3. You make fewer mistakes

One and a half years ago, a generous friend of mine shared with me an investment idea, Civmec Limited. Civmec is largely involved in the mining, oil and gas industry of which I know nothing about!

Due to the hugely optimistic mining outlook in Australia, where Civmec largely operates, the management was confident of their business growth and that its share price would hit $2 and up. At the time, the stock was trading at $1.20 which signified a potential upside of 66%.

Unfortunately (or fortunately for me!), its stock is now trading at 75 cents – a massive 37.5% drop. Staying within my circle of competence helped my dodge that bullet. You make much fewer mistakes if you stay with something you understand and are familiar with.

Seek to expand your circle…

In closing, while you should always stay within your circle of competence, at the same time you should always seek to expand it. As you become a better investor and gain competence in one area, you can start to push yourself a little further.

There are undervalued investment opportunities everywhere, and the larger your circle of competence grows, the more of them you have access to. Just one thing… remember where your boundaries are.

Upcoming Event

We managed to invite a few popular names in the finance and investment education world to speak at our upcoming Shares Investment Convention on 16 September 2017 (Saturday)!

They’ll be covering topics on personal finance, macroeconomics and investment strategies to help retail investors make more shrewd decisions especially in the current uncertain and volatile economy. Click on the button above to learn more and grab your early bird tickets. See you there!