One of the first steps in becoming a better investor is to know yourself. Take some time to think about your strengths and weaknesses. Take inventory of your likes and dislikes. Truthfully examine how much time, effort, emotional stress, and commitment you are willing to make in managing your investments.
Let’s start by thinking about how much time and effort you are willing to set aside for investing. The amount of time you will truthfully spend on investing is likely to be influenced by your likes and dislikes.
- Do you enjoy doing research?
- Do you like to follow the financial press?
- Is a night out at a shareholder meeting your thought of a good time?
- Is math your friend or does it freak you out?
I personally have at least about 8 hours a week to dedicate to investing. I do much of my investment research while I commute an hour each way to work on a train. I enjoy reading financial articles and learning about new companies. I even enjoy working through the math involved in estimating the intrinsic value of a company. Does this sound like you?
Don’t worry if it doesn’t. There is a very good alternative for you to get good market matching investment returns. Warren Buffett even states in his 1996 letter to Berkshire Hathaway shareholders:
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. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.
Beating the majority of investment professionals with very little effort is probably a very attractive alternative for many of you. I utilize index funds in my 401k, and they are also a core component of my taxable account.
However, if you have the time, desire, and knowledge it is very possible that you can achieve outstanding returns as an individual investor. The CXO Advisory Group recently discussed a 2002 paper entitled “Can Individual Investors Beat the Market?“. In summary, the paper indicates that skillful individual investors can beat the market by exploiting market inefficiencies.
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.
This quote above, also from Warren Buffett’s 1996 letter, introduces the concept of “circle of competence”. Knowing what you really know is very important. It may be that you know a lot about the industry that you work in or that one of your hobbies has made you very knowledgeable about certain products. One of my hobbies is playing with computers and the Internet, so I am fairly knowledgeable about the software and hardware industries, especially when it comes to consumer products. That is one of the factors that contributed to my recent purchase of Microsoft stock.
The importance of discovering your circle of competence is that gives you insight into what your personal competitive advantages as an individual investor might be. For example, I am very familiar with federal regulatory process. I have used that knowledge, combined with my technology skills, to identify and track companies that are in the process of taking their companies private to avoid the regulatory costs of compliance with the Sarbanes Oxley Act. It is likely that you also have a competitive advantage potentially in analyzing fashion brands, golf products, restaurants or some other product or industry.
So what do you really need to know? Let’s see what Buffett has to say:
To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of
course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses – How to
Value a Business, and How to Think About Market Prices.
I am sure that we will cover the topic of how to value a business and how to think about market prices over the next 30 days. As a first step tonight, think about your inner investor. Please feel free to use the comment box below to write down and share your investor profile. Maybe together we can help identify your circle of competence and your potential competitive advantages. I am sure this journey of self discovery will help you improve your investment returns.