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Circle of Competence Paradox


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Hi Guys,

 

Lately I have had a repeating thought, due to my own experience in some investments.

 

My returns have been much better in investment ideas that were clearly outside of my circle of competence, but the opportunity seemed too good to ignore, so I put in the work and found some "gems" and had pretty good results.

 

In contrast, investment opportunities inside my circle of competence, didn´t perform so good, I put much less work and I guess I was biased because I "loved" the company or industry.

 

My point is, when a potential investment is outside of your circle of competence, you are way more likely to put in the work and not having so many biases upfront. When the potential investment is inside your circle of competence, you are more likely to do less work cause you feel you are an expert.

 

Has anyone had a similar experience?

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Yeah I see this too. I think for you to stray into something outside the circle the value has to be even more apparent, thus probably investing in better opportunities.

 

Also when i think i understand an investment and believe it is in my circle it soon becomes obvious i dont have a clue. I think there is a certain amount of bias when assesing outcomes also. If you were not sure if an investment would work out and it does its a more positive experience than if you were sure something would work and it does.

 

 

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My point is, when a potential investment is outside of your circle of competence, you are way more likely to put in the work and not having so many biases upfront. When the potential investment is inside your circle of competence, you are more likely to do less work cause you feel you are an expert.

 

 

I think it comes down to the base rate within your circle of competence and your accumulated expertise. Even with less intense scrutiny you can more easily identify winners because of the latticework of insights/ideas/patterns that you've accumulated over hundreds of ours of studies/cycles which makes it easier to spot patterns sooner. It's kind of like the difference between raw intuition and intuition of an expert that has been honed over numerous iterations. The problem with this as you rightly articulate is that instead of treating it as a first step we can become too dependent on such shortcuts and not do the necessary legwork to cross the Ts and dot the Is.     

 

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circle of competence should be rebranded as circle of research. The more intense work you do in any field , and if you are good at detective work and connecting the dots in general, the more controlled the result. Of course luck plays a large part in investment and many investors don't like to admit it. but you can't depend on it. But I would argue that longer term, whether it's your competence or another field, there will always come a surprise you didn't anticipate that educates you. It's a life long learning process. But research and synthesizing information is the core action.

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I fully agree with everything you are saying guys, I think very similarly.

 

If I had to resume it all it would be something like:

 

Amazing apparent opportunity outside of your core circle of competence = more extensive research and less biased = a better understanding of the company and the situation = better decisions (buying/holding/selling) = better returns

 

I am not saying you should purposely look outside of your circle of competence, I just think it has a place and reframe circle of competence as: "something I am able to understand if I do some proper research on it"

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Competence is everything from risk management, through current industry knowledge, company specific knowledge, and basic investment 'expertise'. Most folks will be 'OK' around the company they work for, and the industry it is in ... risk management and investment 'expertise' have to be learnt. For many, it's just not worth the time invested - vs simply buying an ETF focused on your industry.

 

Assuming competence, aren't you really now making concentrated bets? and only in the things you know?

Diversification over 5-7 'investments' vs 20+, and a very different approach?

 

Index funds, and ETF's are great inventions, and more than adequately meet most requirements. Yes there is a cost to using them, but so is your INcompetence. So unless you're willing to treat the cost difference as 'tuition' ... for most, the index/ETF will be the better option.

 

Different strokes.

 

SD

 

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I’ve come to the conclusion that I have no circle of competence within the investment world.

I’m a generalist with a lot of opinions that I frequently mistake for knowledge.

https://knowledge.wharton.upenn.edu/article/generalists-vs-specialists/

The following is anecdotal and may not reflect exactly what truly happened but it's related to what you describe.

It is said that Henry Ford became concerned (he may even have been a direct witness of a friend being injured) with injuries caused by broken pieces of windshield glass after head-on collisions (then people had visceral reactions to such event, similar to accidents that occur these days with self-driving). Some report that he went to his engineers, asked for a solution and was told that such a solution did not exist. Apparently, Mr. Ford then decided to submit the problem to others who hadn't learned the reasons suggesting that this was impossible. Very rapidly, this became a problem of the past (the solution already existed) .

Even if Mr. Ford was a master at his own game, one could politely submit that a safety belt would have worked also but that's another story.

Keep the informed opinions coming!

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I’ve come to the conclusion that I have no circle of competence within the investment world.

 

I’m a generalist with a lot of opinions that I frequently mistake for knowledge.

 

https://knowledge.wharton.upenn.edu/article/generalists-vs-specialists/

 

I am with you DooDiligence, I read the book "RANGE" and I believe is one of the best books to improve your investing

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Just sharing my personal experience as well. I started out being super-disciplined investing within my circle of competence. However, ran into the issue of a concentrated portfolio within a few industries (don't see this as an issue thou). The real challenge for me is the business cycle. For example, ended up finding the market being really attractive when the cycle favours my circle of competence. It became more of a waiting game. I think this may play a part in the returns experienced. Ultimately, it's the business quality that really matters to me and hence, the short-term return is more of a noise.

 

 

 

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