Let’s say you have a solid understanding of the telecom, banking and home renovation sectors. You currently own or are interested in buying companies like Rogers, TD Bank and Rona because you understand the industries they’re in. In other words, it’s clear for you what your area of knowledge is or what is within your circle of competence.
What would you do if you turn on your TV and hear a money manager on a business show recommend with conviction a stock in an industry you don’t know anything about? Would you be influenced by his opinion and be tempted to buy the stock? If your honest answer is "yes" or "sometimes", you would not be alone.
Like many individual investors, if you are influenced by opinions you hear on TV or read on the Internet, you will likely make poor decisions and buy or sell stocks on a whim. By doing so, you would be crossing the boundaries of your circle of competence and going to a place filled with landmines.
If this money manager owns this stock in his portfolio, you can be sure he will only bring up all the positives about the company and how its stock is undervalued or on the verge of going up very quickly.
Sometimes, they’re not completely wrong but will only focus on the positive points, which may not be inaccurate but can be misleading as they don’t make any mention of the negative points or the potential risk and downside.
Not convinced? Consider the appalling behaviour of stock brokers during the dot com boom where they were recommending technology stocks to their clients at the height of the Internet mania just as they were selling at the same time the same stocks in their personal accounts and making huge profits.
The minute you step outside your circle of competence, you go from being a smart investor to being a speculator or gambler. You go from investing with knowledge and confidence to investing with ignorance and hope.
The key is to always stay inside your circle of competence and resist the temptation of investing in popular companies that are widely covered by the mainstream media.
The size of your circle of competence can start off small but as long as you commit to continue to learn, it will grow and you will be able to spot more opportunities across different sectors.
What would you do if you turn on your TV and hear a money manager on a business show recommend with conviction a stock in an industry you don’t know anything about? Would you be influenced by his opinion and be tempted to buy the stock? If your honest answer is "yes" or "sometimes", you would not be alone.
If this money manager owns this stock in his portfolio, you can be sure he will only bring up all the positives about the company and how its stock is undervalued or on the verge of going up very quickly.
Sometimes, they’re not completely wrong but will only focus on the positive points, which may not be inaccurate but can be misleading as they don’t make any mention of the negative points or the potential risk and downside.
Not convinced? Consider the appalling behaviour of stock brokers during the dot com boom where they were recommending technology stocks to their clients at the height of the Internet mania just as they were selling at the same time the same stocks in their personal accounts and making huge profits.
The minute you step outside your circle of competence, you go from being a smart investor to being a speculator or gambler. You go from investing with knowledge and confidence to investing with ignorance and hope.
The key is to always stay inside your circle of competence and resist the temptation of investing in popular companies that are widely covered by the mainstream media.
The size of your circle of competence can start off small but as long as you commit to continue to learn, it will grow and you will be able to spot more opportunities across different sectors.
I was wondering why you chose the blog title "Smart Canadian Investor"... Aren't all businesses the same, fundamentally, and therefore, sound investing strategies apply to any publicly traded company no matter where they are? Or are you specifically targeting Canadian readers/investors? Thanks.
ReplyDelete- Global Dude
You're right, all businesses are more or less the same and investing strategies should apply to all of them, although investors should be cautious when investing in foreign markets as they may not be fully aware of domestic issues affecting these countries.
ReplyDeleteI chose Smart Canadian Investor as the title of my blog because I want to help Canadian investors improve their investing knowledge; there are very few Canadian investing sites offering sound advice and knowledge out there.
That being said, I believe the content on my blog can help all investors, not just Canadian ones.