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The Circle of Competence

One of my favorite books of all time is “The Snowball.” I consider it to be one of the best biographies ever written. I’ve read it at least three times. It brilliantly recounts Warren Buffett’s life. One thing that strikes me (and millions of others) is when you see interviews, documentaries, and specials on the man, he rarely seems stressed or anxious. Excited, definitely excited, maybe a bit socially awkward, but not anxious. That said, Buffett is the man who coined the phrase, “Be fearful when others are greedy, and greedy when others are fearful.”

His relaxed manner seems incongruous in light of the fact that at any given time, he has billions in cash to deploy and exponentially more under management, $330 billion at last count. With the stock market dropping precipitously, and doom and gloom in the headlines, it would only be natural for someone with so much at stake to live or die by the direction of the market, high inflation, and interest rate volatility. But he doesn’t. He is famously unconcerned with the day-to-day movements of the market and has coined some memorable quotes to summarize his perspective…

“The stock market is a wonderfully efficient mechanism for transferring wealth from the impatient to the patient”

is one of my all-time favorites.

And to give you an idea of his state of mind during economic downturns and financial doom… 

“Charlie and I have no magic plan to add earnings except to dream big and to be prepared mentally and financially to act fast when opportunities present themselves. Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.” — From Buffett’s 2016 shareholder letter.

Note: These letters are always interesting, often illuminating and will make you a better investor. You can find them at berkshirehathaway.com/letters/letters.htmlSo, the obvious question is how? How can a man with so much at stake, and so much seemingly outside of his control, remain so non-plussed? The answer, in large part, is… the circle of competence. Buffett writes that…

“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.”

To truly understand what Buffett means and how he embodies this principle, you’ll need to do some further reading, but in summary, he identifies certain types of businesses where he has a baseline understanding of the business model, and then he researches them to death, forever. He has famously missed out on massive opportunities in emerging sectors because he was honest enough to admit he didn’t understand them well enough to invest. It wasn’t worth leaving his circle of competence.

He places maximum value on making investment decisions where he has an extremely high degree of confidence that he won’t lose money, and a relatively high degree of confidence that the investments will perform well. He places a high premium on peace of mind. So do we.

I’ve had some enjoyable conversations with many of you over the last couple of months. Many of those have included discussions about the economic cycle and our perspective. As I’ve shared with many of you, we’re not unduly concerned about interest rates, inflation, or the drop in the stock market. Our strategy hasn’t materially changed, and we’re well-positioned to benefit from the current volatility. Dan, Danny, Brandon, and the rest of the team prize sleeping well at night and making decisions in which we have a high degree of confidence in a profitable outcome. We’ve defined our circle of competence, we’ve built a margin of safety into every apartment community, self-storage facility, car wash, hotel, and short-term lending business opportunity–and we’re ready to rush outdoors with washtubs when the gold starts to fall.