Why Buffett asks you to invest within circle of competence

Amit Trivedi“Invest within your circle of competence. It is not how big the circle is, it’s how you define the parameters.” These are golden words of the legendary investor Warren Buffett. Last month I got an opportunity to address some primary school teachers during an investor awareness program. I asked the participants how many of them invest in equity. Out of around 25 teachers, only one raised her hand. Then I asked them the reason for not investing in equity. While a couple of them said, “equity is risky”; many of them said, “Because we do not understand it”. While the former is a more common answer to this question, the latter impressed me. It is quite ok to let some opportunities go. It is not ok to lose capital. Many a times we hear the argument that one must “make hay while the sun shines”, meaning one should be quick to encash the opportunities presented. Agreed. However, it is important to understand what “opportunity” means. The dictionary meaning of opportunity is: a situation or condition favorable for attainment of a goal. This is where knowledge is required. How does one know whether this situation or condition is favorable? What if the situation looks favorable, but is risky? How does one assess the risk in the situation?Knowing what you know and what you don’t is the starting point to acquire wisdom. It is also an important trait for investors compared to arrogance or overconfidence. Often the confidence in one’s abilities is misplaced and one is not even aware of the same.I really appreciate those teachers, who did not invest their money in equity when they did not understand it. At the same time, they were willing to learn and that is why they were not just attending the session, but also taking down notes. Making money is not difficult provided you are willing to learn. Stay away from investments if you do not understand. At the same time, what should be the starting point? To begin with, learn about equity as an asset class. Learn the risk and return relationship. Understand your needs to figure out whether you really need to invest in equity. After that, learn about mutual funds. A new equity investor is advised to start investing through mutual funds only rather than diving into stocks directly. Within equity funds, the starters must avoid sector funds as well as mid-cap and small-cap funds. Go with the diversified equity funds with good long term track record. The author runs Karmayog Knowledge Academy. Views expressed here are his personal views. He can be reached at amit@karmayog-knowledge.com.