Monday, February 19, 2018

Landlording & Investing: Circle of Competence

Warren Buffet and Charlie Munger are among the world's best investors.   As are all of the panelists on the popular series Shark Tank.  There is one thing they all have in common when it comes to their investing practices.

They do not invest outside their circle of competence.

In fact, determining your circle of competence is the first step toward becoming a great investor.  What exactly does that mean?  Simple: Determine what you you actually understand or are capable of understanding.  Warren Buffet doesn't invest in technology.  It's just one of those things that are further outside the realm of his understanding than he cares for when it comes to investing.  The folks on Shark Tank frequently claim the same thing.  They say things like "I'm sorry, this is just not an industry that I'm comfortable with, and I can't help you."  If they aren't putting their money in things they don't understand, then why should you?

It's funny.  Today, people are either holding their money in savings accounts that earn them next to nothing, or they throw their money into investments that they don't really understand.  These both sound like fools errands to me.

Right now, my biggest investment is a rental property in Portland, Oregon.  I lived in Portland for many years.  I understand the real estate market there very well.  I have rented there; I have owned there; I have lived there.  I understand how much houses sell for, rent for..  I know which neighborhoods are good, bad, and ugly.  Portland real estate is definitely within my circle of competence.  I would definitely place another investment there if the other numbers made sense, because I am confident in my ability to actually determine whether or not the numbers make sense.  Unfortunately, right now, I don't really think the numbers in Portland real estate make sense for investing purposes (at least not for me; you should make your own determination).

"Circle of Competence" is one of the primary reasons real estate investors are so frequently only really looking into real estate in the town/city where they live.  It makes sense, right?  They live there, and they understand the basic real estate environment.  On one hand, this is pretty smart.  You definitely shouldn't invest in things you don't understand (Hello crash of 2008!).  On the other hand, the numbers have to make sense as well.  I know, I'm not actually telling you what numbers to look at yet, but I don't want this post to become a novel on its own, so we'll do that another time.  Regardless,  my point is that first, you need to understand what's in your circle of competence.  Then, you need to determine what the numbers need to look like to make sense before you pull the trigger.  Then, you wait.  Very little of an investor's time is spent actually making deals.  Most of it is involved in self-education and waiting.  I haven't pulled the trigger on an investment in some time...

If you're looking to determine your own circle of competence start by considering what businesses or industries do you frequent?  Do you understand how they work, or could you?  What cities or towns to you understand well enough in terms of real estate?  Once you have a list, use your smart phone to start following the stocks of companies that fit within your sphere.  Perhaps, you sign up for some real estate notifications so that you can keep up with the market in the cities/towns you understand.    You'll have more research to do, but this is a really great start.

I have determined my Circle of Competence in both real estate and the stock market.  Now, I am researching and waiting.  The brilliant part of this is that the research is helping to expand my Circle of Competence, and when the numbers look right on a piece of real estate or a stock I'm interested in, I will be ready to move!

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