Define Your Competency: 5 Methods to Prevent Overestimating Your Knowledge
In the 1992 Berkshire Hathaway shareholder letter, Warren Buffett wrote:
“What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know.”
Buffett leads with humility and is quick to eschew an opportunity if he cannot understand the business model or the technology.
Internalizing what he doesn’t know helps him avoid big blunders by concentrating investments within his Circle of Competence.
With new projects and technology applications popping up daily, there is much we don’t know about how the web3 ecosystem will evolve.
And that’s okay!
Purposefully defining what we don’t know provides a path to:
(1) learning about a new area, or
(2) avoiding it as an investment option.
Avoiding investments in things you don’t understand is a crucial principle to reduce the risk of financial losses.
In this post, we’ve included five examples of ways you can work to define your circle of competence and avoid investing in things you don’t understand.
Thorough Research
Conduct extensive research before making any investment. Understand the industry, market trends, competition, and the company’s financials. If you can’t grasp the fundamentals, it’s best to avoid the investment.
Complex Financial Instruments
Avoid investing in complex financial products like derivatives, options, and certain types of structured products if you don’t understand how they work. These instruments can be highly intricate and risky, and a lack of understanding can lead to significant losses.
Unfamiliar Sectors
Stay away from investing in sectors or industries you’re unfamiliar with. If you can’t explain how a company operates, generates revenue, and competes within its sector, it’s better to pass on the investment.
Lack of Transparent Information
If the information about an investment opportunity is unclear or not readily available, it’s a red flag. Avoid investments where the documentation, financials, or terms are not transparent.
Overreliance on Recommendations
Don’t invest solely based on someone else’s recommendation without understanding the rationale behind it. Blindly following advice without comprehending the underlying reasons can lead to poor investment decisions.
Defining your own circle of competence takes humility. Many are not comfortable with embracing a lack of knowledge or expertise in a certain area.
In striving to limit mistakes of capital allocation, be honest with yourself about what you don’t know.
Here’s how I can support you!
