The Circle of Competence: Invest in What You Know

Warren Wednesday 2/8

In the 1976 Berkshire Hathaway shareholder letter, Warren Buffett wrote:

“We select . . . investments on a long-term basis . . . [in industries] with which we are familiar and whose long-term business characteristics we feel competent to judge.”

This approach seems an obvious one, and it clearly worked for Buffett, but do others put it into practice? Do we overestimate what we think we know?

Everyone hates looking uninformed. Therefore, it makes sense that we spend time becoming familiar enough with a topic to be dangerous. We know just enough to sound smart and in the “know.” This can be particularly problematic when it comes to making investments.

Amid the rampant inflation and market uncertainty of the 1970s Buffett touted the ultimate investor humble-flex: he won’t invest in things he doesn’t understand.

He dubbed this the “Circle of Competence” and this approach to finding investable opportunities served him and Berkshire Hathaway well over the course of its 60 year track record. The benefit for investors in the web3 space is that this maxim applies whether you are investing in a new NFT project or the latest DeFi asset.

In 1976 the top 5 equity holdings of Berkshire Hathaway’s consisted of the following industries:

1. Insurance (GEICO)

2. Print News (The Washington Post)

3. Healthcare + Manufacturing (Kaiser)

4. Water (California Water Service)

5. Clothing…more specifically underwear! (Munsingwear)

(Munsingwear — AKA Penguin — don’t worry I had to google it too!)

What do these all have in common? They are easy to understand businesses, with strong demand for their products and services, and a runway to provide earnings over the long-run. After all, everyone needs insurance, water and (in most cases) underwear. Not a thing has changed about this in over 4 decades.

These industries are all — dare I say — completely boring, mundane and sedentary businesses. And that’s just how Buffett likes it.

What’s missing? Complicated business models, derivatives, and — you guessed it — cryptocurrencies and GoblinTown NFTs.

Just like I don’t make investments in biochemistry, pharmaceuticals or oil futures, Buffett doesn’t dabble in memecoins or NFTs. He doesn’t believe it’s within his circle of competence. Ever the consistent mind, Buffett has always been reticent about betting on new technologies, so his aversion to nascent web3 businesses should come as no surprise.

So how can investors in the web3 space use this to their advantage?

1. First and foremost, test yourself by trying to explain how blockchain technology works to someone over the age of 50. I’m not talking about from an investment perspective (this coin going is to the moon grandpa!). Instead, ask yourself if you can describe its innovative functionality, benefits to society and what the future might look like with greater adoption.

2. Make sure you clearly understand how a given cryptocurrency or NFT project will generate income and returns for holders. Too many projects tout excessive returns without any mechanism to do so sustainably.

3. Seek out the boring options! It’s hard to admit, but in 2023 Bitcoin is BORING. It’s easy to understand (for web3 enthusiasts anyway) and has a clear value proposition that grows with adoption in the long run.

Being willing to admit what you don’t know is just as important as what you do know. Channel your inner Ruth Langmore and just internalize:

Keep the “Circle of Competence” mentality in your investment evaluation toolbox and you’ll be adding diamonds in the rough to your portfolio.

If you found this post interesting give us a follow and stay tuned for more Warren Wednesdays featuring excerpts from our book, Warren Buffett in a Web3 World.

We took over 1,000 pages of wisdom from the Oracle of Omaha and condensed it into a snackable, easy-to-read investment guide to help you on your journey to grow wealth in the web3 space!