Be sceptical of fads — operate within your circle of competence

As the old joke goes, St Peter had some bad news for an oil prospector who appeared at the pearly gates of Heaven: “You’re qualified for admission,” said St Peter. “But, as you can see, the section for oil prospectors is packed. There’s no way to fit you in.” After a moment, the prospector asked to say just four words to the occupants. That seemed harmless to St Peter, so the prospector yelled, “Oil discovered in Hell!” Immediately, most of the prospectors stampeded out for the nether regions. Impressed, St Peter invited the prospector to stay. The prospector paused, saying: “No, I think I’ll go along with the rest of them. There might be some truth to that rumour after all.”

Let that be a warning to CEOs and shareholders. Steering clear of rumours and self-delusion has been one of Warren Buffett’s key rules, ingrained into Berkshire Hathaway shareholders for years. We all need to hear such lessons repeatedly because reality’s temptations are always at war with our ideals.

The serial frenzies in meme stocks such as GameStop and cryptocurrencies such as dogecoin make this a good time to contrast what investors should do from what many seem to do. Comparing Berkshire’s and crypto’s faithful is apt given their outsized followings: an estimated 30 million Americans have traded cryptocurrencies and 30 million were expected to stream last week’s Berkshire virtual annual meeting.

Buffett defines Berkshire as a corporation with a partnership attitude. The value of each investor’s stake will rise (or fall) in lock step. This contrasts with how many seem to view companies with meme stocks or most of the crypto space. There, the culture is casino-like, where a small few stand to reap unimaginable riches while the overwhelming majority lose their shirts. Moreover, Berkshire’s culture emphasises patience and permanence. The company ideally holds investments and businesses forever and encourages its shareholders to hold indefinitely, through thick and thin. In the world of meme stocks and cryptocurrency trading, a strong norm favours immediate payday profits to be taken off the board.

Relatedly, the Berkshire ideal accepts that it requires decades to build capital and that accumulating wealth entails skill and time — as well as a bit of luck. In contrast are those who strive to get rich quickly — and effortlessly. Today, some investment market players even seem to believe that everyone should be rich, as a matter of entitlement.

The ideal Berkshire investor focuses on business, operating strategies, products or services, and competitive advantages. For many in the meme-crypto world, what counts is hype and adrenaline, not whether there’s a business plan, let alone operations or customers. The Berkshire model is sceptical of fads, fashions and trends, while dogecoin and other cryptos thrive on these.

This leads to the Berkshire canon’s cardinal principle: the circle of competence. It prescribes to invest only in what you can understand with a moderate amount of effort. This excludes at least some meme stocks and many faddish “blank-cheque” IPO-mergers. For most people, cryptos are outside their circle of competence. Indeed, large numbers of investors nowadays appear to be way out of their circle. For investments within one’s circle of competence, Berkshire adherents appreciate that prices
fluctuate widely and no one can predict such volatility. “Mr Market” is a moody manic, always willing to trade with you at the going price, sometimes elevated, sometimes depressed.

Following from both the limits of personal competence and the whims of markets, the Berkshire playbook demands a wide margin between the price paid and the value received. In Berkshire’s value-investing lexicon, this is the “margin of safety” and Buffett has long said that these are the three most important words in investing.

Finally, besides avoiding rumour-mongering and self-delusion, the Berkshire playbook says to beware the delusions of others. Berkshire’s vice chair, Charlie Munger, tells a story about fishing for muskies at Leech Lake in Minnesota. A visiting angler asked the local guide, “Are any muskies caught in this lake?”

“More muskies are caught in this lake than in any other lake in Minnesota. This lake is famous for muskies,” said the guide. The angler asked: “How long have you been fishing here?” The reply came:“Nineteen years.”

“And how many muskies have you caught?” asked the inquisitor. “None,” the guide answered.

So the next time someone tells you of the untold riches being made in day trading, ask them, “How much cash have you banked?”

Lawrence A Cunningham is a professor at George Washington University and editor of The Essays of Warren Buffett: Lessons for Corporate America

This article was published by MarketWatch.

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