Those Three Little Words That Investors Hate to Say: "I Don't Know"
Those Three Little Words That Investors Hate to Say: "I Don't Know"
"Our job is to find a few intelligent things to do — not to keep up with every damn thing in the world."
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Sitting on the front corner of Warren Buffett’s office desk is a tray labeled “TOO HARD” in big, bold, red letters. In it, he deposits any investment idea, 10-K, or prospectus that he considers too hard, too confusing, or just not worth his time to investigate further.
When it comes to sifting through potential investments, Buffett is ruthless. He will only get involved with companies that he fully understands. Everything else gets relegated to that Too Hard Pile.
Now, I know what you’re thinking: How can anything be too hard for Warren Buffett?
Therein lies the rub. Buffett is not great because he knows everything, but rather because he knows that he doesn’t. And he’s not afraid to admit that to himself and to others.
That tray on his desk provides a physical reminder that the best investor of our era has a shockingly small ego. Here is a man with as close to an encyclopedic knowledge of stocks as anyone, who spent his formative years poring over every single page of Moody’s manuals (and, no doubt, remembers much of what he read). But, even with all of that compounded knowledge and over eighty years of market experience, he remains quick to discard any idea that does not fit.
“Charlie [Munger] says we have three boxes: In, Out, and Too Hard,” Buffett once said. “You don’t have to do everything well. At the Olympics, if you run the 100 meters well, you don’t have to do the shot put.”
One more point: Buffett keeps his Too Hard Pile right out front on his desk for all to see. When television cameras come around, he doesn’t hide it — but, instead, shows it off. If Buffett isn’t too embarrassed to admit that he doesn’t know everything, then why are we?
So many investors feel like they should have a strong opinion on every stock. Which is fine, as long as one of those opinions can be, “I don’t know.”
But that’s not exactly a common occurrence around these parts.
Despite the many lessons and exhortations about sticking to one’s circle of competence, we’re all tempted to opine on every stock that we’re asked about. To prove to the person asking that we can’t be stumped. That we actually do know a thing or two about investing.
Resist that temptation with all of your might.
Defaulting most ideas to the Too Hard Pile doesn’t make you dumb or lazy. It makes you smart. Only the most intelligent of investors possess the self-assurance and confidence to recognize their own limits — and then abide by them.
When it comes to your Too Hard Pile: the bigger, the better.
A Too Hard Pile is for all of those stocks that aren’t even worth bothering with. Maybe it’s from an industry that you don’t understand well enough. Or the path to profitability — and future cash flows — remains too uncertain. Or the accounting in the latest financial report seems a little too good to be true.
If anything sets your “Too Hard” senses a-tingling, toss it in the pile and move on.
As Charlie Munger says, “Our job is to find a few intelligent things to do, not to keep up with every damn thing in the world.”
Give yourself permission to say, “I don’t know.” It can actually be quite freeing.
Today, people are encouraged to be flexible and open to new experiences, to say yes to life. Whether that’s worthwhile advice or not, who am I to say? But it probably shouldn’t be the mantra of the intelligent investor. Instead, get used to saying no.
Danielle Town, author of Invested, explained how this approach makes her a better — and happier — investor in a 2018 Facebook post:
My dad [Phil Town] says most of the companies I look at will be Too Hard, which actually makes me feel safer. Super weird, right? But it’s because it takes the pressure off. The pressure to work at understanding, to wade through the mud, to spend precious time on something hard. No thanks. It goes into the Too Hard box, just like Mr. Buffett’s.
Your circle of competence can expand and get bigger. But it won’t happen overnight.
An intelligent investor need not be a stagnant one. By all means, embrace lifelong learning and keep pushing the bounds of your circle of competence outwards. Just don’t rush the process.
If I read an article about the semiconductor industry, that doesn’t suddenly make me an expert on TSMC, Intel, and all of the rest. Maybe it sparks an interest and leads to further research, but it will be months (or longer) before I can announce Mission Accomplished! and add that particular concept, industry, or company to my circle of competence.
As always, slow and steady wins the race.
Harsh truth: Being ruthlessly exclusionary with investment ideas will mean missing out on some big winners. The FOMO is real. Come to terms with that now.
Some stocks that you wave away will turn into ten-baggers. Some will go bankrupt. Many will end up somewhere in between.
Staying inside your circle of competence doesn’t magically bestow upon you a prescient ability to pick stocks. Rather, it instills the discipline needed to resist the siren song of supposedly can’t-miss sure things that you don’t fully understand.
In 1991, Warren Buffett spoke at the University of Notre Dame and regaled the assembled students and faculty with stories and advice from his legendary career. He touched upon one of his favorite memories — acquiring Nebraska Furniture Mart in 1983 — and how the great Mrs. B (Rose Blumkin) never strayed one inch outside her circle of competence.
I couldn’t have given [Mrs. B] $200 million worth of Berkshire Hathaway stock when I bought the business because she doesn’t understand stock. She understands cash. She understands furniture. She understands real estate. She doesn’t understand stocks, so she doesn’t have anything to do with them.
She is going to buy 5,000 end tables this afternoon [if the price is right]. She is going to buy twenty different carpets in odd lots, and everything else like that [snaps fingers] because she understands carpet. She wouldn’t buy 100 shares of General Motors if it was at 50 cents a share.
This story is a Rorschach test of sorts.
Did Mrs. B make a mistake by refusing to consider Berkshire stock (or passing up GM at bargain-basement prices) in these hypothetical examples or did she smartly avoid trading in assets that she didn’t fully understand?
To Buffett, the answer was clear. Mrs. B’s iron discipline and steadfast refusal to step outside her circle of competence is exactly what made her such a legendary entrepreneur and business leader in the first place.
Stock were in Mrs. B’s Too Hard Pile and, as such, didn’t even exist to her. No regrets. No handwringing. No exceptions. No matter what. Just a ruthless devotion to those areas of business that she understood.
Sure, it might have cost her a few bucks in these hypothetical examples, but she happily played the long game and never compromised her intellectual framework.
Along the same lines, I don’t think Ben Graham ever lost any sleep over turning down the chance to buy Xerox stock in the 1950s. When a young Walter Schloss pointed out that the company was selling at a fair price for its explosive growth profile, Graham calmly explained, “We don’t really buy stock like that.”
And that was that. Graham understood deep value — and he stuck to it.
Back to Buffett’s lecture at Notre Dame:
The most important thing in business and investments — which I regard as the same thing from our standpoint — is being able to accurately define your circle of competence. It isn’t a question of having the biggest circle of competence. I’ve got friends who are competent in a whole lot bigger area than I am, but they stray outside of it.
In [Father, Son & Co.: My Life at IBM and Beyond], that Tom Watson Jr. recently wrote, he quoted his father as saying, “I’m not a genius. I’m smart in spots, but I stay around those spots.”
And that’s all there is to it in investments — and business.
Kingswell, this article was superb. Thank you!
Staying within ones circle of competence is critical. Growing that circle is also important (and one of the great joys of investing!). To expand our circles, we simply follow rabbit holes of curiosity all the while learning and acting in small, consistent steps.