Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) chairman Warren Buffett (Trades, Portfolio) has been investing in shares since 1941. As such, he has extensive experience with buying and selling stocks in a wide range of market conditions.
Conversely, around 15% of today’s investors only started buying shares in 2020. Indeed, there has been a surge of interest in investing over recent months across a broad range of demographics. Many of them responded to the low valuations on offer following the stock market crash in 2020 Some have also been attracted to investing by the stock market’s recent bull run.
A lack of experience
Either way, many of today’s investors have very limited experience. However, their success over recent months may mean they have high opinions of their own ability. This is natural, since they are likely to have achieved large profits in a short space of time.
The problem, though, is that bull markets have historically only lasted for around three years on average. Therefore, there is very likely to be a market crash over the coming months or years that could highlight their lack of experience. Some may have purchased richly valued shares that post relatively large declines in the next bear market.
Knowing what you do not know
This point has previously been highlighted by Warren Buffett (Trades, Portfolio). As he once said: “There is nothing wrong with a 'know nothing' investor who realizes it. The problem is when you are a 'know nothing' investor but you think you know something.”
I think his view is highly relevant at the present time. It is impossible to gain sufficient experience to make consistently sound capital allocation decisions having been investing for only a year or two years. The problem is when an investor believes they have sufficient experience to cope with a range of market conditions after investing for such a short space of time. It could lead them to make significant mistakes such as failing to understand the risks facing a stock or investing in companies that they do not fully understand.
A circle of competence
Indeed, it may be prudent for investors - especially relatively inexperienced ones - to focus on developing their circle of competence. This could mean specializing in a specific industry or sector so that they can build detailed knowledge of the companies operating within it. Once this is achieved, they may be more capable of identifying sound businesses and investment opportunities that offer good value for money relative to their peers.
This view has previously been discussed by Buffett. As he once said: “You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
Clearly, it will take time to develop a circle of competence. Mistakes will be made while this process is ongoing, which could dissuade some investors from persisting with it. However, doing so could allow an investor to generate attractive long-term returns across a range of market conditions.
