In Tom Peters’ most famous book, In Search of Excellence, he mentions a great principle: Stick to the knitting. In other words, stick to the business you know.
Warren Buffett often talks about things he’s does not know. When he doesn’t know something he is apt to point it out. That seems simple enough, but there is tremendous wisdom in that. In life, as in business, it’s important to know what you know and know what you don’t know. As Warren often says, know where your parameter is and when you’re getting close to it.
In the heyday of real estate many general contractors (GC’s) left working for other builders and started developing themselves. Instead of just making their GC fee (a percentage above cost) why not develop for themselves and get the upside. That was easy in a bull market – a rising tide lifts all boats.
Low and behold, when the tide goes out you see who’s swimming naked. When the market fell, many builders instantly went bankrupt, even before they filed notice to creditors. GC’s were faced with lines of credit that were up for renewal, warranty and construction issues, mismanagement of costs, over-leverage, you name it. Everything can go wrong when you least expect it. And for many people it did in 2007 and 2008.
That happens when you move beyond your competence.
The tendency to resemble lemmings and follow the crowd is a human flaw that will never disappear. Psychologists call this social proof. Essentially, you do something for the sole reason that others do it. If people make money in penny stocks, why shouldn’t you buy 10,000 shares? Your neighbor just bought ten homes and saw the value of them go up by 15% in one year. Why shouldn’t you get just a few?
In Search of Excellence, Peters talks about businesses that get an itch to enter new industries and expand for expansion’s sake, a cardinal sin of business management. Not that businesses shouldn’t be creative and innovate. Or that companies shouldn’t be nimble and open-minded. But that businesses should stick to their core competence and expand those competitive moats in which they already have.
Whether you plan to invest in stocks, bonds, ETF’s, private equity, real estate or anything else make really make sure you understand what you’re getting yourself into. If not, you might as well hire a money manager or financial advisor to protect you against yourself.
When it comes to money and finance, better safe than sorry, know what you’re doing.