Last week, I wrote about one of Warren Buffett’s classic rules: Invest in companies and assets with “wide moats.”
As I explained, Buffett “looks for companies with businesses that are well protected against competition.” They might “offer consistently better prices,” “have a first-mover advantage,” or “they’ve created a unique brand appeal.”
That kind of focus has helped me make a lot of money for myself and my readers. But there’s another Buffett approach that has to go with it: “Never invest in a business you cannot understand.”
That’s a lesson I learned the hard way two decades ago – well before I ever heard that quote.
You see, around 2003, I had a net worth of over $20 million. Which was pretty good for a small-town South Carolina boy who had to pay his own way through college.
After graduating, I worked until I could buy my first home in 1990 for $50,000, which I used to begin my wealth-building journey. The place had three bedrooms, and I rented out two of them to some friends of mine.
That meant they were paying off my mortgage while I benefited from appreciation. Plus, it made it much simpler for me to build a nest egg that allowed me to invest further.
My grandfather was a motel owner down at the shore. So I had grown up getting up-close-and-personal insights into commercial real estate. And then I studied it much more expansively in college.
Those combined experiences prompted me to buy up single-family rentals and duplexes one by one. Then I launched my development business from there. It took some extra research on my part, but it was well worth it when I signed my first contract with Advance Auto Parts (AAP).
They liked my efforts enough to keep signing me on. So did Blockbuster, Walgreens, PetSmart, Dollar General, Goodyear Tires, and other up-and-coming companies.
If only I had left it at that.
Understand Your Circle of Competence
But I didn’t.
I wanted more, which wasn’t a bad thing in and of itself. What was bad was the partnership I made in order to achieve more.
For one thing, as I’ve said in previous articles, he kept all the bookkeeping to himself. (Talk about a silent partner.) I wasn’t privy to any of it.
For another, he didn’t necessarily care to know what he was doing. While both he and I had significant experience in handling shopping centers, warehouses, subdivisions, and golf courses, he had zero experience in developing high-end hotels.
Yet that’s what he decided to get into anyway.
My partner – let’s call him C – began construction on The Renaissance Project: a mixed-use property with a five-star hotel and convention center. While I apparently didn’t know enough to stay clear of partnerships with people who wouldn’t let me look at the books…
I did know enough to recognize that C’s side asset wasn’t going to end well.
And so it didn’t. He ended up losing:
- That hotel
- His wealth
- My wealth
All because he didn’t understand the logistics of what he got involved in and I didn’t understand the finances of what I got involved in.
That’s how I lost my fortune the first time. (The second was because I didn’t diversify properly – a story for another time.) And it took me years and years and years to recover.
It’s not a place I ever want to be again. Nor is it something I want anyone else to experience.
Yet the sad truth is that most of them do.
Don’t Burst My Bubble
I’ve heard story after story after story similar to the one I just described.
Take the now classic example of the dot.com bust. People invested in those companies because it was “the thing,” not because they understood how they worked, what their management structure was, or what their balance sheets looked like.
Everyone knew that everyone was making money off the bigger idea. The wave of the future. The movement that was too big to fail!
So they invested too much, and they lost it all.
I’m not trying to shame anyone here. As I already admitted, I’ve been guilty of such foolishness too.
But, today, I’m committed to avoiding this kind of mistake. Every. Single. Time.
You can’t guarantee your investment choices from everything, of course. There’s always the potential for a company or sector to get hit.
However, you can lessen the probability of getting hit by staying in your lane of expertise.
For instance, I’ve personally worked hard to become an income expert. I know the ins and outs, the potentials and pitfalls of dividend stocks. That’s why my personal and professional portfolios alike are filled with:
- Real estate investment trusts
- Business development companies
- Master limited partnerships
- Utilities
- Asset Managers
- Dividend Kings
- Dividend Aristocrats
- Preferred stocks
- Bonds
It’s also why I employ people with varying expertise who can fill in important details I otherwise wouldn’t know. And it’s why I don’t get full of the knowledge I do have even when I am working with familiar areas.
I always research a company’s management, debt details, business history, and competitors before I buy. Then, if all of that checks out, I keep up to date on those details, selling if they change too much.
That’s how I’ve built my wealth back over the last 15 years. That’s how I plan to continue building my wealth.
And that’s how I plan to maintain my wealth after everything is said and done.
Regards,
Brad Thomas
Editor, Wide Moat Daily
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Source: Wide Moat Research