No. of Recommendations: 19
This video explains the phenomena. Shortly speaking, competence and confidence are often inversely related at the two extremes of the spectrum:
https://youtu.be/JpMreN8dceE?si=LwlnxFvCz2cY_UZZWhilst typically not framed as related this to investing, our overconfidence may drive us to make impulsive trades, ignore diversification, or become afraid of or charmed by ”in the moment” themes, without objective analysis, increasing our exposure to permanent losses, and long-term underperformance of index funds.
The quick and dirty method to avoid the problem is to stick purchasing buainesss that you have expertise in, or deep knowledge of the industry.
This is a subtly different variation to Buffett’s way of explaining the solution as sticking to businesses that you "understand". I make the distinction here that we may think we understand something when we lack competence with it, whilst underestimating how much we understand about industries that we have strong knowledge about.
The related problem is that we have difficulty determining what we have strong knowledge about and where we have little or no competence. So a mental test might be extra careful to remain not just the boundary of our competence, as Buffett puts it, but try to move into an even smaller boundary of industries (a smaller circle within the circle) where we have objectively superior knowledge. In those industries we we have lower confidence (according the the phenomena), allowing us to enter investments with a more critical analysis, and with crucial insights, that others taking the opposite trade have skipped.
- Manlobbi
