In 1942, the world was at war. In December of the previous year, the United States entered WWII when Japan attacked Pearl Harbor.
By that time, the US got into a war that started in 1939. While Americans were quick to adjust back at home, by turning factories into manufacturers of weaponry, the war itself didn’t play out well at all.
America was struggling in the Pacific. It was a rough first year with many casualties. Some people started to lose faith.
That was the year an 11-year-old boy made his first stock purchase. He bought six shares of Cities Service, an energy company, for $38 per share. He bought three shares for himself and three shares for his sister, Doris Buffett.
The boy was of course Warren Buffett, the greatest investor of all time. About 1942, he remembers, “We were losing the war in the Pacific.” Buffett learned an important lesson: “Never bet against America.”
That same year, in the midst of the crisis, the Manhattan Project started, which eventually developed into a nuclear weapon that ended the war in 1945.
There’s always bad news
When Warren Buffett bought his first stock, it looked like the allied forces were losing the war. But as long as you’re bullish on the future, you must become callous to what’s reported on the news. Buffett says:
“If it’s a good business at a good price, we buy it. There is always going to be bad news out there.”
Buffett and his partner Charlie Munger claim they never allowed macro factors to interfere with their investment process. They have a system for picking stocks and they have a mental model for staying in those stocks.
When you want to make an investment, whether that’s in the stock market, real estate, or in a private business, I bet that you can point to at least a handful of factors and say, “Let’s see how that plays out.”
Maybe you want to see how inflation plays out or whether a geopolitical conflict gets solved, but let’s face it, these are excuses. As Buffett says, there will always be bad news out there.
Instead of focusing on the news or listening to the opinions of people on CNBC, FinTwit, or YouTube, focus on your behavior.
There are many ways to get rich; only a few ways to go broke
There are multiple ways to build wealth. You can get rich in endless ways. That’s exactly what makes building wealth so difficult.
We have so many options that it’s difficult to pick one and say;
“I’m going to follow this path to wealth, and I’m going to stick to it NO MATTER WHAT.”
What happens to most people is indecision and they fall for the “grass is greener” investing fallacy. They might start on a certain path, but after a while, they get impatient and get swayed by the opinions of others.
- “Bitcoin is the future!”
- “Pot stocks are the way to go!”
- “Buying real estate with no money down will make you rich!”
- “Swing trading currencies is a sure way of making good money!”
I can go on like that for a while. There are thousands of ways people claim to generate wealth through investing and trading.
Instead of focusing on how you want to get rich, focus on avoiding financial ruin. When you avoid ruin, you set yourself up for success. This has always been the focus of Buffett as well:
“We think in terms of not exposing ourselves to any mistakes that could really hurt our ability to play tomorrow. And so we are always thinking about, you know, worst-case situations… We have to think about whether we’re doing anything really big that could have really terrible consequences.”
While there are many ways to get rich, there are only a few ways to go broke. And these are very obvious ways.
Circle of competence: How Buffett avoids financial ruin
When you focus on avoiding the following things, you will make sure you avoid going broke. When it comes to the game of building wealth, that’s the most important thing.
Here’s one mental shortcut you can use next time you’re considering putting your hard-earned money on the line:
“Do I understand this investment?”
Warren Buffett and Charlie Munger refer to this principle as the “circle of competence.” In this short clip, Buffett explains what that means:
The idea is that even the smartest person in the world has a limited amount of knowledge. Buffett and Munger believe that investors need to have self-knowledge if they want to avoid financial ruin.
When you ask people who lost money how it happened, they often say, “I didn’t know what I was doing.”
Self-awareness will help you to invest in what you know
One of my friends who owns a lot of real estates said he got into trading stocks in the 1980s. This was before the ETF investing revolution and low transaction costs.
Back then you had to pick stocks if you wanted to build wealth in public markets. I still remember vividly when my friend said, “I tried it a few times and I lost a lot of money. I had no clue what I was doing. So I said, I’m never touching stocks again.”
He got into real estate because he did know what he was doing. Once he had a strategy that worked, he stuck to it until now, decades later. He never changed his strategy. Never tried to do things bigger or differently.
This is the way we can avoid financial ruin—by investing in what we know. When you have a basic understanding of how the stock market works, which you can learn from books and courses, you will feel more comfortable investing in the broader market.
But we still need to have self-awareness. I’ve been investing since 2007, but I realized within a few years that picking stocks is not within my circle of competence. It was also not something I wanted to learn.
I cared more about becoming a successful passive investor.
Next time you want to make an investment, use the mental model of Buffett and Munger. Ask yourself whether you know what you’re doing.
If the answer is no, either move on or start learning more.
“Do I understand this investment?”
That might be a simple question. But if you keep asking yourself it will save you a lot of money.
