Berkshire Hathaway co-chairman Charlie Munger is chock-full of more investment knowledge than almost anyone else alive. What truly sets him apart from other investing greats, however, is the breadth of his knowledge -- his ability to intertwine the lessons of a variety of disciplines into investing, or what he refers to as a "latticework of mental models."
Such was the case when, at a past Berkshire Hathaway shareholder meeting, Munger told a story of composing great Wolfgang Mozart. It goes something like this:
A young man, around 25 years old, goes to Mozart and asks him for advice on writing symphonies. Mozart suggests to him that he is too young to write symphonies. The young man gets confused and reminds Mozart that Mozart himself had been writing symphonies since he was 10 years old. Mozart responds, "Yes, but I wasn't asking anyone for advice."
Humbling, isn't it? More importantly, this story can easily be related to the world of investing.
In the past decade, it's become a heck of a lot easier to manage your investments by yourself than it was in the past. With the advent of do-it-yourself discount brokers, managing your own money has become a point-'n'-click adventure that many of us have decided to tackle ourselves. But is this really the smart thing to do?
Anyone in charge here?
It's important to remember exactly what we're doing when we invest: We're purchasing an ownership stake in a company. That said, successful investing requires a breadth of knowledge about all sorts of things: the industry, management, consumers, the economy -- and that's just to gauge the prospects of the company. On top of that, in order to ensure you bag your investment at an attractive price, you'll need to grapple with the world of valuation, which will require knowledge of everything from free cash flow to net present value. Yikes!
So, wait a minute, am I telling you that you're not competent to manage your personal investments? Of course not! There is enough public information on companies out there for the average Joe to sift through and find winning investments, no question about it. Putting the pieces together and sharing information is part of what The Motley Fool is all about. Nonetheless, that doesn't make investing on your own a walk in the park.
So how do you know when you've gained enough knowledge to strike out on your own? Certainly a tough question, but here are some quick tips.
Stay within your circle of competence
Warren Buffett attributes his success partly to this small piece of advice. If you don't have in-depth knowledge about the industry you're investing in, don't even dip in your toes. The universe of investments is huge. Why venture into areas you aren't comfortable with?
Few investors have a clue what actually happens behind the scenes at Dendreon (Nasdaq: DNDN ) , Texas Instruments (NYSE: TXN ) , or even Apple (Nasdaq: AAPL ) , for that matter. But most of us can get our heads around PepsiCo (NYSE: PEP ) or McDonald's (NYSE: MCD ) .
Moreover, if you have specialized knowledge about a difficult sector, you have a huge advantage. For instance, if you know the energy industry well, then you can easily go beyond giants like Chevron (NYSE: CVX ) and ConocoPhillips (NYSE: COP ) to look at more promising smaller plays in the sector.
By staying with what you keenly know, you greatly lower the odds of making a serious blunder. If you can't look in the mirror and succinctly explain exactly what the company does, you're better off moving along to something you can.
Read the annual reports
Think you've got what it takes to venture out on your own? Try this: Take a company you're thinking of investing in and read through its annual report, called the 10-K. Don't cheat ... read every page.
If there are parts of the report that make your head spin or your eyes glaze over, you should take a hint. If the financial statements look more like ancient hieroglyphics than a great source of data, there's nothing to be ashamed of, but you should probably take another route in investing.
Well then, what to do?
If going it alone isn't your thing, then what? Thankfully, there are indeed many more options than just individual stocks. Over the past decade, the explosion of exchange-traded funds has made diversified investing for those not quite ready to take the plunge into individual stocks as cheap and easy as it's ever been. All you do is pick a sector, market index, or even a geographical area, and your funds are put on autopilot.
Be honest with yourself
In times like these, it's critically important to keep your ego in check and not be afraid to admit that investing in individual stocks might not be your thing. The road to successful investing is a journey -- not something that can be learned overnight, but nonetheless achievable with the right amount of desire and determination.
Turns out you can listen to Mozart in more ways than one.
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