My Circle of Competence
~Success is more a function of consistent common sense than it is of genius~
An Wang,
1920-1989, Chinese-born American Physicist, Founder of Wang Laboratories.
From time to time I’ve often thought about more diversification in my portfolio. Why? While I’m not grossly exposed in any one market sector I am heavy in financials, almost 50% of my unregistered portfolio resides in this sector. I own great companies but this weighting is admittedly a bit riskier than I’d like. I also believe what casts of thousands including all the talking heads and experts have advocated for decades many times over: diversification is essential for any investor because it mitigates risk.
In this big country of ours, let alone in foreign markets, there are tons of companies out there producing and selling everything from A to Z.
Some of these companies I understand, most I do not. I know what Canadian banks do. I know what Canadian utility companies do. I know what Canadian telecommunication companies do. Not everything about these organizations mind you, I don’t understand every product or service they deliver but I understand their business model and raison d’être.
To be a successful investor I believe knowing what you know is just as important as knowing what you don’t know.
Diversification for my portfolio is a long-term need but in the same light I know I can’t invest in too many businesses because a) I won’t ever have the money for it and b) investing in companies that I don’t understand is just plain guesswork and foolish.
If you’re an expert in an industry I suggest you leverage that expertise to your investing advantage, but don’t go overboard – you’re throwing out the prospects of diversification. I work in healthcare and I think I have a pretty good idea how healthcare companies operate, with experience in both public and private sectors. In reviewing my portfolio, I don’t own tons of healthcare companies but I own a couple because I understand this sector quite well. I know how healthcare, pharmaceutical, biological, and medical device companies run better than most. I only own a few companies from this sector because I’m also trying to be diversified.
Even though I stay within my body of knowledge more often than not, I’ve made mistakes – click here to read more. I know I’ll make more in the future. Everybody does. You don’t accelerate your learning if you don’t make a few. Just keep them as small and as infrequent as possible 
By continuously reviewing my experiences, applying what I understand and not taking risks with companies that I don’t, my circle of competence will become forged over time. I think I can become a successful investor if I remain objective with my investment choices, stay patient and buy businesses I understand. I’ll try to always avoid the ones I don’t as shiny or as sexy as they may appear. Investing directly in companies can be challenging but like An Wang mentioned, I think the process can be made easier by consistently making sensible choices. Businesses I own will always have highs and lows and many cycles of each. I expect this. I’ve taken time to understand these companies and how they behave, especially when times are rough. There are more companies to learn about. I’m looking forward to that.
Like rings on a tree I hope to grow my circle of competence year by year, patiently and steadily. This approach should make me a better dividend investor. Time will certainly tell. The beauty of this blog is, you’ll get to read that journey all the way 
Are you developing your own circle of competence? Are you already “there” as an investor?
Share your thoughts!
@TWC,
Thanks very much for the details about KBL. Very true, a niche sector, but a great niche all the same! I will read up on it more. It might be a great fit for my TFSA down the line!
Cheers!
@My Own Advisor
Hey there,
KBL has been a hidden gem for me. Since I bought my positions (2 separate occasions), they have always either maintained or increased their dividends. Their IPO was in 2005 when they were a Trust. They converted from a Trust to a Corporation on Jan 2011.
It’s one of those small cap Canadian companies that allows you to diversify into a niche sector that you normally can’t get into. They are the largest largest owner and operator of laundry and linen processing facilities in Canada and have a boat load of long-term contracts.
Nice yield, stable company in my view. Heres’ the divvy history: http://irsolutions.snl.com/GenPage.aspx?IID=4104834&GKP=205477
I probably do not diversify the way I should. I probably do not invest the way I should. I have read a lot on the subject, then I have gone my own way.
I have made most of my money in financial and utility stocks. I do a have bias towards both financial and tech stocks. I worked in the IT in the financial industry. I also have industrial and retail stock. I have a bit in REITs and very, very little in resources. For me resources are very risky and are not long term investments.
Because I am living on my investments, I usually have around 5% in MMFs. Currently this has been run down a bit over the last recession. I will build up my MMF funds over the next while and have enough in place before the next recession (or bear market) comes.
@Susan,
Yeah, I think Canadian financials and utility stocks are the way to go, predominantly. Everything I have read says these sectors, historically anyhow, reward shareholders generously with dividends. I expect nothing more from the future. I need more retail in my portfolio. I’m kinda low in REITs also; I’d like to have between 5-10% in there and I’m just short of that.
When I got interested in the art of investing, I started reading any book on the topic I could lay my hands on. You know, from the classic “The Wealthy Barber” through Derek Foster’s five books, a few books form “The Little Book of …” series, “The …For Dummies” series and many, many more. I learned a lot, I bought my first companies and commenced my DRIP portfolio. I must admit I even passed “The Investments Funds of Canada” course just for fun and more knowledge.
One of the things I learned early in my journey was the proverbial: “Never put all your eggs in one basket” or, in other words, the importance of diversification. Then, one day I said to myself: “Self, who is the greatest investor in the world? Well, Warren Buffett is of course. What have you read about/by him and what do you know of his investment habits and methods?” The answer was simply nothing. It was sort of like living in the Vatican, and not even thinking of seeing the Pope himself. How shortsighted of me? So, off I went to the library and I got pretty much every book about Mr. Warren Buffett. And what did I read there about diversification- “Wide diversification is only required when investors don’t understand what they are doing.” I think this relates nicely to what you write about investing in what you know and understand, and avoid investing in the opposite. Currently, my financial stocks represent about 30% of my portfolio, most of it being BNS. I would like to grow my BMO holding to the point of starting a sunthetic drip, and if that puts the financials close to 50% , so be it. I won’t lose my sleep over it.
As for the circle of competence, I really like the methaphor about the tree’s rings. I must say that finding this (and other blogs linked to this website) meant adding a few rings on my tree of knowledge trunk!
@Elemag,
You make me chuckle, the art of investing – is there such a thing?
Good of you to pass the “The Investments Funds of Canada” course – if only for kicks.
Diversification cannot be understated but folks do not need to go overboard. If you buy what you know you always have much less to worry about.
I guess that’s why while I enjoy (err, love) investing in dividend-paying stocks, nothing is for certain. So, I use my RRSP as a supplement to my defined benefit pension. I’m really risk adverse. I consider my DB pension as a bond for the most part (something I need to write a blogpost about
, but I use my RRSP to be diversified in what I don’t know or can’t afford (tons of companies via cheap ETFs) and my dividend-paying stocks that I understand to do the rest. As I understand more companies, I’ll buy more companies and hopefully hold them forever for passive income.
So far my strategy seems to be working, but time will tell. I must say, I was pretty happy about the falling market yesterday. I might get to buy some of my stocks cheaply via DRIPs this month!
Glad you liked the metaphor about the tree’s rings. It was something that resonated with me too.
Thanks for your detailed blog contribution again!
Yep! Buy what you know. I agree with Susan. Not buying what you know is what led a lot of financial institutions into ruin. Even when you are buying what you know, there is still a lot of risk. Why amplify it?
It takes a big person to say “I really don’t understand this”.
@Mantra, you’re right, there’s always risk so why amplify it? Great point.
I agree with you that you should buy what you know. Wasn’t this what the last recession was about, people buying things they did not understand? I have been though a few recession and this is a recurring theme.
Currently I have 27% of my total portfolio in financials (banks, insurance companies and mutual funds companies). I am sure that this will go higher as the banks and insurance companies recover.
Susan
@ Susan,
Thanks for your comments and sharing your experience. Even when you buy companies you understand, bad things can happen to good people. I can’t imagine investing in any hot stocks, inverse ETFs or other products I consider “wild”. I guess that makes me a very boring investor. Have you written a post on your blog about your sector allocation? How that compares to the indexes?
50% might be a little high, but if you were to buy TSX ETFs right now they are usually 30-40% financials anyway!
The one nice thing about being overweight in Canadian financials is that they are already pretty diversified anyway right?
@University Money,
Yeah, 50% is a little large for my liking in financials, but at least I’m pretty close to XDV in terms of sector weighting. You’re right, Canadian financial are inherently diversified, with branches, offices, products and services in Asia, Europe and South America. Instant diversification really, although the core business remains here at home. Thanks for your comment!
I just began a nine-part mini series on my blog about my own personal portfolio, partly because I wanted to share my investment decisions with others, but also to force myself to do justice to my hard earned dollars by calculating all of my weightings within each sector.
Roughly 7% of my own portfolio is currently allocated to financial services. Like you, most of my stocks are held in non-registered accounts and I just love the juicy divvy’s the big banks send our way. With that being said, my percentage exposure to financials would have been dramatically higher had I not bought investment properties over the past couple of seasons – probably closer to 20%.
You may be right in that 50% might be a bit on the high side. I’d be curious to know your weightings in other sectors such as oil & gas. Over the past couple of weeks, I bought into a few large cap oil & gas plays that I’ve always wanted to such as SU, CNQ and XOM but didn’t over the years because of the lower yields. I am an income-oriented investor and I find it hard sometimes biting the bullet to buy stocks like WMT or other fairly low yielding plays in exchange for more long-term growth.
I noticed you mention that you work in the health care industry. Have you ever heard of K-Bro Linen (KBL)? It’s a small cap company that has long-term contracts and the services they provide are within such a great niche. It’s yield is currently over 5%, pays monthly distribution and it’s been a darling for me, even through the 2008-09 mess it paid nicely.
Great post.
TWC
@ TWC,
Thanks for your detailed comments. I must say, again, I really enjoy the look and feel of your site. It’s well done!
Now, to your comments.
I can’t wait to read your 9-part series. I’ll head over to your site soon
I’m surprised your financials are only 7%, but if you own investment properties that some serious passive income long-term as well.
I’m not that high in the O & G sector, I own HSE but no SU or other stocks. I do want to own XOM in my RRSP, even with the low(er) yields but I don’t have enough cash to spring for it. I’d like to buy enough shares to run a synthetic DRIP for XOM, but that means I’d have to sell some existing equities and with equities going lower, I really don’t want to do that. I’m a buyer, not a seller!
I have absolutely heard of KBL. What is their dividend history like? I’m more a fan of large caps and blue-chips but the 5%+ yield is very tidy. That might be a good one for my TFSA at some point.