How to Invest: Meaning and the 3 Circles

Welcome to the introduction to the Rule #1 course. I’m Phil Town and this is Tutorial 2: Meaning-The Three Circles. 

This is part 2 of a 9-part series on How to Invest using Rule #1 strategies
Part 1: Rule #1 Strategy- Overview of the Basics
Part 2 [You are Here]: Meaning- The Three Circles
Part 3: Moat- A Durable Advantage
Part 4: Moat- The Big Four
Part 5: Management- Owner Oriented
Part 6: Margin of Safety- The Growth Rate
Part 7: Margin of Safety- Sticker Price and MOS
Part 8: Margin of Safety- Payback Time
Part 9: Zombie Value- Tangible Book Value

 

Investing For Beginners: Circle of Competence

The most important thing I can tell you about becoming a great investor is to focus on your circle of competence. That means that area of the world that you live in, that you actually know quite a lot about.

For most beginning investors, we sort of think we don’t know anything about anything. I know I certainly felt like that when I started off, but in fact my teacher told me start by looking for meaning in each investment.

Invest in a Business That Means Something to You

Try to buy businesses that really mean something to you. To start with, I have to find out more about me. What actually means something to me? What do I actually know something about? To figure it out, I want to look at the three circles exercise.

We’re going to go to do this on the ruleoneinvesting.com toolbox. This will help us figure out what kinds of companies we already know a lot about.

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Choose Industries You’re Interested In

What we’re doing is loading in industries where we already have a lot of knowledge. I’m pretty good at computer software and services, internet, hardware, real estate stuff, clothing, personal items, automotive and I’m just getting those off of this list. If I see things that I might really already know quite a lot about like, let’s say leisure and media, recreation entertainment and hobbies. I just read the description and you can see some of the stocks are in that category. For example, Storm and Ruger and Company. They make guns, and I like guns, so I’m adding leisure and media to my list.

Now we’ll see that leisure and media is on my list and I’m on to the next part of the three circles, which is the talent circle, to add to that. So you go through each of these circles, and simply save and continue by putting on items that you know you already know a lot about.

How to Choose a Business That is Right for You

The first one is passions. The second one is talent. What are you really talented at? What do you know a lot about? What can you be world class at? And the third one is where you spend your money.

You start to look for things that are in all three of these, save them and the program will go out and find industries that match the talent, passions, and money circles that you already put up. Now you can see this has come up with a pretty darn good list, so it started off that I wasn’t sure I’d have any companies I might know anything about. It turns out, there are many, many companies that I know a lot about.

For example, let’s go over and look at recreational vehicles. That sounds like something I might know a bit about. What I get is a list of all the companies that are in the recreational vehicle industry group. You can see it’s got Harley-Davidson. They make motorcycles. Polaris makes snow machines and four-wheelers. Arctic-Cat makes snow machines. Winnebago makes those big Winnebago’s, right? I already know something about these companies. These are companies that I have some connection with in my life.

Why We Care About Understanding a Business

Now why do we care about understanding the business? In Rule #1 if we buy one share of a company, it’s as if we bought the entire company. When I buy one share of something I feel like I own the entire business.

Investing Tip: The “My Uncle” Rule

One way to think about this is that, imagine that my uncle gave me a billion dollars to go out and buy a company with, but the rules were that I’d only get to buy one company, and that company would be the only way I’d make money the whole rest of my life and if that company went under, I would have to live on welfare.

So I buy every company that I look at as if it’s the only company my uncle will let me buy. This is a great rule, you should think about it. I call it “my uncle” rule.

Investing Tip: The “10-10” Rule

I also have what’s called a ten-ten rule.  It says I’m not going to own a company for 10 minutes unless I’m willing to own it for 10 years. So if I’m going to buy a company and be willing to own it for 10 years it better be something I like and matches my value systems. I’m passionate about it, I love it, I’m talented at it and I spend my money in it.

Conclusion

Those are the things that make me connect to my investments, and the more I connect with my investments the more I own it as if I own the whole business. The more I understand the meaning of the business and the better investor I’m going to be.

So now it’s time for some homework. The first thing I want you to do is log into the toolbox, do the three circles exercise. At the end of three circles exercise, pick out at least one business you already know a lot about.

Well, that’s it for Tutorial 2, now we’re going on to Tutorial 3: Moat- A Durable Advantage.

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Phil Town is an investment advisor, hedge fund manager, two-time NY Times best-selling author, ex-Grand Canyon river guide and a former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence. You can follow him on google+, facebook, and twitter.