Wednesday, 23 January 2013

The Zulu Principle

Currently I'm reading a book, called "The Zulu Principle"*, with a view to making some selections this year to start up my investment portfolio with.
*amazon affiliate link

It's a book outlining a particular investment strategy based on your own "circle" of knowledge.

Warren Buffet refers to the "circle" of knowledge and advises you don't invest outside it.

So what is this "circle of knowledge"?
Basically, the circle of knowledge, is what you as an individual know.

Let's take an example with sports teams, specifically football teams, as it's such a global thing:

If you follow the English Premier League (EPL) you'll know that out of the 20 teams that make up the premiership, there's generally only 4 at most, with any realistic chance of winning it at the start of the season, despite the unpredictable nature of the game. So if you were going to place a bet and pick a winner, your chances are pretty good, although even amongst those 4 choices, there's 1 or 2 standouts. Basically, what I'm saying is this: if you put your money on Manchester United there's a better than 60% chance you'll come out ahead.

However, if you know nothing about football, you're faced with 20 choices and your chances of picking a winner are greatly reduced. It looks more like a lottery, with a 5% chance of winning.

The stock market is exactly the same. The more you know about something, the better your chances of picking a great investment.

What's so good about this is: everyone knows something. Everyone has an interest, or a hobby, or they may work in a particular industry. Whatever you do, or whatever you read and learn about, gives you a "circle of knowledge", within which you can make more informed choices that relate to that knowledge. Outside of that knowledge you're basically groping about in the dark.

However, there is a fly in the ointment, and that is there might not be any suitable investment that you could put your money into, that relates to what you know. If so, you're going to have to widen your knowledge and look at something new. This is where the Zulu Principle* comes in.

How much do you know about Zulus? Probably not much. If you read a book about them, you would know a lot more about them than the average man on the street. You would probably know more about Zulus than 90% of the population.

But what if you researched Zulus a bit more and read everything about them in your local library? Or read all of the best texts you could find from Amazon? What then?? You would probably know more about Zulus than 98% of the population. In fact, your knowledge would probably be approaching that of an expert.

Now let's say you actually went out to South Africa for a few months, and lived with and studied Zulu tribes up close. You probably know more about the Zulus than 99.9% of the population. In fact, you would probably be one of, if not THE leading expert on Zulus.

The thing about Zulus is that knowing about them is a very narrow area of knowledge, which makes it relatively easy to amass a significant amount of knowledge about them - hence the name of the book.

So, transcribing The Zulu Principle* to the stock market: If you know more about something than the market does, then you can better judge whether an investment is worth it or not. It enables you to invest in a share that you see as good value before the market catches on and prices go up, or to pull out in good time when you think a share no longer has that value.

Truly: Knowledge is Power

2 comments:

  1. That's actually very good advice to stick within your comfort zone when you invest. You better understand business models and how the company makes money in this situation

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    Replies
    1. Yes, it puts you one step ahead of everyone else, doesn't it? Thanks for commenting!

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