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Narrowing Down Your Opportunity Set: How the Best Investors Do It

- By Rupert Hargreaves

Having many options to choose from, in any situation, is never a bad thing, but it is a stumbling block for investors. There are tens of thousands of stocks on public markets around the world to choose from at any one time, and choosing just 30 (or fewer if you are willing to run a concentrated portfolio) requires a great deal of discipline and patience.


This is one of the reasons why Warren Buffett (Trades, Portfolio) has been so successful as an investor. He has shut out the rest of the market and concentrated his bets in just a few positions, which have yielded tremendous results for him and the shareholders of Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) over the past few decades.

Unfortunately, trying to replicate this strategy isn't easy. The market is full of distractions and third parties that are all fighting to get hold of your money. The key is to tune out these distractions and keep focused on only the best opportunities.

Buffett's preferred method of tuning out the noise is to imagine that he has a punchcard with only 20 punches for a lifetime:


"I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches-- representing all the investments that you get to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all. Under those rules, you'd really think carefully about what you did, and you'd be forced to load up on what you'd really thought about. So you'd do so much better."



Although we know Buffett hasn't stuck strictly to this strategy (he's made several thousand investments in total over the past few decades), the idea is a sound one. It applies not just to stocks, but funds as well.

In fact, this advice is probably more suitable for fund investors, particularly index fund investors, because the data show that most investors fail to capitalize on the performance of mutual and index funds because they trade too much. Adopting the 20-punch-card mentality can help eliminate this overtrading.

Buffett isn't the only successful investor that has boasted about the benefits of careful stock selection. Li Lu, who was once believed to be in line to succeed Buffett at Berkshire, has also issued advice on the topic:


"Ted Williams is the only baseball player who had a .400 single-season hitting record in the last seven decades. In the Science of Hitting, he explained his technique. He divided the strike zone into seventy-seven cells, each representing the size of a baseball. He would insist on swinging only at balls in his 'best' cells, even at the risk of striking out, because reaching for the 'worst' spots would seriously reduce his chances of success. As a securities investor, you can watch all sorts of business propositions in the form of security prices thrown at you all the time. For the most part, you don't have to do a thing other than be amused. Once in a while, you will find a 'fat pitch' that is slow, straight, and right in the middle of your sweet spot. Then you swing hard."



Li Lu's quote focuses on waiting for the perfect opportunity, but there's much more to good investing than just waiting for the ideal opportunity. You only know an opportunity is a good one if you are within your circle of competence.

For example, a resource stock may look cheap, but if you don't understand the reasons why the stock is falling, because you have no experience in the resource industry, then this is a risk. If you don't know why a stock is cheap, you don't know more than the rest of the market so you cannot be confident that you are on the right side of the trade. This works both ways:


"If you're comfortably rich and someone else is getting richer faster than you by, for example, investing in risky stocks, so what?! Someone will always be getting richer faster than you. This is not a tragedy." -- Charlie Munger (Trades, Portfolio)

"Soros couldn't bear to see others make money in the technology sector without him, and he got killed. It doesn't bother us at all [that others are making money in the tech sector]" -- Charlie Munger (Trades, Portfolio)



Figures suggest that the best investors concentrate their bets and invest only in companies when they are 100% sure that the investment has a high probability of working out.

These are the views of some of the best investors alive, showing how they try to narrow down their opportunity set. There's no set template for narrowing down the opportunity set, but the ideas above might help you work toward it.

Disclosure: The author owns shares in Berkshire Hathaway.

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This article first appeared on GuruFocus.