The concept the “circle of competence” was developed by Warren Buffett and Charlie Munger to focus on investing in areas they knew best and avoiding areas they didn’t understand.
In his 1996 letter to Berkshire Hathaway, Buffett explained the concept:
What an investor needs is the ability to correctly evaluate selected businesses. Note that word “selected”: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.
Allocating limited resources
The circle of competence mental model is useful beyond the world of investing. It is applicable in every aspect of life. While you may not consider yourself an investor, you allocate time and attention in every activity you undertake daily. Most of us do not think much about how we allocate our limited time and attention. If we treat the allocation of our limited resources as investment, we can utilize our time, energy and attention more effectively.
Your circle of competence
Understanding your circle of competence is key in identifying and selecting opportunities that match your knowledge, skills and expertise. In other words, when you understand what you know and what you don’t, you are able to decide where you devote your time. Importantly, you recognize when something is outside of the perimeter of your competence and are never afraid to say
I don’t know.
However, when an opportunity within your circle of competence presents itself, you can confidently make a decision to allocate your resources knowing you have an edge. You want to keep learning and slowly expand that circle.
You can learn more on making better decisions in this article Better Decisions: 3 Time-Tested Mental Frameworks
Conclusion
It is vital to understand the boundaries of your circle of competence if you want to succeed. I hope you enjoyed this article. I will let Tom Watson Sr., Founder of IBM, conclude this week email with one of his brilliant quotes:
“I’m no genius. I’m smart in spots—but I stay around those spots.”
