The importance of circle of competence

Circle of competence

Where did it come from?

In his 1996 letter to Berkshire Hathaway, Buffett further expanded:

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 circle of competence that Buffett has repeatedly emphasized in Haaretz, March 23, 2011 is “The important thing is to know what you know and know what you don’t know.” — The key point is that the boundary is very important. Most things are incomprehensible.

Many investing masters endorsed

Since Buffett and Munger proposed that investors should pay attention to and limit their investment scope within their own ability circle (in fact, Peter Lin District has also mentioned similar views, interested readers can look at my blog for his book I wrote a brief introduction, “One up on Wall Street“), after the idea that the probability of success can be improved. I found that most people generally agree with each other in concept; but how to discover their own circle of competence, or the actual benefits of their investment, are quite divided.

Reasons for opposing circle of competence

As mentioned earlier, most people basically agree with this concept. The main reasons of the opponents are the less rational and unbelievers (this situation is not included in the discussion, because it is difficult to reason or be persuaded), the main reason of the opponents will greatly limit the scope of investment and optional targets. Which is to reduce the possibility of making money. But this view is specious:

  • Investing should concentrate on limited target: Buffett once put forward the analogy that there are only 20 investment opportunities in a lifetime. In this way, investors will be more cautious in choosing stocks, and the probability of success will increase. For details, please refer to my previous blog article “Why concentrated investment?
  • I personally have also pointed out many times that a person can make investors very wealthy by only looking at two or three stocks during his entire investment career. For details, please refer to my previous blog article “Good Companies are rare, two or three will make you rich. Take Texas Instruments as an example
  • As I listed in section 5-5 of my book “The Rules of Super Growth Stocks Investing”, most of the more successful investors in history have advocated centralized investment, especially for retail investors.

Advantages of investing in the circle of competence

The following points are common, but they are very important; because to invest success, the decision is usually based on these small details:

  • The basis for investment judgment when necessary. Because you will have better knowledge than average people, you will be more accurate, and your judgments will be more correct.
  • Increasing your confidence in holding stocks, will not follow the crowd, nor will you sell stocks when the market crash, leading to regrets when the market recovers.

What if I don’t have any circle of competence?

This is impossible! Everyone must to have circle of competence. The competence circle does not mean that you must be a super expert in a certain field or have won a Nobel Prize, as long as you have a deeper understanding than most people (this is not an absolute, but a relative term). There are not so many Nobel Prize winners, and Nobel Prize winners are not necessarily experts in investing in their fields.

It is very good to have a more professional background or a superior or a top expert in a certain field; but this does not guarantee that the investment will be successful, and there is no inevitable relationship between the two. This is a big myth for ordinary people, and it is also described in another article on my blog “Why successful manager usually not a good investors?

But if I am just an ordinary person, without a good education, no good job, my job is not a professional job; I am just a 9 to 5 office worker, and I’m a woman want to chase dramas on holidays, or a men to play video games all day long (above just for the sake of example, without any gender discrimination or other connotations), or find friends for dinner and coffee. How can this be incompetent?

You must know what movie or series everyone is watching nowadays than most people (at least much better than me). Which game is the most fun and most people are playing, you must know that. That restaurant or cafe is crowded every day, and you can’t make a reservation every time you want to make a reservation.

If I don’t play video games, I don’t chase dramas, and I don’t like to go out for dinner, coffee or chat. Then you always go to the supermarket to buy things, right? What do people buy on the trolleys in the supermarket? The prices of those goods increase every three or five times, but the items are all empty? I don’t go to the supermarket, but my family go. Do you always have a cell phone?

You always know the difference between Apple’s phones and Android phones? It’s impossible for modern people not to surf the Internet, right? Have you always used a computer or mobile phone to on Internet? Even the Taiwan government must go online to sign up for vaccines and consumer coupons. Few people will give up NT$ five thousand consumer coupons that have fallen from the sky, right?

Circle of competence
credit: flickr

How to discover your circle of competence

I personally think that there are several very ordinary ways to discover your investment circle of competence:

  • Find out the records of your past investments (readers can refer to my blog article “What information should investors take notes? Why?“) and review them carefully. Figure out the big money earned from which stock? What do these stocks have in common? think about it carefully, there must be a certain relationship between them ─ this is your circle of competence.
  • Your job, as long as it is a job, is professional.
  • Outside of work, the activities that you spend the most time on are also your special interests. As long as you are interested, you can accumulate considerable experience and knowledge for many years.
  • Your educational background.
  • What kind of non-fiction book do you like the most?

In short, everyone must have a circle of competence, it is impossible not to have it.


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