Circle of competence
A circle of competence is the subject area which matches a person's skills or expertise. The mental model was developed by Warren Buffett and Charlie Munger to describe limiting one's financial investments in areas where an individual may have limited understanding or experience, concentrating in areas when one has the greatest familiarity, and to emphasize the importance of aligning a subjective assessment of one own's competence with actual competence. Buffett summarized the concept in the motto, "Know your circle of competence, and stick within it. The size of that circle is not very important; knowing its boundaries, however, is vital."
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.:2
Nettayanun traces the concept, if not the terminology, as far back as Andrew Carnegie, in his decision to concentrate on iron and steel, writing "My advice to young men would be not only to concentrate their whole time and attention on the one business in life in which they engage, but to put every dollar of their capital into it.":3
Operating within one's circle of competence may be compared with those who act over-confidently. For example, institutional investors who have been successful in the past are more likely to attribute their success to their own abilities, rather than external forces, and are therefore more likely to make investments in areas outside their circle of competence. The strategy of operating within their individual circles has been cited as the reason both Buffett and Munger avoided investing in the technology sector.
The breadth of any individual's circle of competence may be determined by a range of factors, including their profession, spending habits, and the types of products they normally use. Remaining within one's circle confers a number of benefits, such as an unfair information advantage, the narrowing of available options, and the reduction of poor decision making.
- Competence (human resources) – Ability of an individual to do a job properly
- Dunning–Kruger effect – Cognitive bias in which people of low ability mistakenly assess their cognitive ability as greater than it is
- Peter principle
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