Circle of Competence

QUOTE

Charlie Munger once said…

“Knowing what you don't know is more useful than being brilliant.”

CONCEPT

Circle of Competence

The Circle of Competence is a mental model that emphasizes the importance of understanding and focusing on the areas in which an individual has expertise, knowledge, or skills. The idea is to concentrate one's efforts within this circle to make informed decisions, reduce risks, and optimize performance.

By being aware of the limits of their competence, individuals can avoid overextending themselves into unfamiliar territory, where they are more likely to make mistakes or suffer setbacks. The Circle of Competence concept encourages continuous learning and growth within one's areas of expertise while remaining mindful of the boundaries that define those areas.

STORY

He Shouldn't Have ... But He Did

In the early 1960s, an largely unknown investor named Warren Buffett faced a difficult decision.

At the time, Buffett managed the Buffett Partnership, a small investment partnership based in Omaha, Nebraska. He had built a reputation for delivering impressive returns by focusing on undervalued stocks within his Circle of Competence.

One day, Buffett learned about a struggling New England textile company called Berkshire Fine Spinning Associates. Intrigued by the company's low stock price, he decided to invest in it, even though it fell outside his Circle of Competence.

Buffett's investment in Berkshire Fine Spinning Associates did not go as planned. The textile business continued to decline, and Buffett later described it as one of his biggest investment mistakes.

However, Buffett managed to turn his mistake into a valuable lesson.

He realized the importance of sticking to his Circle of Competence, and he decided to use the struggling textile company as a holding company to invest in businesses he understood well. Eventually, Berkshire Fine Spinning Associates merged with Hathaway Manufacturing Company, and the newly formed Berkshire Hathaway became the vehicle for Buffett's investment strategy.

Over the years, Buffett's focus on his Circle of Competence led him to make successful investments which contributed to Berkshire Hathaway's tremendous growth—and made him one of the wealthiest people in the world.

By focusing on areas where he had expertise and avoiding investments in unfamiliar industries, Buffett was able to make better decisions, reduce risks, and achieve unparalleled success in the world of investing.