Circle of Competence
Definition & Origin
The circle of competence refers to the business areas that investors truly understand. Buffett emphasizes that knowing the boundaries of your circle of competence is more important than the size of your circle of competence. This concept explains why he has long avoided technology stocks - not because the technology is bad, but because it is outside his circle of competence.
Key Points
- Know what you don’t know: The most dangerous thing is not ignorance, but not knowing that you are ignorant
- Size doesn’t matter: The circle of competence can be very small, the key is to strictly abide by the boundaries
- Can be expanded slowly: Expand the circle of competence through continuous learning, but do not rush for success
- Be honest with yourself: Acknowledging your own limitations is the prerequisite for investment success
Case Studies
- Avoid technology stocks: During the Internet bubble in 1999, I insisted on not buying technology stocks and was ridiculed as “outdated”, but it turned out to be correct.
- Apple (2016): Buffett bought big when he truly understood the nature of Apple as a consumer goods company
- Avoid Complex Derivatives: Buffett still avoids structures he doesn’t understand even though they are heavily used by other market participants
Common Misconceptions
- Don’t be a generalist who knows everything: Circles of competence encourage focus, not erudition
- Not resting on one’s laurels: Buffett’s circle of competence is expanding over time (such as his final investment in Apple)
Quotes from Buffett
“What investors need to do is to evaluate the boundaries of their circle of competence, and then stay within the circle. It doesn’t matter how big the circle is, what’s important is knowing where the boundary is.” - 1999 Shareholder Letter
“If you have a big screen marked with all the listed companies in the world, you don’t need to understand every one. You only need to take action when the few you know have good prices.”——1996 Shareholder Letter
Related Concepts
- Independent Thinking — Don’t step out of your circle of competence due to external pressure
- Margin of Safety — Make more accurate valuation judgments within the circle of competence
- Intrinsic Value — Only within the circle of competence can accurate assessment be achieved
Letters Mentioned
Frequently discussed since the mid-1990s, it became a key concept in Buffett’s defense of his strategy during the dot-com bubble.