Understanding Your Circle of Competence

Establishing your own circle of competence can help you avoid big mistakes and find more valuable investments.

Dec. 13, 2022

There are a lot of things that can go into picking a stock. We need to consider both the left brain and the right brain, by looking at areas such as enterprise value or company culture respectively. However, while these aspects certainly lay a great foundation for any successful investor, there are a couple of other considerations to take into account.

Chief among these is the circle of competence.

What is the circle of competence?

This concept, coined by investing royalty Warren Buffett and Charlie Munger, is a simple mental model that helps us to focus on the things that we should be focusing on. It works off the idea that we have all built up a base of knowledge throughout our lives from various areas such as education, jobs, or even our hobbies and interests.

By leveraging this knowledge when it comes to investing, we can avoid costly mistakes. If you stay within your circle of competence, you can enter each and every trade armed with knowledge and experience. 

Importantly, your circle of competence not only tells you what you know but also what you don’t know. Pharmaceutical companies, by and large, are outside of our circle of competence here at MyWallSt. As such, despite the potential for huge returns, we tend to steer clear of them.

To be a successful investor it’s simply not necessary — and quite frankly, impossible — to know everything. But by staying within your circle of competence you can find an abundance of excellent opportunities.

As Charlie Munger put it,

“The whole trick of the game is to have a few times when you know something is better than average, and invest only where you have that extra knowledge. If that gets you a few opportunities, that’s enough.”