The Circle of Competence: How Warren Buffett avoids problems

Don't play games where other people have the aptitudes and you don’t. You will lose.

In 1996, Warren Buffet gave the following advice to his investors in the 1996 Shareholder Letter:

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 size of that circle is not very important; knowing its boundaries, however, is vital.

What he says is that inside the circle of competence lie your skills that you have mastered throughout your career, or life. And beyond the circle are the things you understand only partially, or not at all.

Each of us, through experience or study, has built up useful knowledge or a set of useful skills in certain areas of the world. I’m a designer, so my circle of competence is design. If you are a developer, your circle of competence would most likely be frontend or backend development. 

Similarly, for Sachin Tendulkar, it would be cricket. For Roger Federer, tennis. For Amitabh Bachchan, it would be acting. And for Pandit Ravi Shankar, it would be Indian classical music.

Think of the circle of competence like a small circle within a big circle. The bigger circle is what you think you know—where you are not really an expert, and the smaller circle inside the bigger one is what you really know—where you are an expert, and where nobody can beat you.

Buffett’s strategy to avoid problems is fairly simple. It’s a two step process: Firstly, know your circle of competence, especially its boundaries, and secondly, stick within it.

Charlie Munger elaborates it further. His central idea is to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make.

You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence. The size of that circle is not very important; however, knowing its boundaries is vital.

—Charlie Munger

Despite the advice, it is natural for us to step outside our circle of competence. We have an equally strong temptation to broaden it as well. And it is even stronger if you are successful within your circle. It gives you too much confidence—more than you need. Munger advices you to resist it.

It is because skills generally don’t transfer from one arena to another. In other words, skills are domain specific. A master chess player isn’t automatically going to be a good business strategist. A heart surgeon isn’t automatically a good hospital manager. A good actor isn’t automatically a good politician.

So, knowing your circle of competence has several benefits. It not only helps you avoid problems, but it also acts as a guide to identify opportunities for improvement, and learn from others.

The simple takeaway is this: if you want to improve your odds of success in life and business then define the perimeter of your circle of competence, and operate inside. Over time, work to expand that circle but never fool yourself about where it stands today, and never be afraid to say, “I don’t know,” if you are forced to play outside it.

The idea that you can make life stick to a plan is an illusion. Randomness tears through everything, sometimes with the force of a bulldozer. There is only one place where it’s tameable, and that’s inside your circle of competence. That’s how importance it is.

So, stop beating yourself up over your deficiencies, and double down upon your strengths. If you’ve got two left feet, forget the dance lessons. If your sketch of a horse looks like a cow, stop dreaming of a career as an artist. If you can barely cope with your irritating neighbour, drop the idea of becoming a salesman.

The truth is that it’s completely irrelevant how many areas you’re average or below average in. What matters is that you’re far above average in at least one area. Once that’s sorted, you’ll have a solid basis for a successful life.

A single outstanding skill trumps a thousand mediocre ones. Every hour invested into your circle of competence is worth a thousand spent elsewhere.

Best,
Abhishek

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