Circle of Competence - Know The Edges of It

In investing, there are no called strikes. Addressing your circle of competence should be the first item on your investment checklist. I’m going to be paraphrasing Warren Buffet in this post so tag along.

During your investing journey, mistakes will be made. It’s quite inevitable. From my own experience, I believe there is one thing that should be number one on an investors checklist before buying: Do you understand the business? Does it fall within your “circle of competence”?. This is why diversification is not as wise as it sounds. Let’s say you own 50 companies. How can you possibly understand company no. 1 as good as company no. 50?

The size of your circle doesn’t really matter, but knowing its boundaries is crucial.

The point is, it is okay if you don’t understand all the businesses out there. Let’s say you live in a town where you own five of its best companies. Why would you want to own any more? If you already have five of the best, adding more would likely weaken your overall returns. In investing, the key is to wait for the perfect pitch; a company that falls within your circle of competence, at a deeply discounted price from its intrinsic value, and then (and only then), swing. Granted, there are other things to look for than just circle of competence and price when buying, but these will be discussed in upcoming posts.

Here Warren Buffett explains the circle of competence. It doesn’t get much easier to understand than this.

Expanding Your Circle

So what about expanding your circle of competence? Once you truly adapt this mental model, most likely you’ll realize how little you understand. But don’t worry, this is good. When you realize and accept the limits of your knowledge it keeps your investing ego in check.

The wonderful thing about circle of competence investing is that it promotes extreme focus. Your energy and focus levels are a finite resource, and they should be used strategically. Trying to play every game in town is mentally exhausting.

With this said, understand that your circle of competence is something that will expand over time, so long as you dedicate yourself to lifelong learning and continuous improvement. The way to do this is to immerse yourself in a wide array of disciplines, and always be reading. Not just about investing, but other subjects such as history, philosophy and psychology.

Conclusion

You have to mould your investing mind into one that enjoys watching paint dry. During your journey, you don’t need 100 home runs. Buffett has a famous mental model known as the punch card, and it is in the top of my checklist items. I’ll end this post by paraphrasing the model:

“Imagine you are given a punchcard with 20 slots in it. Every time you make an investment, a hole is punched. These 20 slots are all you are given in your entire lifetime, no more. If you are limited to making 20 investment decisions through an entire lifetime, you will think very hard before making a decision“

How do you know if a business is in your circle? If you need to ask, you know the answer. It isn’t.

Finally, Here’s a quick read from Morningstar on the circle of competence.

-IGTSKasimir

Ignore The Street

Intelligent Investing Since 2019

Circle of Competence – Know The Edges of It

Expanding Your Circle

Conclusion

Further Reading