I love the way Warren Buffett thinks. He has this ability to condense something as complicated as investing so that a layman can understand. Buffett often talks about his circle of competence and how important it is that he operate inside that circle of competence. What is fascinating is that we all have this same ability Buffett has when it comes to the idea of a circle of competence. You and I can stick inside this same circle and be successful when it comes to investing.
We may not grow our wealth at the same rate as Buffett, but that doesn’t mean we can’t use this idea to help us increase our investments in the future.
The Science of Hitting
Warren Buffett often references a book he read many years ago. The book, The Science of Hitting, was written by Major League Baseball player, Ted Williams. The Science of Hitting was written in 1971, and Buffett must have been impacted by the book. He often talks about what Williams refers to as the “sweet spot”.
The sweet spot for baseball is a diagram strike zone broken into 77 squares each the size of a baseball. If a pitch ended up inside that sweet spot, Ted Williams knew he could bat .400. But for low outside pitches he would bat .230. If he has two strikes against him, he has to swing at that pitch, and this reduces his chances.
Warren often relates this book to how investors have an advantage when compared to baseball. While in baseball, you only have a small number of tries. Not all of those pitches are going to be within that “sweet spot” Ted Williams talks about.
When it comes to investing – unlike baseball – we have a universe of thousands of potential companies he can “take a swing at”. We can pick and choose which companies we should consider investing in; it is our discretion.
The Circle of Competence
Every U.S. citizen has the ability to invest in publicly traded companies in the United States. The important thing is making sure you invest in what you understand; what lies inside your circle of competence. If you can stay inside this circle, you have a chance of batting a high average. When you veer out of this circle is when you end up risking potential problems.
If a stock increases in value and you did not purchase that stock, there are thousands of other companies you have the potential of investing in. Whether you purchased that one stock that performed well is irrelevant if it is not inside you circle of competence. There are so many other options you have to invest; it doesn’t matter if you take a swing or not.
It is relevant outside the stock market
The idea of the circle of competence can also be used outside the stock market. If you want to purchase a restaurant down the street, or a dry cleaner in your town – if you can understand the economics of that business – you have great potential for that investment to make money. This can be in anything, from investing in real estate to starting your own business. Whatever your circle of competence is, you have the ability to leverage your knowledge inside that circle to generate profits.
The important thing to understand is where the perimeter of your circle of competence ends. This is the most difficult problem for people because, in many ways, you have to be humble. You have to accept you have limits. You can’t be the best at everything, and that is actually your advantage.
Take a look at this article about Buffett and knowing your own limitations – The Propensity to Disbelieve – Challenging Your Previous Conclusions
The beauty of investing is not having to take a swing at every pitch. Learn your circle of competence, where it ends, and embrace the idea that having a limit to your knowledge is beneficial. If you do, I bet you will do well in the future.
Oh…and ALWAYS remember not to worry about things outside your circle of competence!
Thanks for reading!
I love the idea of teaching your children how to invest when they are young. I found the perfect company to help you purchase stock for your children! Take a look at this article: 5 Reasons Why You Need Buy Your Kids Stock for Their Birthday
Or, click here to take a look at Stockpile (you get $5 when you signup using my link) – Stockpile link with $5 towards purchase
Disclaimer: These are the ideas and opinions of the author. The author is not responsible for the actions of those who read the posts on this blog. Each individual reader has a unique situation and unique needs. This blog is not intended to solve those unique situations of the readers. This blog is not liable for decisions made by the readers of this blog.
You know how websites add a section at the bottom that says, “This post MAY contain affiliate links”? Well, I am not going to be vague like those websites. We all know if they write that sentence, the post includes affiliate links. So, I will tell you straight up that this post DOES include affiliate links. Use them, I will make a little dough (at no extra cost to you). Here is my affiliate link disclaimer if you want to read more: DISCLAIMER