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!
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Interesting concept, I can see how the circle of competence can be applied to many areas of life, from finances and investing to hobbies and side hustles. It is so easy to get overwhelmed with the feeling that we have to “learn it all” or “know it all”. The circle of competence allows you to focus on the things that interest you, you are good at and/or you know about while leaving the rest aside and not worrying about it. Thanks for sharing!
Hi Mrs. Adventure Rich! Thanks for the comment. And looks like your net worth is coming along nicely…getting close to that FIRE! Making big gains over the past two years!
I love the concept of the circle of competence. It makes me feel better about the fact that I don’t know everything and that it is ok. Some people think they are geniuses in everything and that ends up hurting them. Other people freeze up because they think they need to have all this knowledge about everything; it prevents them from doing a lot of important things.
Glad you enjoyed the Buffetti-sim!