215. Circle of Competence
“Everybody’s got a different circle of competence. The important thing is not how big the circle is. The important thing is staying inside the circle.” — Warren Buffett
I came across the concept of the “Circle of Competence” for the first time when I read about the legendary investors, Warren Buffet and Charlie Munger. They had been great proponents of circle of competence particularly with regards to personal financial investments. They stick to investments which lie well within their areas of competence. In other words, they invest only in assets that they understand well and have a clear edge.
But what is the big deal about this? Is it not common knowledge that you tend to be successful when you have an edge at what needs to get done? Does not seem so. This surprising lack of grasp is evident in many decisions that people make. Let me illustrate with few examples.
Financial Investments
Meteorological department is expecting above average rainfall this year, so I moved bulk of my capital allocation to companies engaged in food production and agriculture — those that produce tractors, biscuits etc.
Trump’s tariff flip-flops are causing too much uncertainty in the markets. So, I pulled all my capital out of stock markets and will come back when there is clarity in macro-economic environment.
Government has announced build-out of a new airport near my city of residence. I am looking to buy a piece of land in that vicinity so as to take advantage of the inevitable appreciation in real estate prices.
Seems like interest rates are going to go up and hence it is best to move from equity to fixed income products
Educational and Career choices
Given that the whole world is moving towards AI — what with washing machines, beds, stoves and pretty much everything else coming with embedded AI, perhaps, graduate studies in areas such as Artificial Intelligence and Machine Learning would open up high-yielding career opportunities in the future.
Biotechnology, biochemistry, biological engineering (whatever that means) seem like hot fields right now, why not pursue them?
“What is John Arriaga’s circle of competence? Is it real estate? No! Is it U.S. real estate? No! Is it California real estate? No! Northern California real estate? No! Only real estate around Stanford. His circle of competence is this small.” — Mohnish Pabrai
The base-rate probability of success in timing the stock market movements must be really, really low. I’m not aware of any studies to put out a specific number but if you just survey the people who made it big in stock markets (or for that matter in any other capital market), it is unlikely that you will find too many who were able to time the markets well enough. For all practical purposes, it is impossible to predict the future. With deep and diligent study, one may be able to predict trends with some degree of success but predicting the “timing” of the trends almost, always fails. Notwithstanding this, many people try to time the markets all the time.
Trending areas right now need not remain trending in the future — in fact, they generally do not. So, how do you decide which field to pursue as your career? More to the point here, are you competent enough to make such important decisions by yourself OR are you better off seeking help of professional career counsellors? I personally know of folks who made failed attempts at changing their career from “management” or “IT Consulting” to agriculture or running restaurants. Competence in one field does not generally translate into competence in unrelated fields.
I know a number of folks who try to manage their own money but end up getting below par results. I was one of them. I used to have strong views on prospects of specific stocks and mutual funds. These views used to be based on loose and superficial analysis — not deep, diligent study.
“Care about what other people think and you will always be their prisoner.” — Lao Tzu
Default human tendency is to be seen as someone with knowledge and learned views on diverse areas. One wants to come across as competent in a number of areas such as politics, investing, weather, relationships etc. Competence is meaningful when it gives you an edge. In general, it is hard to be competent in a diverse set of areas. In the minimum, developing competence requires deep knowledge and intuition from years of diligent study/experience and relentless curiosity and learning. Given limited time, there can only be a couple of areas that one can hope to become competent in.
“You don’t have to be good at everything, you just need to double down on what you’re naturally suited for.” — James Clear
Also, it is all-round efficient to develop competence in areas that align with your natural strengths. For example, I was able to develop edge in the area of personal financial investing. Years of diligent study coupled with natural fascination with understanding how growth materializes, helped me build this edge. Even within this field, I recognized that my biggest edge lies in asset and capital allocation strategies particularly when compared with valuating and analyzing specific financial instruments. This recognition allowed me to appropriately allocate my capital across meaningful levels of risk. This also freed me from having to spend efforts in identifying specific products for investing. I allocate capital to competent investment managers who in turn invest in specific financial products.
Bottomline
“Knowing what you don’t know is much more useful in life and business than being brilliant.” — Charlie Munger
People who end up achieving extraordinary success (however one defines success) tend to be the ones who develop circles of competence and are also well aware of the boundaries of these circles. In other words, they are not just well aware of what they know but are also very clear about what they do not know. This kind of honest appraisal of their strengths and gaps allows them to focus their efforts and allocate their resources in highly impactful ways.
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Thanks for taking time to read this article. In this newsletter, I share my learnings that could help you improve your decisions and make meaningful progress on your goals. I try to share stuff that I have personally experienced or experimented with.
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