WHAT IS CIRCLE OF COMPETENCE?
Circle of Competence means it is an area where you a person has a detailed knowledge or understanding of a subject. It may be due to love for the subject, education in the subject, experience in the subject, etc.
Quote on C. O. C.
Tom Watson [the founder of IBM] said – “I’m no genius. I’m smart in spots and I stay around those spots.”
Charlie Munger and Warren Buffett define these spots where you are smart as your ‘circle of competence’ – the area beyond which you must not venture out if you were to make effective, profitable investment decisions.
Defining the circle of competence
Defining the circle of competence is the most essential & important factor in life as well as investing.
It just means that one should know which sector, industry, or field he is good at. He should have in-depth knowledge about the current, past & future events which may or may not happen.
This awareness helps a person to be on the top of his game or play the only games in which one can win or have an advantage over the competition. Also, one should always inside or middle of the circle of competence because being on the border can also be risky.
When a person does things or picks stock only when he finds opportunities within his circle, he gets an unfair advantage over others.
For example:-When an owner of a car dealership, try to pick stock he has an advantage over others as he knows more about the sector as it is a cyclical sector, so when the sales start falling he can sell shares & vice versa & over a period of time he achieves an extraordinary return. But if the same person tries to invest in the pharma sector or banking, he will be clueless; in such a situation he may invest in stock tips which can be very risky. Usually, people do this mistake, so be aware of the circle of competence is important.
The size of the circle is relevant but not so important as compared to awareness of the circle. One can increase their circle of competence over a period of time by learning about the new field, sector industry, etc.
Story of Circle of Competence of Charlie Munger’s friend John Arrillaga
John Arrillaga was born in a middle-class family went on to become one of the biggest commercial landlords in silicon valley.
He only invests in real estate one mile from the STANDFORD UNIVERSITY.
In 2006 he sold 5300000 sq ft of his real estate holdings for roughly $1 billion.
Mohnish Pabrai describing JOHN ARRILLAGA’S circle of competence.
“Charlie Munger says, there’s a friend of his. He is a billionaire. He lives near Standford University. John Arrillaga only invests in real estate within one mile of Standford University. From having no money forty years ago he’s a billionaire. All he did was he never put on a lot of debt & when things went down he bought & when everyone got euphoric he sold. That’s all he did. What is John Arrillaga’s circle of competence? is it real estate? No! is it California real estate? No! Northern California real estate? No! Only real estate around Stanford. His circle competence is smaller than the circle on the hand. The good thing about getting wealthy is we don’t need to understand a lot of things!”
The best way to expand the circle of competence is through the reading.