Summary
Each individual tends to have an area or areas in which they really, truly know their stuff, their area of special competence. Areas not inside that circle are problematic because not only are we ignorant about them, but we may also be ignorant of our own ignorance. Thus, when we’re making decisions, it becomes important to define and attend to our special circle, so as to act accordingly.
Definition
In HBO’s new documentary, “Becoming Warren Buffett,” the billionaire compares his investing strategy to America’s favorite pastime, referencing baseball legend Ted Williams’ book, “The Science of Hitting,” in which the All-Star slugger emphasized the importance of knowing your sweet spot.
“If he waited for the pitch that was really in his sweet spot, he would bat .400,” Buffett explains. “If he had to swing at something on the lower corner, he would probably bat .235.”
The lesson for investors, Buffett says, is that you don’t have to swing at every pitch.
“The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot. And if people are yelling, ‘Swing, you bum!,’ ignore them.”
Just as Williams only swung at pitches in his sweet spot, Buffett only invests in companies that are within his “circle of competence,” a concept he first described in his 1996 Shareholder Letter.
So, the simple takeaway here is clear. If you want to improve your odds of success in life and business then define the perimeter of your circle of competence, and operate inside. Over time, work to expand that circle but never fool yourself about where it stands today, and never be afraid to say “I don’t know.”
Examples
Investing
A prime example of why it is imperative to stay in your lane.
At the time of writing, each business day billion of shares are traded throughout the world’s stock markets. They are in different industries, with different business models, and different products. I would posture staying a true expert on each of the differences mentioned would be near impossible.
By sticking to the industries or companies you can easily understand from your competencies, and that have comprehensible business models with honest financial statements, then you can better evaluate them with your knowledge base.
Warren Buffet follows this strategy – with Coke being the proof in the pudding for his theory.
Niche
Munger has talked several times in the past about a man who had “managed to corner the market in shoe buttons- a really small market but he had it all.” That’s an extreme example of a very narrow Circle of Competence.
Academia
Professors who leave their university can make similar mistakes. Charlie has talked about the Nobel Prize winner who left academia to help found Long Term Capital Management: “[When] one of the economists who… shared a Nobel Prize … went into money management himself, he sank like a stone.” Larry Summers, who is a very intelligent and capable person in Charlie’s view, made a huge mistake investing Harvard’s cash account alongside the endowment leaving exposing the university to a huge liquidity risk. That decision by Larry Summers was clearly outside of his Circle of Competence and both he and the university paid the price. As a more current example, a talented venture capitalist who is within his or her circle of competence may not do as well running a macro hedge fund.
