WHAT IS CIRCLE OF COMPETENCE ?
One of the profound & intriguing concepts of investing as well as life. The simplest way to explain it is an area where you a person have a deepest detail knowledge or understanding of a subject. One knows inch by inch or point to point about the 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 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 only game which one can win or have 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.
( Above picture is taken from the website call safalniveshak.com , this picture describes the circle of competence in the best way possible)
When a person does things or pick 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 have an advantage over others has he knows more about the
sector as it is a cyclical sector, so when the sales start falling he can sale shares
& vice versa & over a period of time he achieve extraordinary return.
But if the same person tries to invest in pharma sector or banking, he will be
clueless; in such a situation he may invest on stock tips which can be very
risky. Usually people do this mistake, so being aware of the circle of
competence is important.
The size of the circle is relevant but
not so important as compare to awareness of the circle . One can increase their
circle of competence over a period of time by learn about the new field, sector
industry, etc.
Story of Charlie Munger’s friend John
Arrillaga
https://thumbor.forbes.com/thumbor/fit-in/416x416/filters%3Aformat%28jpg%29/https%3A%2F%2Fspecials-images.forbesimg.com%2Fimageserve%2F945fe0ddbac172f5cc502aa692162731%2F0x0.jpg%3Fbackground%3D000000%26cropX1%3D156%26cropX2%3D668%26cropY1%3D39%26cropY2%3D551
John Arrillaga born in a middle-class family went on to become one of the biggest commercial landlord in the 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 holding 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 invest 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
things about getting wealthy is we don’t need to understand a lot of things!”
Best way to expand the circle of competence is through reading following are some book recommendation:-
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