What is the Circle Of Competence?

The circle of competence is an investing concept introduced by Warren Buffett and relates to making investments only in companies that one is capable of understanding, i.e. companies that fall within one’s circle of competence.

In other words, one needs to be able to figure out how a company makes money, how it can keep competition from eating away its profits over time, and how the company will keep making increasing amounts of money in the future.

Any companies that one does not truly understand, or is not capable of understanding after studying and research, fall outside the circle of competence, and should be avoided as investments.

Size of the Circle Of Competence

According to Warren Buffett, the size of the circle of competence isn’t necessarily important. What matters most is that one knows where the boundaries of the circle of competence lie. As investors read and acquire more knowledge over time, the circle of competence expands organically.

Takeaway

Invest only in companies you can truly understand.