Circle of competence

In his 1996 letter to Berkshire Hathaway, Buffett further expanded:

What an investor needs is the ability to correctly evaluate selected businesses. Note that word 'selected': You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence.

Sampan Nettayanun from Naresuan University traces the concept, if not the terminology, as far back as Andrew Carnegie, in his decision to concentrate on iron and steel, writing "My advice to young men would be not only to concentrate their whole time and attention on the one business in life in which they engage, but to put every dollar of their capital into it."

Operating within one's circle of competence may be compared with those who act over-confidently. For example, institutional investors who have been successful in the past are more likely to attribute their success to their own abilities, rather than external forces, and are therefore more likely to make investments in areas outside their circle of competence. The strategy of operating within their individual circles has been cited as the reason both Buffett and Munger avoided investing in the technology sector.

The breadth of any individual's circle of competence may be determined by a range of factors, including their profession, spending habits, and the types of products they normally use. Remaining within one's circle confers a number of benefits, such as an unfair information advantage, the narrowing of available options, and the reduction of poor decision making.