Circle of Competence: How Warren Buffett Avoids Failures

Warren Buffett, as you would know, is an American business magnate, investor, speaker and philanthropist who serves as the chairman and CEO of a company called Berkshire Hathaway. He is considered as one of the most successful investors in the world, and has a net worth of $80 Billion, making him the third-richest person in the world.

Many people around the world study his techniques, try to learn from him, and emulate his methods. One such method, simple mental model that Buffett uses to avoid problems, and in turn win big is called the Circle of Competence.

In 1996, Warren Buffet gave the following advice to his investors in the 1996 Shareholder Letter:

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 . The size of that circle is not very important; knowing its boundaries, however, is vital.

What he says is that inside the circle of competence lies your skills that you have mastered throughout your career, or life. And beyond the circle are the things you understand only partially, or not at all.

Each of us, through experience or study, has built up useful knowledge or a set of useful skills in certain areas of the world. I’m a designer, so my circle of competence is design. If you are a developer, your circle of competence would most likely be frontend or backend development.

Similarly, for Sachin Tendulkar, it would be cricket. For Roger Federer, tennis. For Amitabh Bachchan, it would be acting. And for Pandit Ravi Shankar, it would be Indian classical music.

Think of the circle of competence like a small circle within a big circle. The bigger circle is what you think you know—where you are not really an expert, and the smaller circle inside the bigger one is what you really know—where you are an expert, and where nobody can beat you.

Buffett’s strategy to avoid problems is fairly simple. It’s a two step process: Firstly, know your circle of competence, especially its boundaries, and secondly, stick within it.

Charlie Munger elaborates it further. His central idea is to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make.

“You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence. The size of that circle is not very important; however, knowing its boundaries is vital.”

— Charlie Munger

Despite the advice, it is natural for us to step outside our circle of competence. We have an equally strong temptation to broaden it as well. And it is even stronger if you are successful within your circle. It gives you too much confidence—more than you need. Munger advices you to resist it.

It is because skills generally don’t transfer from one arena to another. In other words, skills are domain specific. A master chess player isn’t automatically going to be a good business strategist. A heart surgeon isn’t automatically a good hospital manager. A good actor isn’t automatically a good politician.

Sherlock Homes has famously said:

“I consider that a man’s brain originally is like a little empty attic, and you have to stock it with such furniture as you choose.”

And you would be surprised to know that Holmes, despite being a genius, didn’t know much about anything that lay outside his area of work. When Dr. Watson tells him about the solar system, Holmes says, “You say that we go round the sun. If we went round the moon it would not make a pennyworth of difference to me or to my work.”

So, knowing your circle of competence has several benefits. It not only helps you avoid problems, but it also acts as a guide to identify opportunities for improvement, and learn from others.

The simple takeaway is this: 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,” if you are forced to play outside it.

Michael Phelps and Hicham El Guerrouj

You are most probably familiar with Michael Phelps, who is widely considered to be one of the greatest athletes in history. Phelps has won more Olympic medals not only than any swimmer but also more than any Olympian in any sport.

Fewer people know the name Hicham El Guerrouj, but he was a fantastic athlete in his own right. El Guerrouj is a Moroccan runner who holds two Olympic gold medals and is one of the greatest middle-distance runners of all time.

These two athletes are wildly different in many ways. (For starters, one competed on land and the other in water.) But most notably, they differ significantly in height. El Guerrouj is five feet, nine inches tall. Phelps is six feet, four inches tall.

Despite this seven-inch difference in height, the two men are identical in one respect: Michael Phelps and Hicham El Guerrouj wear the same length inseam on their pants.

How is this possible? Phelps has relatively short legs for his height and a very long torso, the perfect build for swimming. El Guerrouj has incredibly long legs and a short upper body, an ideal frame for distance running.

Now, imagine if these world-class athletes were to switch sports. Given his remarkable athleticism, could Michael Phelps become an Olympic-calibre distance runner with enough training? It’s unlikely.

At peak fitness, Phelps weighed 88 kg, which is 40 percent heavier than El Guerrouj, who competed at an ultralight 62 kg. Taller runners are heavier runners, and every extra kilo is a curse when it comes to distance running. Against elite competition, Phelps would be doomed from the start. Similarly, El Guerrouj might be one of the best runners in history, but it’s doubtful he would ever qualify for the Olympics as a swimmer.

Since 1976, the average height of Olympic gold medallists in the men’s 1,500-meter run is five feet, ten inches. In comparison, the average height of Olympic gold medallists in the men’s 100-meter freestyle swim is six feet, four inches.

Swimmers tend to be tall and have long backs and arms, which are ideal for pulling through the water. El Guerrouj would be at a severe disadvantage before he ever touched the pool.

Both of them are successful because they play within their own circle of competence.

Double Down Upon Your Strengths

The idea that you can make life stick to a plan is an illusion. Randomness tears through everything, sometimes with the force of a bulldozer. There is only one place where it’s tameable, and that’s inside your circle of competence. That’s how importance it is.

So, stop beating yourself up over your deficiencies, and double down upon your strengths. If you’ve got two left feet, forget the dance lessons. If your sketch of a horse looks like a cow, stop dreaming of a career as an artist. If you can barely cope with your irritating neighbour, drop the idea of becoming a salesman.

The truth is that it’s completely irrelevant how many areas you’re average or below average in. What matters is that you’re far above average in at least one area. Once that’s sorted, you’ll have a solid basis for a successful life.

A single outstanding skill trumps a thousand mediocre ones. Every hour invested into your circle of competence is worth a thousand spent elsewhere.