Sunday, June 18, 2006

Circle of Competence

This is another concept from the guru himself. Basically it simply means to invest in industries and sectors that you know well, in fact, so well that you can say you are an expert in it. Buffett terms this as the Circle of Competence.

Essentially, this is saying that you should not be a Jack of all trades lah. If you are good at differentiating good bah chor mee from bad bah chor mee, then you should always eat different bah chor mee (both with and without liver) all over Singapore and Malaysia, and try to rate them 1 to 5 stars accordingly. Regardless of whether they have CCTV cambera in their stalls or not. You should not go and try to differentiate and give ratings to mee siam or wan tan mee or maggi mee.

So the circle of competence is just that: invest only in areas that you are very familiar with. Over time your circle of competence can grow bigger as you gain more knowledge. (Ok you can try wan tan mee when you are ready but without the wan tan first, step by step lah.) However you must also know your limits and try not to invest in areas where you are weak, or very ignorant and may never gain competence. For Buffett, this was technology. That's why he never participated in the IT boom and bust.

For most of us, the circle of competence will usually be related to our work, or observations from our daily lives. If you encounter other companies in your work that impressed you, might want to know how their stock performed. Similarly, if you wear a particular brand of shoes, and like it so much, it might be worthwhile to do some research on the company that produces the shoes.

See also Investment Philosophy and Process

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