This may be probably one of the most important aspects of investing i.e to know your circle of competence. The first question which arises here is to what do you mean by circle of competence.
A random google search leads to the following meaning of the word competence
The ability to do something well or efficiently.
A circle of compentence is the area in which you are comfortable and is the area in which you can have a reasonable enough prediction about the future. You can absolutely have your own circle of competence and you should not get influenced by the circle of competence of others. By circle of competence i mean that you can have your own sector industry or company in which you are comfortable with. Circle of competence can be influenced by a variety of factors. Some of these can be
1) You might be working somewhere in an IT company and you know how the business is carried out and hence you understand that business well. That’s your circle of competence.
2) You have a business of retailing. You know how the consumer buys the goods when it comes to you. You know the consumer behaviour. You know what factors the consumer wants when he buys the goods. That’s your circle of competence.
3) You might be using a product for awesomely long enough. You know when and why does the company offer the product cheap. You know where you will the get the product in bulk. That’s your circle of competence.
You can predict with reasonable accuracy predict the future for companies within your circle of competence and hence you should be able to explain your circle of competence not to others (you don’t need to explain it to every one) but to yourself.
The circle of competence in investing would mean what sort of companies are you comfortable with and ideally you should only invest in those companies which are within your circle of competence. People will go about analysing each and every company in the market without really understanding any. It is of prime importance that you work within your circle of competence. It is extremely easy to get out of your circle of competence and equally difficult to stay within it.
It is again felt by me that again reading the baseball lines by Warren Buffett is useful here
The stock market is a no-called-strike game. You don’t have to swing at everything–you can wait for your pitch. The problem when you are a money manager is that your fans keep yelling, ‘Swing, you bum!’
You would surely know the baseball game in which the referee calls a strike if you miss the ball. But in investing you can just stand at the place and wait for your favourable pitch and then swing when the pitch or ball is in your circle of competence. No one is going to call a strike if you just wait there and hence there no need to strike on every pitch.
It is quite important to know that only you can define your circle of competence. only you can do it for yourself. It is important that you give sometime thinking about your circle of competence. It is not only about investing but also in life you should focus on what is you circle of competence.
Again if in the words of Warren Buffett
It is not about how big your circle of competence is but it is about how certain are you about its boundaries. A person who has a bigger circle of competence but is somewhat sketchy with its boundaries has no particular advantage than you.
Thus it is important that you know what is your circle of competence and when you come across something it would ideally take less than 30 seconds for you to know whether it is in your circle of competence. Try it. It works. For sure.
This video is i guess one of the best investment videos ever and the lines on circle of competence would surely strike upon everyone. i owe it to Mr Sanjay Bakshi who is popularly called fundoo professor for sharing this video. It is worth the time. Please do watch it. You can also click on the headline to go to youtube directly.
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Thnx for your time.