Circle of competence

In One Sentence

Buy only what you truly understand; the size of your circle doesn't matter — what matters is knowing exactly where its edge is.

Why It Matters

The most dangerous thing isn't not knowing; it's not knowing that you don't know — making a little money a few times and thinking you've figured out the market. For most families, the best circle of competence is small and steady: I don't understand every company's business, but I do understand that the market as a whole grows along with the economy over the long run, and that's enough. However popular something outside your circle becomes, you can simply leave it alone.

One Number

Psychology research has found that the less competent people are, the more likely they are to overestimate themselves — what's known as the "Dunning-Kruger effect" (Kruger & Dunning 1999 · Chapter III).

In the Book

Section 7 of Chapter V, "Don't Lose Money," lists the circle of competence as part of avoiding fatal mistakes, and reminds you to keep reading so that your circle slowly grows.

Go Further

• Warren Buffett The idea of a circle of competence comes from his 1996 letter to shareholders: "The size of that circle is not very important; knowing its boundaries, however, is vital."
• Broad-market index ETFs It's fine not to understand individual companies; just buy the whole market.
• Defensive investing One of my investing rules says the same thing: don't buy what you can't understand.
• Bonds and cash I took a detour through long-term US bonds and concluded that long bonds are too complicated to touch.
• Charlie Munger He urged people to go to bed each night a little wiser than when they got up — that's how a circle grows.