One of the best lessons I’ve learned in my investing journey is to stick to what I know—what Warren Buffett calls the circle of competence. The concept is simple but incredibly powerful: focus on the areas you deeply understand, and avoid venturing into industries or companies that are outside your expertise. This approach has helped me avoid costly mistakes and seize opportunities where I had a clear advantage. Let me share why this concept is so important and how it has shaped my approach to investing over the years.
Understanding Your Circle of Competence
Your circle of competence is essentially the boundary of your expertise. It’s the industries, businesses, or sectors you know well enough to evaluate intelligently. When you stay within this circle, you’re making decisions based on genuine understanding rather than speculation. The idea is that it’s much safer to invest in what you understand than to take a gamble on something you know little about.
Early in my career, I made the mistake of venturing into sectors I didn’t fully understand. I remember in 2011 when the biotech sector was all the buzz. The potential breakthroughs and high returns sounded incredibly enticing, and many of my peers were investing heavily. I decided to buy shares in a biotech company that was developing a promising new drug. I didn't fully understand the science, the clinical trial process, or the regulatory hurdles. I bought in at $35 per share, only to see it fall to $12 when their key drug failed a Phase 3 trial. I learned a hard lesson: investing in what I didn't truly understand was more akin to gambling than smart investing.
The Benefits of Staying Within Your Circle
After that experience, I decided to focus on areas where I had a deep understanding. For me, this meant industries like consumer goods and financial services—sectors where I had worked and spent years studying. One of my most successful investments came from following this principle.
In 2014, I invested in a consumer goods company that had a well-known brand and a long history of consistent cash flow. At the time, the company was trading at a price-to-earnings (P/E) ratio of 12, which was lower than the industry average. I knew the business inside and out—I understood their product line, their competitive advantages, and their customer base. I recognized that the market was undervaluing the company due to short-term concerns over a new competitor entering the market. I bought in at $50 per share, and over the next three years, the stock climbed to over $90. Staying within my circle of competence allowed me to see the value that others had missed.
The advantage of focusing on what you know is that it reduces the risk of unexpected surprises. You’re not relying on luck—you’re relying on knowledge. When you deeply understand a business, you can identify when it’s truly undervalued and when the market is mispricing it due to temporary noise. This clarity gives you the confidence to invest decisively, even when others are unsure.
Expanding Your Circle—Slowly and Deliberately
The beauty of the circle of competence concept is that it’s not static—you can expand it, but you should do so slowly and deliberately. Over the years, I’ve expanded my own circle by taking the time to study new industries and learn from experts. For example, I was initially unfamiliar with the renewable energy sector. It was a space I found intriguing, but I didn’t rush in. I spent almost a year reading industry reports, talking to people in the field, and understanding the regulatory environment. Once I felt confident, I made a small investment in a renewable energy company. Over time, as my understanding grew, I added more to my position, and it became a profitable part of my portfolio.
The key here is that expanding your circle of competence should be done gradually. You can’t expect to become an expert overnight, and it’s better to take small, informed steps rather than diving in headfirst. When I look back, the mistakes I made were often because I tried to leap into unfamiliar territory without putting in the necessary work to understand the nuances.
The Risks of Venturing Outside Your Circle
I’ve learned that the biggest risks in investing often come from stepping outside your circle of competence. When you invest in areas you don’t understand, you’re far more vulnerable to making poor decisions. You may be tempted to follow the crowd or invest based on hype rather than fundamental analysis.
A great example of this was during the cryptocurrency boom in 2017. I had friends and colleagues making huge profits, and there was immense pressure to join in. But the reality was, I didn’t understand the underlying technology well enough to invest confidently. I couldn’t determine what made one cryptocurrency better than another, and I had no idea how to value them. So, I chose to stay out. When the market corrected sharply in 2018, many of those same people saw their gains evaporate. My decision to stay within my circle of competence protected me from potential losses.
How to Identify Your Circle of Competence
If you’re not sure what your circle of competence is, start by asking yourself a few questions:
What industries do I understand well? Think about your professional experience, your hobbies, and the areas where you’ve spent a lot of time learning.
Can I explain this business to a friend? If you can’t explain how a company makes money or what its main challenges are, it’s probably outside your circle.
Do I know the key drivers of success for this industry? Every industry has a few key factors that determine success or failure. If you don’t know what these are, you’re probably not ready to invest in that space.
Conclusion: Invest Where You Have an Edge
Understanding and respecting your circle of competence is one of the most important things you can do as an investor. It keeps you focused, reduces your risk, and helps you make informed decisions based on real knowledge. The market is full of opportunities, but not all of them are meant for you. The best investors aren’t those who know everything—they’re the ones who know what they don’t know and act accordingly.
For me, sticking to my circle of competence has been a game-changer. It’s helped me avoid costly mistakes, capitalize on undervalued opportunities, and build a portfolio that I truly understand. If there’s one piece of advice I can share, it’s this: know your circle, stay within it, and expand it thoughtfully over time.