In his 1983 letter to shareholders, Warren Buffett talked about Rose Blumkin ('Mrs. B').
Without any formal education, she'd built America's largest furniture store...
How did she do it?
Starting with savings of $500 in 1937...
She took Nebraska Furniture Mart (NFM) to $100 million in sales in 1983.
When Buffett wanted to buy NFM in exchange for shares in his company, Mrs. B shares refused, instead asking for cash.
He later said:
“She understands furniture. She understands real estate. She does not understand stocks, so she does not have anything to do with them. If you deal with Mrs. B in what I would call her circle of competence...she is going to buy 5,000 tables this afternoon…20 different carpets…and everything else like that because she understands carpet. She would not buy a hundred shares of General Motors even if it was at 50 cents a share (very cheap)."
“She understands cash.”
With this story, Buffett teaches us the idea of the 'circle of competence’.
The idea is simple.
Through experiences and study, you build up useful knowledge in certain areas.
It may be accounting, medicine, banking, painting, software engineering...
You get the idea.
Sticking to what you know - your circle of competence - is valuable.
The problem most people have?
There's a big difference between what they think they know... and what they know.
While Buffett has often talked about this idea in relation to investing, practising it is instrumental for success in all areas of life.
Consider baseball.
The average baseball hitter swings and misses 8/10 times.
These are poor odds by any standards.
Ted Williams, ranked amongst the greatest hitters in American baseball history, swung and missed 6/10 times.
His secret?
As per his biography, he carved the strike zone into 77 cells, each the size of a baseball.
He then swung only when the ball was in his 'sweet spot', where he thought he had the highest chance of hitting, and then avoided when the chance of hitting was low.
Applying Ted’s strategy to investing, Buffett says,
“The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot. And if people are yelling, ‘Swing, you bum!’ ignore them."
Your circle of competence
How do you know where the boundaries of your circle of competence lie?
Charlie Munger says,
"If you have competence, you pretty much know its boundaries already. To ask the question (whether you are past the boundary) is to answer it.”
There is nothing wrong with staying within your circle, no matter how narrow.
Instead, work to expand that circle by reading, learning, studying, being curious, and asking great questions.
But never kid yourself about where your circle stands today.
Only then will you know where the boundaries lie.
And never be afraid to say ‘I don't know’ to things that lie beyond your circle.
If there's one place where you can deal with the inevitable uncertainties of life, it's inside your circle of competence.
Like Thomas J Watson Sr., founder of IBM, said,
"I am no genius. I am smart in spots - but I stay around those spots."
Stay around your spots.
Quote
"You have to figure out what your own aptitudes are if you play games where other people have the aptitude and you don't, you are going to lose. You have to figure it out. Where you've got an edge and you've got to play within your own circle of competence."
Further reading
After 15 years in life financial planning, I’ve realised almost everyone gets the same thing wrong
How should affluent investors understand and deal with risk?
How to safeguard your family’s financial future
What I'm reading #15: A secret to solving the most difficult problems
Goals vs. capital: Are yours aligned?
Retirement planning for affluent expats: The right balance between spending and saving
