The circle of competence describe the areas where one has useful knowledge that can be used for evaluation. Coined by Warren Buffet he uses the term to focus his investors to operate in areas they know best. The origin comes from his 1996 shareholder letter:
What an investor needs is the ability to correctly evaluate selected businesses. Note that word “selected”: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.
For example most people understand how a restaurant operates. You need to have space, decorate it, hire employees to serve, cook and clean, and eventually make sure you make money. We all could invest into a restaurant. However, most people does not understand how a chip-manufacturer works or a biochemical company. Investing in these companies should be left to people that do understand that and have that understanding in their circle of competence.
Charlie Munger takes this concept into the realm of life. According to Munger to achieve success you need the follow a simple prescription:
You have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.
If you want to be the best tennis player in the world, you may start out trying and soon find out that it’s hopeless—that other people blow right by you. However, if you want to become the best plumbing contractor in Bemidji, that is probably doable by two-thirds of you. It takes a will. It takes the intelligence. But after a while, you’d gradually know all about the plumbing business in Bemidji and master the art. That is an attainable objective, given enough discipline. And people who could never win a chess tournament or stand in center court in a respectable tennis tournament can rise quite high in life by slowly developing a circle of competence—which results partly from what they were born with and partly from what they slowly develop through work.