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What Is A Circle Of Competence And How Does It Help In Investing?

An investor should probably not be blamed for trying to know too much, as he is constantly bombarded by news articles, research reports and other stimuli.

Amidst the din, the investor may struggle to sift out what’s relevant to apply it to his investment process or to make sense of this barrage of information. It’s no surprise that in the current information age, investors end up with more information than they bargained for and this may result in “analysis paralysis” – a term which describes how an investor “freezes” (i.e. does nothing) because there is simply too much information to analyse.

So, how do we go about organising the information we receive? We can rely on our circle of competence to guide us.

Defining Our Circle Of Competence

The term “circle of competence” was first coined by the value investor Warren Buffett, and refers to knowledge of subject matter or an area of focus which matches a person’s skills sets and/or expertise.

Essentially, this is a way for investors to know what they can understand well, and what they are not able to grasp. For example, a doctor may be familiar with the hospitals and pharmaceuticals industry, while a mechanical engineer may be more familiar with engineering companies with their associated technical jargon. It’s important to be able to define the boundaries of what we know so that we do not stray too far into unfamiliar territory.

Compartmentalising Information

Based on this knowledge of our circle of competence, we would be able to compartmentalise the information we receive and place them into relevant “buckets”.

If the information is something we can understand quickly and easily, then it should be processed immediately and made sense of. If the information turns out to be somewhat unfamiliar or alien, then we may wish to evaluate the time and effort taken to make good sense of it, and then either proceed or discard the information. Finally, if the information is either too technical or tough to comprehend, then the investor should filter it out and ignore it completely.

Broadening The Circle

While the above seems to be a good method to manage the deluge of information, it’s also the intention, over time, to widen our circle of competence. This can be achieved through extensive reading and slow learning over time. As knowledge should not remain static, we should make reasonable effort to expand our circle of competence.

Continuous Learning

As investors, it’s vitally important for us to adopt an attitude of constant learning. This would not only help us to build up our investment acumen, but also open us up to more diverse views and opinions to counteract the influence of behavioural biases. Investing is a lifelong learning journey and is a necessary component as we walk along the road towards financial freedom.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.