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🎯 Circle of Competence

📝 Description

Circle of Competence is a foundational investment principle at Berkshire Hathaway, stating that an investor's success is not determined by how much they know, but by how well they define the boundaries of what they do not know. Investors should only play in games (industries or companies) where they have a distinct advantage in understanding.

🔑 Core Philosophy

  • Definition: "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."
  • Discipline: The size of the circle is less important than staying within its perimeter.
  • Expanding the Circle: The circle can be expanded over time through rigorous study, but never by guessing.

🔗 The 1999 Context

The principle of the Circle of Competence was most famously tested during The Dot-Com Bubble.

  • The Tech Gap: In 1999 Letter, Buffett admitted that technology businesses were outside his circle of competence because he could not predict their durable competitive advantages or long-term cash flows.
  • Performance Trade-off: Staying within the circle led to significant underperformance relative to the S&P 500 in 1999 (0.5% vs 21%), but it protected Berkshire from the subsequent 2000-2002 market crash.

⚖️ 2013: Macroeconomics and the Boundary

During the 2013 Meeting, Buffett and Munger aggressively pushed macro-economic forecasting (e.g., predicting interest rates, inflation, or the "new normal") outside their circle.

  • The Unknown vs. The Knowable: Buffett argued that macroeconomic trends are inherently unknowable, and therefore should be ignored. Spending time on the unknowable distracts from evaluating the knowable (the competitive position of a specific business).
  • The Advice: Acknowledging that evaluating individual businesses is outside the circle of competence for most people, Buffett offered his most famous rule: buy a low-cost S&P 500 index fund (the core thesis of his Advice for the Non-Professional).

💡 Quotes

"If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter." — Warren Buffett, 1999

"Knowing the edge of your own competency is much more difficult than being a genius." — Charlie Munger

index | Concepts

🌱 Idea Evolution & Maturity

How this concept developed over time, tracking its transformation from an early practice to a formalized Berkshire pillar.

📊 Interactive Heatmap & Comparison →
1
◌Seed Stage

Practiced, Unnamed

1957 – 1975
Strategic Catalyst
Early partnership years — Buffett only buys what he can deeply analyze
Operational Shift

Buffett operates within a de facto circle without naming it. He only buys businesses he can understand deeply enough to price. Tech, pharma, and novel financial products are avoided without explanation.

Philosophical Shift

Competence is demonstrated through selection, not articulated as a principle.

“

We try to buy these at a price that would be attractive to a private owner... Intrinsic value is what a business is worth.

— 1961 Letter
2
◐Named Stage

Emerging Framework

1976 – 1995
Strategic Catalyst
The Munger influence and the failed airline investments force articulation
Operational Shift

The term 'circle of competence' appears and is defined. Buffett begins actively telling shareholders what he won't do (tech, foreign currencies, macro forecasting) as a way of defining the circle's edge.

Philosophical Shift

Competence is binary at the margin — either you understand the durable competitive dynamics of a business or you don't. The border matters more than the size.

“

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.

— 1996 Letter
3
◑Defined Stage

Active Defense

1996 – 2009
Strategic Catalyst
The 1999-2000 dot-com bubble — Buffett refuses tech, suffers public ridicule, is vindicated
Operational Shift

The circle is tested publicly and severely. The tech bubble creates massive pressure to expand the circle into unfamiliar territory. Buffett holds the line, losing 0.5% vs. the market's 21% gain in 1999 — and then watches the Nasdaq fall 78%. The circle of competence becomes a contrarian badge of honor.

Philosophical Shift

The edge of the circle is where danger lives. The circle must be defined by what you truly understand — not by what you hope to understand.

“

If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter.

— 1999 Letter
4
●Mature Stage

Evolving + Apple

2010 – 2024
Strategic Catalyst
Apple investment (2016) — the circle expands to include consumer franchise businesses with tech delivery mechanisms
Operational Shift

The Apple investment challenges the received wisdom that Buffett never buys tech. He reframes it: Apple is a consumer franchise (like Coca-Cola), not a tech hardware company. The circle hasn't expanded — the mental model for categorizing businesses has matured.

Philosophical Shift

The circle is not defined by industry labels — it is defined by the ability to predict durable competitive advantage and pricing power. A 'tech company' can be inside the circle if its moat is a consumer brand or ecosystem lock-in, not technological superiority.

“

Apple is not a tech company. It is a consumer products company that uses technology as its delivery mechanism. That is within our circle.

— 2017 Annual Meeting

📚 Historical Mentions & Citations (34)

Click a reference document below to expand and read the exact paragraph(s) containing this concept in the archive.

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1994 LetterReference Only
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1994 MeetingReference Only
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1999 LetterExcerpt Available
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If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter. Predicting the long-term economics of companies that operate in fast-changing industries is simply far beyond our perimeter. If others claim predictive skill in those industries — and seem to have their claims validated by the behavior of the stock market — we neither envy nor emulate them. Instead, we just stick with what we understand. If we stray, we will have done so inadvertently, not because we got restless and substituted hope for rationality. Fortunately, it’s almost certain there will be opportunities from time to time for Berkshire to do well within the circle we’ve staked out.
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1999 MeetingExcerpt Available
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I mean, I asked — first time I met Bill Gates in 1991, I said, “If you’re going to go away on a desert island for 10 years, you had to put your stock in two companies in the high-tech business, which would they be?” And he named two very good stocks. And if I’d bought both of them, we’d have made a lot more money than we made, even buying Coca-Cola. But he also would have said at the same time that if he went away he’d rather buy Coca-Cola, because he would have felt sure about that happening. It’s — you know, different people understand different businesses. And the important thing is to know which ones you do understand and when you’re operating within what I call your “circle of competence.” And the software business is not within my circle of competence, and I don’t think it’s within in Charlie’s. Charlie? AUDIENCE MEMBER: Good afternoon, Mr. Buffett and good afternoon, Mr. Munger. My name is Mohnish Pabrai and I’m from the Chicago area. Mr. Buffett, I’d like to thank you for all your insights over the years. I’m especially amazed at the pace of which you answer my letters, point by point. I have a question for you related to circle of competence. I have a notion that both Mr. Munger and yourself understand the Kleiner Perkins model of early-stage venture capital investing and, currently, their focus in the internet space, extremely well. My notion is that I think it is well within your circle of competence to understand what they do, just like you understand what your managers at See’s Candy or Executive Jets do. So the question is, that with the internet, I think we’re seeing a change that has not been seen in the last 500 years as humans. We haven’t seen something that is as dramatic and as profound that’s going to come upon us.
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2000 LetterReference Only
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2000 MeetingReference Only
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2001 LetterExcerpt Available
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They accept only those risks that they are able to properly evaluate (staying within their circle of competence) and that, after they have evaluated all relevant factors including remote loss scenarios, carry the expectancy of profit. These insurers ignore market-share considerations and are sanguine about losing business to competitors that are offering foolish prices or policy conditions.
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2001 MeetingExcerpt Available
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WARREN BUFFETT: Yeah. I might add that when we speak of errors of omission, of which we’ve had plenty, and some very big ones, we don’t mean not buying some stock where we — a friend runs it, or we know the name and it went from one to 100. That doesn’t mean anything. It’s only — We only regard errors as being things that are within our circle of competence. So if somebody knows how to make money in cocoa beans, or they know how to make money in a software company or anything, and we miss that, that is not an error, as far as we’re concerned. What’s an error is when it’s something we understand, and we stand there and stare at it, and we don’t do anything. Or worse yet, what really gets me is when we do something very small with it. We do an eyedropper’s worth of it, when we could do it very big. Charlie refers to that elegantly when I do that sort of thing as when I’m sucking my thumb.
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2002 LetterReference Only
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2002 MeetingExcerpt Available
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I do think there’s certain matters of temperament that may be innate, they may be learned, they may be intensified by experience as you go on, partially innate, but then reinforced in various ways by your experience as you go through life, but that’s enormously important. I mean, you have to be realistic. You have to just define your circle of competence accurately. You have to know what you don’t know and not get enticed by it. You can’t be — you’ve got to have an interest in money, I think, or you won’t be good in investing. But I think if you’re very greedy, it’ll be a disaster, because that will overcome rationality. But I think the same books I read had really molded what I — how I — thought about businesses and investing. I think that they’re just as valid now. I mean, I haven’t seen anything in the last 25 years, and I read — I glance through — most of the books. AUDIENCE MEMBER: Hi, I’m Steve Rosenberg (PH). I’m 22, from Ann Arbor, Michigan. It’s a privilege to be here. First, I’d just like to thank you both for serving as a hero and positive role model for me and many others. Much more than your success, itself, I respect your unparalleled integrity. I have three quick questions for you. The first is how a youngster like myself would develop and define their circle of competence. The second involves the role of creative accounting in the stories of tremendous growth and success over many years. GE, Tyco, and IBM immediately come to mind for me, but I was hoping you could also discuss that issue in relation to Coke. Some people have said that their decision to lay off much of the capital in the system onto the bottlers, who earn low returns on capital, is a form of creative accounting. On the flip side, others counter that Coke’s valuation, at first glance on, say, a price-to-book metric, is actually less richly valued than it seems because they earn basically all the economic rents in the entire system. My final question is, if you could comment on the A.W.
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2003 MeetingExcerpt Available
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WARREN BUFFETT: Yeah. And of course that’s where we made our big mistakes. I mean we have — or I’ve made the big mistakes, actually. I — There have been a couple of things that we knew enough to buy, that were in our circle of competence, where we could have bought lots of stock, except it went up a little bit and then we faded because of price. We didn’t fade because we didn’t want to put more than X dollars in. If we find an idea that we want to put $500 million in, we probably would be even happier if we could put 3 or 4 billion in. Good ideas are too scarce to be parsimonious with once you find them.
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2004 LetterReference Only
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2004 MeetingReference Only
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2005 LetterReference Only
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2005 MeetingExcerpt Available
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WARREN BUFFETT: (Laughter) No, the answer is that Charlie and I, in managing Berkshire, try to do things — put money in things — that we understand. And when I mean understand, I mean, that we — where we think we know, in a reasonable way, what the economics will look like in five or 10 or 20 years. And Bill [Gates] is a lot smarter about a whole lot of things than I am. But it’s still Charlie and I that have the responsibility for managing the money. And we’ll stick in what we consider to be our circle of competence. And the fact that somebody else’s circle is wider or different, you know, that’s the way the world is. I’ll listen to any idea Bill has. Believe me, I will listen to him. I mean, he is a — he’s not only a smart manager, but he’s a smart investor. And I think, actually our ideas on investment overlap to quite an extent. But I still wish I’d bought a little Microsoft when I first met him. (Laughs) Charlie?
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2006 LetterReference Only
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2006 MeetingExcerpt Available
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You know, some other guy can throw the shotput and you’ll still get a gold ribbon, you know, if you run the hundred meter fast enough. So, we try to stay within the circle of competence. Tom Watson, Sr. — I think it was Senior — yeah, Tom Watson, Sr. — many years ago said, “I’m no genius, but I’m smart in spots, and I stay around those spots.” Well, that was pretty damn smart, you know. And we have found a lot of our managers who don’t think, you know, they can solve every problem in the world, but they run their businesses extraordinarily well. You do not want to — Frank Martin mentioned Forest River. You do not want to go and compete with Pete Liegl and his business. He’s going to kill you. He’s very, very, very good. But he doesn’t come around and try and tell us how to run the insurance business, because that’s not his game. We look for people that are very good at things they understand.
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2007 MeetingReference Only
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2008 LetterReference Only
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2008 MeetingReference Only
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2009 LetterReference Only
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2009 MeetingExcerpt Available
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You don’t have to be right on 40. You just have to stay within the circle of competence, the things that you can understand. And look for things that are selling for less than they’re worth, of the ones you can value. And you can start out with a fairly small circle of competence and learn more about businesses as you go along. But you’ll learn that there are a whole bunch of them that simply don’t lend themselves to valuations and you forget about those. And I think if — accounting helps you in that, you need to understand accounting to know the language of business, but accounting also has enormous limitations. And you have to learn enough to know what accounting is meaningful and when you have to ignore certain aspects of accounting. You have to understand when competitive advantages are durable and when they’re fleeting. I mean, you have to learn the difference between a hula hoop company, you know, and CocaCola. But that isn’t too hard to do. And then you have to know how to think about market fluctuations and really learn that the market is there to serve you rather than to instruct you. And to a great extent, that is not a matter of IQ.
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2012 LetterReference Only
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2013 LetterExcerpt Available
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It’s vital, however, that we recognize the perimeter of our “circle of competence” and stay well inside of it. Even then, we will make some mistakes, both with stocks and businesses. But they will not be the disasters that occur, for example, when a long-rising market induces purchases that are based on anticipated price behavior and a desire to be where the action is.
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2013 MeetingReference Only
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2014 MeetingExcerpt Available
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AUDIENCE MEMBER: Hello, Mr. Buffett, and hello, Mr. Munger. Thank you for being extremely generous with sharing your wisdom. My name is Chander Chawla, and I am visiting from San Francisco. In the past, you have said that people should operate within their circle of competence. My question is, how does one figure out what one’s circle of competence is? (Laughter) WARREN BUFFETT: Good question. (Laughs) Some of the people in the audience are identifying with it, I can hear them. The — it’s — you know, it is a question of being self-realistic, and that applies outside of business as well. And, I think Charlie and I have been reasonably good at identifying what I would call the perimeter of that circle of competence, but obviously we’ve gone out of it. I would say that in my own case, I’ve gone out of it more often in retail than in any other arena. I think it’s easy to sort of think you understand retail, and then subsequently find out you don’t, as we did with the department store in Baltimore. You could say I was outside of my circle of competence when I bought Berkshire Hathaway, although I bought it, really, to resell as a stock, originally. I probably was out of my circle of competence when I decided that I should go in and buy control of the company. That was a dumb decision — which worked out.
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2015 MeetingReference Only
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2016 MeetingReference Only
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2017 MeetingReference Only
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2020 LetterReference Only
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2020 MeetingReference Only
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2022 MeetingReference Only
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2023 MeetingReference Only
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2024 MeetingReference Only
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