Want To Avoid Bad Decisions? Here’s How Warren Buffett and Charlie Munger Stick to What they Know.
We all want to avoid making bad decisions. We want to avoid making bad investments. Avoid failure, losing money, etc.
Warren Buffett and Charlie Munger (may he Rest in Peace) have a mental model for this. It’s called the “Circle of Competence”.
Here is a short video of their explanation of the topic.
What’s so great about this principle is that helps you to stick to what you know.
It allows you to operate where you are best, and avoid where you’d make stupid decisions.
Here is a breakdown of the rules and how it applies:
Your Circle of Competence is an area you know well. You’re an expert in. You have a lot of experience in.
You Know Less Than You Think You Do
We naturally think we know a lot more than we do.
Our ego gets in the way.
We get overconfident.
We think we’re smarter than we are.
We end up thinking our expertise in one area applies to other areas, then we end up making bad decisions.
It’s important to know the difference between what you think you know vs what you actually know.
Know Your Limits
Building a Circle of Competence takes years to cultivate. There are not shortcuts. It takes hard work and experience to build one.
And once you have one, it takes work to maintain, otherwise it atrophies and you can lose (or shrink) your circle.
Further, when you’re in your Circle of Competence, it becomes much clearer what you don’t know.
If you don’t know what you don’t know, chances are you are already outside of your Circle of Competence.
Thus, when making important decisions, it is critical to understand where the edges of your competence lie.
Grow Your Circle of Competence
As Farnam Street’s The Great Mental Models Vol. 1 points out, there are three keys to building your circle of competence:
- Curiosity and desire to learn
- Monitoring
- Feedback
Underpinning all of this is hard work and practice. However, staying curious and trying new things, monitoring progress and getting feedback on what you need to improve on will grow your Circle of Competence over time.
Operating Outside of Your Circle of Competence
Life becomes boring if we never venture outside of our Circle of Competence. We also stifle our growth and learning.
We’ll also naturally find ourselves outside of our Circle of Competence from time to time, or maybe even often.
So how do you survive when you’re outside of it?
Firstly, know that you’re outside of it. Then:
- Learn the fundamentals of the subject matter your in. But be transparent with others (and yourself) that you’re a beginner
- Learn from the experts. And ask them good questions to learn faster
- Use mental models—these are no substitute for expertise, but they arm you with a variety of tools to think through problems in a lot of different, powerful ways.