Warren Buffett once introduced the concept of a “circle of competence.” Simply put, it means investing only within the areas that you truly understand and are able to evaluate.
And here, “understanding” does not mean knowing a company’s name, nor having read a few news headlines. It means genuinely knowing how the company makes money, why customers choose its products, where future profit growth is likely to come from, and what risks could potentially disrupt its business model.
For example, someone who has spent years studying banking and insurance will be more familiar with loans, deposits, interest rates, and asset quality. Someone working in manufacturing will have a clearer understanding of raw material costs, order flow, and capacity utilisation. Others who follow consumer, pharma, or IT services sectors closely will have more direct insight into industry competition and customer demand dynamics.
Every investor’s circle of competence is different. A larger circle does not necessarily mean better investing skill. What truly matters is whether one clearly understands where that boundary lies.
A person who only understands a few sectors, but is very clear about what they can and cannot judge, may actually be safer than someone who follows dozens of industries at once.
Because the most expensive mistakes in the market are often not made when we truly know nothing—but when we do not understand something, yet start believing we do simply because the stock price has been going up.
When a stock keeps rising, the market creates an illusion: strong price performance must mean the company is fundamentally excellent.
We start paying attention to its news flow, hearing increasingly bullish narratives, and seeing other investors posting gains. Industries we were previously unfamiliar with suddenly feel easy to understand.
But a rising price only tells us that the market is currently willing to pay a higher price for the stock. It does not prove that the underlying business risks have disappeared.A company operating in a hot sector does not necessarily mean it can make money; and a stock showing strong recent performance does not mean we have developed the ability to correctly judge it.
A true circle of competence does not suddenly expand just because stock prices are rising. It can only be built gradually through long-term learning, research, and experience.
For investors, what is often hardest to accept is not a loss, but watching a stock they did not buy continue to rise.
It is easy to fall into regret: if only I had known it would go up, I should have bought it; I had already noticed it, so why didn’t I act?
But it is important to remember that missing an upside move and actually incurring a loss are two completely different things.
Not buying a stock that goes up only means missing that specific gain—it does not reduce the capital in our account. However, chasing a stock without proper understanding, and buying it at a high price, can lead to real and permanent losses if the judgment turns out to be wrong.
The market does not revoke our ability to invest simply because we have missed a few opportunities in a row. Missing defence stocks today does not mean we will not see opportunities in sectors like consumption, banking, healthcare, or manufacturing tomorrow.
The true scarce resources are not stock tickers, but our capital and our judgment.
Therefore, mature investors do not try to capture every single rally in the market. They are more willing to wait for opportunities that they can understand clearly and whose risks they are capable of bearing.
