The edge of competency is a term that derives from Charlie Munger, and Warren Buffett’s analogy of the circle of competence. The circle of competence is defined by the areas in which an investor is an expert. Therefore, the edge of competency represents the limit of someone’s expertise.
Investors should be not only aware of what they know, within their circle of competence, but also identify their edge of competency. It allows them to know exactly what their limitations are.
Why you should not cross your edge of competency
One of the most defining aspects of investing successfully is to stay within your circle of competence when researching and evaluating investment opportunities. This ensures that you are not making decisions on topics that you are not knowledgeable about.
One of the ways of doing so is by not crossing your edge of competency. By limiting your decisions to areas, and industries that you know well. This way you will avoid making investing mistakes, based on your
How do you know your edge of competency?
To know your edge of competency you need to be radically transparent with yourself. Analyze exactly what kind of areas you are an expert on, and be frank when considering your knowledge.
Be radically transparent with yourself
We tend to overvalue ourselves, and part of it manifests itself by overstating our abilities, or our insights into a specific topic. In order to identify your edge of competency, you need to start by frankly pinpointing certain areas in which your knowledge is limited.
This requires you to be brutally honest with yourself, in an inner discussion to justify your own expertise.
One of the simplest ways of doing it is creating a list of topics that you know well. Start with the areas in which you have vast experience, and consider yourself an expert. Add topics
Talk to experts
We have mentioned this before as one of the ways of expanding your circle of competence. However, talking with experts in different industries may also help you to validate your own knowledge on a topic.
Consider that you are talking with an industry expert about a specific company, and he is not sharing anything you do not know about. Then this might be an indicator that this industry or company is within your circle of competence.
As a rule of thumb, if an industry expert is not sharing anything new that you did not know about, then the topic is not beyond your edge of competency.
Backtesting your own views
One of the most challenging ways of determining your edge of competency is to compare your past projections with what eventually happens. One of the simplest ways of doing this is to keep your own investing journal. Every investment idea, projection, or speculative thought that comes into your mind should be included in your investing journal.
This way you can go back, and evaluate whether you made the right call or not. This takes time and some effort. But it allows you to compare your past views with what eventually happened. If you notice that some of your views or predictions ended up materializing, that is a good sign that those topics are within your circle of competence.
How to expand your edge of competency
Even if your circle of competence is quite small. it does not mean that it cannot expand. Doing so requires you to increase your edge of competency.
That is achieved by studying, and researching different topics and gaining expertise in new areas. There are several ways to expand your circle of competence, and your edge of competency.