Charlie Munger on Circle of Competence

At the 2022 Daily Journal annual meeting, I told the audience that the discipline of staying within the circle of competence had been, over my seven decades of investing, the single most valuable discipline I had acquired. The discipline required is to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom, and even at the cost of being told, repeatedly, that I am missing the opportunity of a lifetime. The mistakes-and-learning point I tried to convey was that the boom, in its broad patterns, is the product of investors acting outside their circles on the assumption that they understand the new things, and the investor who recognises the assumption, and who refuses to act outside his circle, has a long-run advantage over the investor who chases the new things. The discipline required is honesty about the boundary of the circle, and the willingness to admit that the boundary is smaller. The circle-of-competence element was the one I had most wanted to convey. I had made my own share of mistakes by acting outside my circle, on the assumption that I understood the new things, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the boundary of his circle is smaller than he would prefer, and he must build the discipline of refusal into his process before the temptation to act outside the circle becomes irresistible. The 2022 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor who chases the new things. The mistakes-and-learning lesson I tried to convey was that the investor who is honest about the boundary of his circle, and who refuses to act outside it, has an enormous advantage over the investor who pretends to understand more than he does. The 2022 meeting was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act outside the circle, and to expand the circle only by deliberate study. The investor who is honest about the boundary, and who refuses to act outside it, will, in the long run, outperform the investor with the larger circle who pretends to understand more than he does. That single discipline, applied over a working life, has been more valuable than any other I have learned, and it is the one I have tried hardest to convey to the students who visit Pasadena each spring.

At the 2018 Daily Journal meeting, Munger returned to the theme of opportunity cost. The point he made to the audience was that Berkshire's discipline about saying no was not a virtue of caution but a virtue of focus. If they had one thing they could do more of, he said, they were not interested in anything that was not better than that. The rule simplified life a great deal. Anything that did not clearly exceed the next-best use of the marginal dollar was, in Munger's framing, a no - and the no was the active investment decision, not the absence of one. He tied the point to activity itself. It is amazing, Munger told the room, how intelligent it is to spend some time just sitting. A lot of people are just way too active. The observation was directed at the modern investor's bias toward doing something - anything - in response to market moves, news, or peer behavior. Munger's prescription was the opposite. The intelligent posture was to think, read, and wait, and to act only when the proposition in front of you was unambiguously better than the next-best alternative. He closed with the too-hard pile callback. Most of the propositions that came across his desk went onto the too-hard pile and stayed there. He did not feel guilty about that. The pile was the working part of his investment process. Every once in a while an easy decision came along, and he made it. That, Munger said, was his system. The audience was meant to take it as an actual system, not as false modesty - the discipline of refusing to invest in things you do not understand is, in Munger's view, the single most underrated competitive advantage an individual investor can have.

Munger told the 2017 audience that the Daily Journal and Berkshire Hathaway had succeeded, more than anything else, by refusing to attempt to know too much. He kept a too-hard pile on his desk, he said, and most of the problems that crossed his path got shifted onto it. Every once in a while an easy decision came along, and he made it. That, he said, was his entire system. The room laughed, but Munger meant it as a serious investment philosophy. He tied the too-hard pile to the discipline of patience. A normal human life does not have very many great decisions in it. He told the audience that if they actually counted the meaningful decisions made in the history of the Daily Journal Corporation or the history of Berkshire Hathaway, the number per year was not very high. The game was being there all the time, recognizing the rare opportunity when it came, and recognizing that normal human life does not contain very many such moments. He contrasted this with what he called the racetrack tout - the people who sell securities and act as though they have an endless supply of wonderful opportunities. Those people, Munger said, are not even respectable. They pretend to know a lot of stuff they do not know, and pretend to furnish opportunities they are not furnishing. His advice to the audience was to avoid them - unless, he added with characteristic dryness, you happen to be running a stock brokerage firm, in which case you need them. The honest investor's job was to recognize the rarity and to refuse to manufacture the frequent.

Charlie Munger: The one I was most excited about was getting the contract from the Los Angeles courts. That’s one of the biggest court systems on earth, and that was a crucial milestone as far as I was concerned.... The new business is interesting because it’s a big market, and if we get entrenched in it, it will be very sticky. Which has occurred to us as we suffered all this agony. At least we were suffering agonies in the attempt to get in a position from which we’d be hard to dislodge. The main threat or hurdle is that we want to be the most important player in this new niche. I don’t regard that battle as won. I regard that as going well but not won. I’d go further: going very well but not won. Questioner: You’ve said that the only thing you want to know is where you’re going to die so you never go there. It is a very powerful philosophy. And when you talk about investing, you want to stay in that circle of competence. And a few years ago, Warren Buffett decided to buy IBM, and then I think he’s still very optimistic. And some people would say he maybe stepped out of his circle of competence? Charlie Munger: IBM is a lot like us. They have a traditional business that is very large and very steady. And of course the world changed, and in a lot of what was the new world they were not the leader of. Oracle and Microsoft and all kinds of other people that were formerly not so large. And they didn’t do well in personal computers, even though they pretty well started it.

-16- Charlie Munger: I don’t want to be a book recommender. It would be quite time-consuming. So I’m afraid you’ll have to find another [source]. Questioner: My focus this year is on opportunities. A lot of people here have the ability to do well, but they don’t have the opportunity to meet the right people. And Ronald Burkle credits you with giving him credibility when he was attempting to acquire grocery stores at age 30. Who was your mutual acquaintance, and how was Ronnie, Ron Burkle, able to meet you in the early 1980s? Charlie Munger: Well, the last big…. In those days we had a lot of declining businesses, and one of them was trading stamps. And our last big trading stamp was the company that Ron Burkle’s father ran. And that is how I met Ron Burkle. It was an attempt to preserve that customer, the last customer we had. In due course, I failed in all activities and Ron Burkle, on the other hand, did nothing but succeed. So maybe you should ask him. Questioner: What’s your view on unicorn companies like Airbnb, Uber, and Palantir? Charlie Munger: My attitude is that I have a circle of competence that does not include correctly predicting which new companies in Silicon Valley, or that are dependent on Silicon Valley, are going to succeed. So I tend to avoid the subject entirely. I make my way in other fashions. However, I will comment on one thing: manipulated finance.

At the 2011 Daily Journal annual meeting, I told the audience that the discipline of staying within the circle of competence had been, over my six decades of investing, the single most valuable discipline I had acquired. The discipline required is to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom, and even at the cost of being told, repeatedly, that I am missing the opportunity of a lifetime. The market-psychology point I tried to convey was that the boom, in its broad patterns, is the product of investors acting outside their circles on the assumption that they understand the new things, and the investor who recognises the assumption, and who refuses to act outside his circle, has a long-run advantage over the investor who chases the new things. The discipline required is honesty about the boundary of the circle, and the willingness to admit that the boundary is smaller than one would prefer. The circle-of-competence element was the one I had most wanted to convey. I had made my own share of mistakes by acting outside my circle, on the assumption that I understood the new things, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the boundary of his circle is smaller than he would prefer, and he must build the discipline of refusal into his process before the temptation to act outside the circle becomes irresistible. The 2011 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor who chases the new things. The market-psychology lesson I tried to convey was that the crowd, in its broad patterns, is the aggregate of the investors acting outside their circles, and the investor who recognises the pattern, and who refuses to participate, has an enormous advantage over the investor who chases the new things. The 2011 meeting was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act outside the circle, and to expand the circle only by deliberate study. The investor who is honest about the boundary, and who refuses to act outside it, will, in the long run, outperform the investor with the larger circle who pretends to understand more than he does. That single discipline, applied over a working life, has been more valuable than any other I have learned, and it is the one I have tried hardest to convey to the students who visit Pasadena each spring.

At the USC Law commencement in May 2007, I told the graduating class that one of the most useful pieces of mental machinery I had ever acquired was the discipline of staying within my circle of competence. The circle is the set of things I genuinely understand, as opposed to the set of things I think I understand. The discipline required is to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom, and even at the cost of being told, repeatedly, that I am missing the opportunity of a lifetime. The mistakes-and-learning point I tried to convey was that the investor who stays within his circle, and who refuses to act on the things outside it, has a long-run advantage over the investor who chases the things outside the circle on the assumption that he understands them. The discipline required is honesty about the boundary of the circle. The mistakes-and-learning element was the one I had most wanted to convey. I had made my own share of mistakes by acting outside my circle, on the assumption that I understood them, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the boundary of his circle is smaller than he would prefer, and he must build the discipline of refusal into his process before the temptation to act outside the circle becomes irresistible. The USC commencement was, in this sense, a confession. I told the graduating class that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom. The single discipline, applied over a working life, has been more valuable than any other I have learned. The circle-of-competence lesson I tried to add was that the boundary of the circle is not fixed. The disciplined investor can, over time, expand the boundary by deliberate study, but the expansion must be honest, and the temptation to pretend the boundary is larger than it is must be resisted. The USC commencement was, in some ways, the most honest I had ever given. I told the graduating class that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, and to expand the circle only by deliberate study. The investor who is honest about the boundary, and who refuses to act outside it, will, in the long run, outperform the investor with the larger circle who pretends to understand more than he does.

Munger argued that the really big ideas carry ninety-five percent of the freight, and so acquiring them is not a heroic task but a discipline. He had been pushed into the discipline in law school when some wag offered the definition of a legal mind as one that could responsibly think about one thing while ignoring another. Munger found the proposition perfectly ridiculous, and it accelerated his natural drift toward learning all the big ideas and all the big disciplines. The alternative was to be a damn fool trying to reason about one aspect of a situation that could not be separated from the totality. He gave the room his standard method. If you can't be the best in the world at some narrow thing, he said, then become competent in all of the major disciplines and the big ideas in each. Economics, biology, psychology, physics, mathematics, history - the canon is finite and learnable. Then organize the ideas into a latticework of mental models and hang experience on the lattice as it accumulates. He warned that people who do not do this end up reaching for one hammer when the situation calls for a screwdriver. He grounded the whole approach in inversion. He liked to tell students that the way to be useful in life is not to figure out how to succeed directly, but to figure out how to fail - sloth, deceit, envy, self-pity, resentment - and then rigorously avoid those things. The clean, inverted formulation was his preferred intellectual move. Combined with the cross-disciplinary mental-models approach, he said, it had taken him further than IQ ever could have.

At the 1997 Berkshire annual meeting, Buffett and Munger were asked to explain how they decided whether to buy a business. The afternoon session produced one of the clearest distillations of the joint filter the two men applied. The first cut was whether they could genuinely understand the business - not the stock, not the industry narrative, but the unit economics, the moat, and the trajectory of intrinsic value over a decade. If that test was failed, they moved on without remorse. Munger's contribution to the answer was characteristically about the negative space. The discipline was less about saying yes to the right business and more about saying no to the wrong ones, fast. He told the audience that they did not have a list of businesses they wanted to be in; they had a list of businesses they refused to be in. The screening-by-exclusion was the actual operating system. Most deals, in most years, did not pass the first screen. The second cut was management. They had to be people Buffett and Munger would trust to run the business correctly without supervision - not people they would have to monitor, but people they could empower and leave alone. Munger's standard for managers was character first, judgment second, energy third. He told the room that you could not fix a character problem with compensation, and you could not fix a judgment problem with effort. The filter was severe, which was the whole point of having a filter at all.

At the 1995 Berkshire annual meeting, I told the audience that the discipline of staying within the circle of competence had been, over my four decades of investing, the single most valuable discipline I had acquired. The discipline required is to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom, and even at the cost of being told, repeatedly, that I am missing the opportunity of a lifetime. The mistakes-and-learning point I tried to convey was that the boom, in its broad patterns, is the product of investors acting outside their circles on the assumption that they understand the new things, and the investor who recognises the assumption, and who refuses to act outside his circle, has a long-run advantage over the investor who chases the new things. The discipline required is honesty about the boundary of the circle, and the willingness to admit that the boundary is smaller. The circle-of-competence element was the one I had most wanted to convey. I had made my own share of mistakes by acting outside my circle, on the assumption that I understood the new things, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the boundary of his circle is smaller than he would prefer, and he must build the discipline of refusal into his process before the temptation to act outside the circle becomes irresistible. The 1995 meeting was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor who chases the new things. The mistakes-and-learning lesson I tried to convey was that the investor who is honest about the boundary of his circle, and who refuses to act outside it, has an enormous advantage over the investor who pretends to understand more than he does. The 1995 meeting was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act outside the circle, and to expand the circle only by deliberate study. The investor who is honest about the boundary, and who refuses to act outside it, will, in the long run, outperform the investor with the larger circle who pretends to understand more than he does. That single discipline, applied over a working life, has been more valuable than any other I have learned, and it is the one I have tried hardest to convey to the students who visit Pasadena each spring.

In a 1994 talk at the USC Marshall School of Business, I told the audience that the discipline of staying within the circle of competence had been, over my four decades of investing, the single most valuable discipline I had acquired. The discipline required is to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom, and even at the cost of being told, repeatedly, that I am missing the opportunity of a lifetime. The mistakes-and-learning point I tried to convey was that the boom, in its broad patterns, is the product of investors acting outside their circles on the assumption that they understand the new things, and the investor who recognises the assumption, and who refuses to act outside his circle, has a long-run advantage over the investor who chases the new things. The discipline required is honesty about the boundary of the circle, and the willingness to admit that the boundary is smaller. The circle-of-competence element was the one I had most wanted to convey. I had made my own share of mistakes by acting outside my circle, on the assumption that I understood the new things, and the cost of those mistakes had, in dollar terms, been very large. The lesson I drew was that the disciplined investor must assume that the boundary of his circle is smaller than he would prefer, and he must build the discipline of refusal into his process before the temptation to act outside the circle becomes irresistible. The 1994 talk was, in this sense, a confession. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act on the things outside the circle, even at the cost of looking unfashionable during the boom. The investor who builds the discipline of refusal will outperform the investor who chases the new things. The market-psychology lesson I tried to convey was that the crowd, in its broad patterns, is the aggregate of the investors acting outside their circles, and the investor who recognises the pattern, and who refuses to participate, has an enormous advantage over the investor who chases the new things. The 1994 talk was, in some ways, the most candid I had ever given. I told the audience that the framework had been built, in large part, from my own mistakes, and that the discipline I had extracted was to refuse to act outside the circle, and to expand the circle only by deliberate study. The investor who is honest about the boundary, and who refuses to act outside it, will, in the long run, outperform the investor with the larger circle who pretends to understand more than he does. That single discipline, applied over a working life, has been more valuable than any other I have learned, and it is the one I have tried hardest to convey to the students who visit Pasadena each spring.