Key Takeaways
- Buffett urges investors to stick to a “circle of competence,” investing only in businesses they fully understand.
- His top priority is a company’s durable competitive advantage, not trends, forecasts, or buzzwords.
Warren Buffett, revered for turning Berkshire Hathaway Inc. (BRK.A, BRK.B) into a global powerhouse, credits his success not to complexity, but to discipline. “You don’t have to be an expert on every company, or even many,” he wrote in a 1996 letter to Berkshire Hathaway shareholders. “You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
This tip still provides a practical blueprint for smarter, safer investing choices. Here’s what Buffett means, why it matters, and how you can apply it in today’s market.
Warren Buffett’s Advice
Buffett’s formula for success is clear: An investor needs the ability to evaluate selected businesses correctly.
“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, 10, and 20 years from now,” Buffett wrote in the 1996 letter.
For Buffett, then, investing isn’t about chasing the hottest trend or using complex formulas. We can see this in his ventures like investing in Coca-Cola (KO) when others doubted the move, sticking by See’s Candies over the years, and avoiding the dot-com craze in the 1990s.
This advice shouldn’t be taken to mean you should be so overcautious that you never invest in the first place. “Buffett’s style keeps you focused on what the business does and why it matters,” Pamela Sams, a financial advisor at Jackson Sams Wealth Strategies, told Investopedia. “That’s how you avoid mistakes and busted portfolios.”
Applying Buffett’s Investment Rule
How can everyday investors use Buffett’s rule? Begin by honestly evaluating the industries, products, or services you’re familiar with, possibly through your job, hobbies, or lifelong interests. Only invest in companies where you grasp how they make money, who their customers are, and how they’re positioned long-term.
“People chase trends or fall for flashy numbers, but Buffett knows that revenue is meaningless if expenses are out of control, and leadership is critical for success,” Sams said. She pointed to Apple Inc. (AAPL) as an example: Buffett initially avoided tech because it was outside his circle of competence, but once he recognized Apple had built unparalleled customer loyalty and a long-lasting brand, he saw it as a consumer staple, not just a tech company.
Taking this advice, here’s how you would assess an investment:
- Look into whether the company has loyal users, a real barrier to entry, and sustainable profits, not just growth projections.
- Put more emphasis on stable businesses that you understand, rather than jumping into unfamiliar sectors because they’re “hot.”
- Remember that expanding your circle of competence is possible, but overconfidence can lead to costly mistakes if you stray too far beyond it.
Tip
Buffett popularized the idea of a company’s “moat,” which refers to competitive advantages that protect it from rivals, like Coca-Cola’s brand recognition or Amazon.com Inc.’s (AMZN) logistics network.
The Bottom Line
Buffett’s “circle of competence” rule isn’t restrictive; it’s liberating. You don’t need to predict the next big thing; you need to know your own strengths and stick to them.
This principle helps investors avoid hype, focus on true business fundamentals, and invest with discipline and confidence. As Buffett himself stressed and as other experts agree, success comes not from knowing everything, but from recognizing what you don’t know.
