Circle of Competence. How to Combat Overconfidence Bias

Rational decision-making requires honestly identifying the boundaries of your "circle of competence" and operating only within it.

At a family dinner, the conversation turns to cryptocurrency. One cousin, a software developer, explains the technical details of blockchain with deep knowledge (he is inside his circle).

Another uncle, who heard a single news report, starts giving confident investment advice (he is operating far outside his circle). The quality of their statements, one nuanced and careful, the other dangerously oversimplified, makes the boundary of competence obvious to everyone listening.

What is the Circle of Competence and how does it prevent overconfidence bias?

Popularized by investors Warren Buffett and Charlie Munger, the concept of a "circle of competence" is a discipline in intellectual humility. It is not about how large your circle is, but about how well you know its perimeter.

• Inside the circle are the skills and subjects you have mastered through deliberate practice and study.

• Outside the circle is everything else. The majority of catastrophic errors in business and life come from making decisions outside one's circle, which is a common result of overconfidence bias.

The goal is not to have the biggest circle, but to have the clearest definition of your own, and to have the humility to say "I don't know" when you are outside of it. This is a key concept to understand alongside the Dunning-Kruger Effect, which highlights how low competence can often lead to a feeling of overconfidence.

How can I apply the Circle of Competence in my daily life?

Before making a significant decision, draw a literal or mental circle and ask:

• Is this topic squarely inside my circle, or am I standing on the edge or outside of it?

• If I'm outside, who is inside this circle that I can consult?

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