Circle-of-Competence Investment Discipline
Concentrate on what you know and personally verify every material bet
- Difficulty
- Moderate
- Time to result
- ~ongoing to results
- Steps
- 6
- Confidence
- 96%
Circle-of-Competence Investment Discipline starts by defining the industries, transaction structures, and operating patterns an investor understands in depth. Opportunities outside that boundary are rejected or tested only with amounts small enough to make failure instructive rather than destructive. Inside the circle, the investor conducts material diligence personally, supported by a stable team whose accumulated experience improves judgment. The framework treats avoided losses as a central component of performance: rejecting a seductive but poorly understood deal may create more value than completing another winner. Its mechanism combines focus, independent verification, humility, and institutional memory. The competence boundary can expand, but only through evidence and learning—not because recent success creates confidence that every new domain is understandable.
Origin
Extracted from Masters in Business through Martin Franklin's reflections on avoided deals, losses from venture-style investments, personal diligence, and staying within his lane.
Core principles
- 01Avoided losses are a major source of returns
- 02Deep knowledge can outperform broad superficial coverage
- 03Independent diligence preserves judgment
- 04Small failures should become durable lessons
- 05Humility protects discipline after success
- 06Trusted long-term teams improve pattern recognition
How to run it
- 1
Map the competence boundary
List the sectors, business models, transaction types, and risks the team understands from direct experience. State explicitly what remains outside the boundary.
Pro tip Define competence through demonstrated judgment, not familiarity with terminology.
Watch out A broad boundary that excludes nothing is not a useful risk control.
- 2
Filter before pursuing
Reject opportunities that require unsupported assumptions about unfamiliar markets or technologies. Reserve detailed work for situations where the team has a genuine analytical advantage.
Pro tip Treat an early no as saved time and protected capital.
Watch out Deal excitement can make a weak fit appear strategically adjacent.
- 3
Verify personally
Keep responsibility for the decisive diligence rather than outsourcing judgment to consultants. Use specialists for evidence, but integrate and challenge their conclusions internally.
Pro tip Investigate the assumptions that would cause the largest loss if wrong.
Watch out A respected adviser cannot absorb the investor's downside.
- 4
Make new learning cheap
When exploring beyond existing competence, limit exposure so a total loss remains tolerable. Extract a specific lesson before considering another experiment.
Pro tip Set the maximum loss before enthusiasm builds.
Watch out A small experimental position can quietly become a large commitment.
- 5
Compound team memory
Retain trusted people, document decisions, and compare outcomes with original assumptions. Let repeated experience sharpen the boundary and improve future filters.
Pro tip Review rejected deals as well as completed investments.
Watch out Team longevity helps only when disagreement and learning remain welcome.
- 6
Guard against success-induced drift
After strong returns, deliberately retest assumptions and risk limits. Preserve humility so a winning streak does not justify unfamiliar or oversized bets.
Pro tip Ask which current opportunity resembles the conditions preceding past losses.
Watch out Complacency can erase years of disciplined compounding in one transaction.
In the wild
Franklin says the two occasions when he left his lane for venture-like investments resulted in total losses. Because the amounts were relatively small, he treated them as inexpensive lessons and returned to the investment discipline that had worked throughout his career.
→ Small controlled failures reinforced his commitment to familiar sectors and deal structures.
An industrial investor is offered a fast-growing consumer application at an attractive projected valuation. The team cannot independently validate user economics or technology risk, so it declines rather than relying on consultants, then redirects diligence toward a regulated services company it understands.
→ The investor preserves capital and concentrates analytical effort where it has an advantage.
Common mistakes
Mistaking intelligence for competence
General analytical ability does not replace direct understanding of an industry's economics, incentives, and failure modes.
Delegating the investment judgment
Consultants can supply information, but outsourcing the decisive conclusion separates responsibility from analysis.
Expanding after a winning streak
Recent success can create false confidence that expertise transfers automatically into unfamiliar domains.
Is it for you?
Best for
It is best for investors and acquisition teams seeking superior long-term returns through depth, selectivity, and loss avoidance.
Not ideal for
It is not ideal for mandates requiring broad market coverage or rapid diversification across unfamiliar asset classes.
From the transcript
“my father always used to say, you make more money on the deals you don't do than the deals you do.”
“did my own due diligence, never sort of delegated it to consultants.”
“if you really know something in depth, stick to it for the long term”
From the episode
Martin Franklin on Building Businesses (Podcast)