The circle of competence is a mental model developed by Warren Buffett and Charlie Munger. I first came across it at Farnam Street and The Great Mental Models, volume 1.
Here is how it is usually visualized:
This diagram shows two circles of different sizes. The smaller one is fully contained within the larger one. This is intentional. There is a lot you can learn from and with this model. The obvious is in plain sight: One circle is smaller and fully contained in the larger circle; the former refers to a proper subset of the latter.
What to make of it, in the context of what the model is describing? You know less than you think you do. You are less competent than you believe. There is a difference between actual and perceived understanding.
Here is a different view that provides additional perspective.
It is valuable to know where you are at. Your area of known strength is your circle of competence. It is an excellent place to be. Capitalize on your strengths, when you are able to. Likewise, having clear-sighted awareness of your weaknesses is good. When you know, where you do not know much, you can strive to position yourself to managing it.
To have knowledge or ability but to be unable to see it or believe it will likely prevent your from really capitalizing on it. You might treat the area like a weakness rather than a strength.
The remaining quadrant is the least desirable one. You do not know, but think you do. It is ignorance, often due to assumptions and/or driven by mental blind spots. This is the gap area between the two circles in the above circle of competence model, the difference between the two sets.
The matrix hopefully makes it a little clearer, why that area is concerning, perhaps dangerous even: Your belief does not match reality – but you may be convinced that it does. It can be difficult to see and you might mistake an area of ignorance for one of known strength.
You need confidence in your ability — and also humility, because you may be wrong.