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Charlie Munger's System of Mental Models
Charlie Munger is known for his extensive System of Mental Models, often called Munger's Latticework of Mental Models. Today, we'll take a look at 8 of these Mental Models.
1. The Swiss Army Knife Approach
Charlie Munger’s Mental Model Approach can be described pretty well by a mental model itself—the Swiss Army Knife Approach.
A Swiss army knife is a little pocket knife with numerous tools attached. No matter the problem, you will find something that helps you solve it.
That’s how Charlie Munger thinks about his latticework of Mental Models. Every tool represents one mental model. The many different use cases represent the multidisciplinary approach. You want your models to be diversified over a variety of fields—maths, physics, economics, biology, chemistry, psychology, etc.
2. Make Friends with the Eminent Dead
“I would say you are not restricted to living people when picking your mentors. Some of the very best people are dead.” - Charlie Munger
Knowledge adds up. And we have centuries of acquired knowledge behind us. Why shouldn’t we use that? All of the most brilliant ideas originated at some point. Through books, we can learn from the genius people who came up with them. Using that is almost a duty.
Apart from their ideas in certain subjects, Munger enjoys explicitly reading biographies of people he admires to understand their way of thinking better.
“Take a simple idea, and take it seriously.”- Charlie Munger
There are areas in life where difficulty is rewarded. However, those are the exception, not the rule. For most things in life, investing is one of them, you are not rewarded for a higher level of difficulty.
In fact, investing is an activity that punishes one for adding unnecessary difficulty. Paradoxically, it is a field in which a whole industry (Wall Street) is built around unnecessary complexity. That’s a bad mix.
The average returns of individual investors have gone down for decades while the asset management industry grew bigger and bigger and created new complex products year in and year out.
If we look at the most successful investors, we notice that their approach is pretty straightforward. They take a simple idea: Buy good businesses and don’t overpay. And take it seriously.
4. Invert, Always Invert!
“Invert, always invert: Turn a situation or problem upside down. Look at it backward.” - Charlie Munger
The idea of inversion is to simplify problem-solving by turning problems around. When we do that, we realize how much easier it is to look for disqualifying features instead of qualifying ones.
There are many ways to achieve success, which makes it very hard to create a clear plan. However, only a handful of features or traits make sure you’ll fail—sloth, envy, resentment, self-pity, entitlement, and other self-defeating habits.
Last Weekend, I released my first Company Deep Dive. It was a 50-minute piece on Visa. From now on, there will be a new Deep Dive for Paid Subscribers every month.
Generally, features for Paid Subscribers are:
Monthly Deep Dives/Valuations of Companies
A Comparative Intrinsic Value Sheet with all analyzed Companies
Free Access to all the Products I’ll release (My Investing Checklist System will be sent out tomorrow)
Direct E-Mail Access to Me
A Community Portfolio starting with $1,000
In case you’re interested (If you’re a student, message me, and you’ll receive a discount):
5. Crush Your Most Cherished Beliefs
“One should recognize reality even when one doesn’t like it. Indeed, especially when one doesn’t like it.”- Charlie Munger
I write a lot about psychology, and this Mental Model has a very psychological background. We all have ideas in our minds that we just want to be true. Often, because we always thought that’s the case, and admitting now that it isn’t so makes us feel dumb.
This is one reason why we have certain beliefs that we, once accepted, never change again. There are many other factors that play a role, but that’s not for this article to be discussed.
What matters is that we change that attitude and develop a mindset of prioritizing truth over being right.
I think it’s a lot scarier to hold false beliefs for my whole life than feeling dumb for a minute.
6. Secondary and Tertiary Effects
Economics is highly complex. We don’t understand most of what happens in markets and economies across the world. That’s why our ability to forecast seems to be so bad. The recent years have shown how little we actually know about inflation and interest rates and how markets and economies react to them.
The reasons for that are secondary and tertiary effects. We can’t do much to understand them. What we can do, however, is be aware of them and avoid situations in which we are dependent on them.
A piece of practical advice for investing is to choose a strategy that doesn’t require us to forecast the macroeconomic environment of next year. As Munger put it:
“If our predictions have been a little better than other people’s predictions, it’s because we’re trying to do fewer of them.” - Charlie Munger
We unconsciously use filters every day of our life. But in order to really benefit from the power that filters can have, we need to use them consciously. Think about which filters you want to use in which situations.
Investing is a good example. There are over 40,000 publicly listed companies in the world. You want to find about a dozen to include in your portfolio. Without actively being aware of it, we use filters that cut the number of 40,000 to a couple hundred. The most common filter we use is geography. We either invest in the country we are based in or the biggest stock markets in the world.
That’s a very reasonable first filter. One of Warren Buffett’s first filters, after geography, is the complexity of a business. If he doesn’t understand it in 5 minutes, it’s ruled out.
Charlie Munger likes the filter of opportunity costs.
"I would argue that one filter that's useful in investing is the idea of opportunity costs. If you have one idea that's available in large quantity that's better than 98% of the other opportunities, then you can just screen out the other 98%.” - Charlie Munger
8. The Fat-Pitch Strategy
The Fat-Pitch Strategy is perhaps Charlie’s most used mental model in Investing. The idea is simple. Only swing when there’s an extraordinary opportunity. But when you spot that opportunity, swing as hard as you can.
“Not investing big when there’s the opportunity is as much of a mistake as not investing at all.” - Charlie Munger
That’s it for today!
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