Mastering Mental Models
How to become a better investor...
This installment of The Matt Allen Letter is free for everyone. If you would like to read about stock analysis, stock market analysis, and much more.
One of the most important traits of a great investor is the ability to think outside the box. For example, I was just recently upset with myself because I didn’t connect the dots between China covid re-opening and the surge in oil prices.
With that being said, I was an early person who connected the dots between the price of bitcoin and bitcoin mining stocks.
This allowed our premium subscribers to make significant profits during the last bitcoin bull-run.
Using mental models allows me to think outside the box to become a better investor. Charlie Munger was the one who I learned these from originally.
Keep in mind, you can use these for anything in life not just investing.
Here are 3 of my favorites to use below:
Charlie Munger is the right hand man of Warren Buffett. I believe that Charlie is one of the smartest people that has ever lived. I do not mean when it comes to only investing, but in just all areas of life. Charlie even says, “You have a moral duty to make yourself as un-ignorant and un-stupid as you can.” If you didn’t know, Charlie Munger is the 100 year old Billionaire, who is the Vice Chairman of Berkshire Hathaway.
In fact, Warren Buffett has said that “Munger has the best 30-second mind in the world. He goes from A to Z in one move. He sees the essence of everything before you even finish the sentence.”
Munger has become famous from putting together ideas from multiple disciplines to form what he calls a latticework of mental models. Mental models are frameworks that help us to understand and simplify the world.
Charlie observes reality/investments and observes it against his mental models.
“A large part of the difference between the experienced decision maker and the novice in these situations is not any particular intangible like “judgment” or “intuition.” If one could open the lid, so to speak, and see what was in the head of the experienced decision maker, one would find that he had at his disposal repertoires of possible actions; that he had checklists of things to think about before he acted; and that he had mechanisms in his mind to evoke these, and bring these to his conscious attention when the situations for decisions arose.”
“You’ve got to have models in your head. And you’ve got to array your experience—both vicarious and direct—on this latticework of models.”
Charlie Munger believes that people who think very broadly and understand many different models from many different disciplines make better decisions.
These mental models have helped Charlie conquer the stock market. However, these models have allowed Charlie to run a large hospital, a massive non-profit, and many other things. There are 100 mental models that he uses, but we will only discuss a few.
Below we will explain some of the mental models that Charlie Munger uses.
Swiss Army Knife Approach
Let’s say that you were learning to drive a car. Would you only learn how to use the accelerator? Absolutely not. (Unless you are from Atlanta or Florida)
If you only used the accelerator while driving a car, it would end up as a disaster for you and others. Before you become a good driver, you need to learn how to use the wheel, the brakes, the turn signals, and many other things.
If you want to be a successful thinker, you need to learn about multiple ideas. Charlie calls this “worldly wisdom.”
Here is one of my favorite analogies:
To the man with a hammer, every problem looks like a nail.
The man with the hammer will torture himself because the only way that he thinks is to use the hammer to solve his problems.
You rather be the man with a swiss army knife that realizes that different problems need different tools.
In corporations, you see this every single day. The marketing department will only care about Marketing. In academia, the science department will only care about science.
First Principles Thinking
First-principles thinking is one of the best ways to reverse-engineer complicated problems and unleash creative possibility. This mental model was made famous by the philosopher Aristotle and used by Elon Musk, Peter Thiel, and Jeff Bezos.
The idea of first principles thinking is to simplify complex problems into basic elements and then reassemble them from the ground up. In other words, the average person looks at solving problems the same way that previous people or generations have solved them.
“First principles is kind of a physics way of looking at the world. You boil things down to the most fundamental truths and say, ‘What are we sure is true?’ … and then reason up from there.”
He contrasts First Principles Thinking with thinking by analogy:
“I think it is important to reason from first principles rather than by analogy. The normal way we conduct our lives is we reason by analogy. We are doing this because it’s like something else that was done or it is like what other people are doing… it’s like slight iterations on a theme.”
In 2016, Jeff Bezos wrote to his Amazon employees to be caution of proxies. Proxies are “like something else that was done.” They can take the form of processes that employees mindlessly follow, or of market research that employees unquestioningly accept as fact.
“Good inventors and designers deeply understand their customer. They spend tremendous energy developing that intuition. They study and understand many anecdotes rather than only the averages you’ll find on surveys. They live with the design.”
Peter Thiel is the founder of PayPal and an early investor in Facebook. He is one of the best investors ever in terms of finding the next big company. Thiel has used first principles thinking for years.
Theil is a believer in “vertical progress” which essentially means going from 0 to 1 or doing something that no one has ever done. Vertical progress is much harder to do than “horizontal progress:” going from 1 to n, copying things that already work. The quote below is one of my favorite quotes.
“Every moment in business happens only once. The next Bill Gates will not build an operating system. The next Larry Page or Sergey Brin won’t make a search engine. And the next Mark Zuckerberg won’t create a social network. If you are copying these guys, you aren’t learning from them.”
In Matt Allen terms: If Henry Ford would have not used first principles thinking, he would have tried to give everyone a faster horse.
The average person is always stuck in how it has “always been” but you have to look at problems with first principles thinking.
When it comes to investing, the next amazon will not be an internet company. The next amazon might be a company where you shop in the Metaverse. Sounds crazy, right? How crazy did Amazon sound in the 1990’s.
Inspired by the German mathematician Carl Gustav Jacob Jacobi, Munger says, “Invert, always invert.” Most of us try to tackle our problems always looking forward. However, Munger believes that it is very beneficial to look at problems from the opposite end.
“All I want to know is where I’m going to die, so I’ll never go there.” - Charlie Munger
As a thinking tool it means approaching a situation from the opposite end of the natural starting point.
For example, rather than asking, “How do I have a successful marriage?” it is better to to ask, “How do I ruin a marriage?”
If you were focusing on not doing things that ruin a marriage, you would end up having a good marriage.
Invert thinking can be great in the workplace.
Leaders can ask themselves “What would someone do each day if they were a terrible manager?” Good leaders would likely avoid those things.
Customer service people can ask themselves, “What would make my customer upset?” If you focused on not doing those things, your customer service would go up.
In personal finance, everyone wants to have more money. They focus on making more money, but they should take some time to think about “What would destroy my finances?”
Spending time thinking about the opposite of what you want doesn’t come naturally to most people.
In Matt Allen terms: When a child doesn’t want to do their homework, they think about all the things that they could do instead of their homework.
If a child thought about what would happen, if they they didn’t do their homework, they would end up doing their homework.
I only covered 3 of 100 today, but I am confident that we will keep revisiting these in the future!
I hope everyone has a great rest of the week!
If you have any questions, feedback, or just wanna say hey, email me at email@example.com
Stay Hungry, Stay Long
Thanks for this writeup!
One of Charlie’s top models is to think through the incentives at play in every circumstance. We have found this model invaluable.