Mental models are simplified versions of how things work in Reality, which is essentially meant to improve decision-making. These models are essentially frameworks or systems of thinking that help us interpret events, predict outcomes, and form strategies. They shape how we perceive and respond to our environment, often operating subconsciously. All of us must have heard of some of the popular mental models, such as the 80-20 principle or the circle of competence. I do not know if this comes out of a bias or not, but I think investing or, actually, successful investing relies a lot on using multiple mental models well. They help us simplify our investment framework and help us pick the right businesses. If Munger and Buffett owe these ideas a lot of success, shouldn't we, too, give it a look?
This blog will attempt to cover the mental models I read about in a book of the same name and try to summarise what's written while also adding my take to it.
The map is not the territory.
The map of Reality is not the Reality. A map is a simplified and minimized representation of something in Reality and, hence, can never be perfect! A perfect map would have to be precisely the same as reality, and that would mean that it's useless because it is no longer minimized or simplified and of no use to us. The idea of a map can be extended to other things as well. The map is nothing but a simple abstraction of Reality.
This blog, for example, is a map of the original book as it summarizes what's written, and the author adds his take to it. The truth is, the only way we can navigate the complexity of Reality is through some sort of abstraction. When we read the news, we're consuming abstractions created by other people. The authors consumed vast amounts of information, reflected upon it, and drew some abstractions and conclusions that they share with us. But something is lost in the process.
The thing we need to recognize is that we must not mistake maps for Reality. The reason is that maps are easy to understand, and this might give a false sense of belief that we know everything that is to know. An annual report is a map of the business, but it can never fully comprehend or explain what the actual business is. Do you think reading the Annual reports of Reliance will give you the same understanding that Mukesh Ambani sir has? Surely not.
Maps are very useful and have been a part of society for longer than we or our great-grandparents have existed; they have helped us navigate a lot of problems in our lives, but remember, Reality is the ultimate truth.
2. Circle of competence
Arguably, one of the most popular mental models amongst investors is the circle of competence. Popularized by Warren Buffett in his letters to shareholders, it is a mental model that will immensely help increase your odds of success. Circle of competence basically means sticking to what you know. To win a million dollars, I have to beat a stranger in table tennis, which I have been playing as a kid or beat him/her in golf, which I have no idea of; what will I do? It's a no-brainer that I will choose table tennis because why would I want to be in uncharted territory when something significant is at stake? This is precisely what a circle of competence is. This goes well with the first mental model because understanding that knowing the map will not mean it's in your circle of competence; it is merely the first step to adding to your circle of competence.
3. First principles thinking
I love this mental model. First principles thinking means breaking down a complex subject to a few bare basics and using these bare basics to improve upon. It basically questions all the assumptions that are believed to be true and builds on the ones that stay.
Let's take an example: how do I improve the performance of my favourite IPL team, RCB or Royal Challengers Bangalore?
RCB does not win. Why? Because we lack good players. Why? We do not buy the suitable set of players, and the ones we buy are very expensive and end up not performing well. Why? Because we fail to find the right local talent at a bargain. Why? Because we do not have the right scouting team. Why? I do not know; let's find out. Asking 5 whys will help break down the problems to their basics and help build us up from there. In this example, I came to the conclusion that RCB fails to spot talents like MI (SKY, Hardik Pandya, Ishan Kishan, Bumrah, Tilak Verma, Nehal Wadhera, etc. How is MI so good at scouting young talents? Wow) and hence fails to build a good team at the right price and ends up underperforming. This is the first principles approach to thinking.
4. Thought experiment
Thought experiments are like devices which help us test hypotheses in our minds. Building on Cricket and RCB. I propose a bet: who scores more sixes in a hundred balls? Is it Kohli or Siraj? It's a no-brainer that you will bet on Kohli because the odds of Siraj beating Kohli in batting are negligible. In a bet like this, we don't need to think much, but what if the bet was: Who scores the most runs in a hundred balls? Is it Shubman Gill or Yashashvi Jaiswal? Now, predicting that will be very difficult. How will you evaluate such a situation? Using a Thought experiment. It can go like this: Both are in good form and are very talented. Gill is good at facing length deliveries, while Jaiswal is better at pull shots. However, Jaiswal is more aggressive and hence can score more, but does that mean he can get out early?
This is a thought experiment. Create scenarios in your head to understand the situation in Reality better.
Thought experiments became famous because of Einstein's elevator-in-zero gravity hypothesis, which ended up with him forming the general theory of relativity, which changed the way humanity looked at the world.
5. Second order thinking
Second-order thinking is a mental model that emphasizes understanding the consequences of the consequences of our actions. Let me give you an example of when people failed to think of the implications of the consequences. During British rule in India, British officers were worried about the rise of venomous snakes in Delhi and offered money for killing these snakes. People started breeding snakes and killing them to earn money from Britishers. They realized the scheme was a little too late, and by then, a decent amount of money had already been distributed. In this scenario, Britishers failed to realize the second-order consequences of their actions.
I believe that playing chess has helped me develop this mental model quite well, as chess requires thinking multiple moves ahead. However, do not fall into a loop of going from Consequence A to B, C, D, E and F. The world is very complex, and It's tough to accurately predict fourth-order or fifth-order consequences. I would suggest just sticking to second or third-order thinking before making decisions, as no one really knows what will happen after that.
6. Probabilistic thinking
The world is uncertain, and there are not a lot of things that can be said with absolute certainty. I can not even be 100% certain that I will survive writing this blog. It's improbable, but it is not impossible. Because of how complex the world is and because we can not be sure of anything, the use of probabilistic thinking is necessary. I think playing poker frequently has helped me a lot. I will always be a favourite with Aces, but that does not mean I will be 100% sure. Knowing this keeps us humble and content with results because nothing we do has an assured result, and there will always be probability involved.
As an investor, this is one of the strongest tools to shape your mind. An undervalued business with good potential is less likely to burn your hands than a similar one but vastly overvalued. However, that does not mean it will be 100% right; instead, we should still bet on what has a higher probability. Being prepared is knowing everything can go wrong and that happens when you embrace uncertainty.
7. Inversion
Another popular mental model is the idea of Inversion. All of us must have heard the phrase "Invert, always invert" from Charlie Munger, but now let's truly understand it. Inversion basically means to look at a problem from a different perspective or turn it on its head. Looking at issues from various perspectives helps us understand the situation better and find solutions that we would have never thought of in the first place. Let's take a simple example. Suppose you want to be rich; how do you do it? With the mental model of inversion. Instead of being wealthy, let's invert the problem and ask how we can avoid being poor? And the answer is the same as being rich. Saving more, avoiding excess debt, investing long-term, etc.
It is very powerful if you can invert the problem the right way.
8. Occam's razor
Something that can be explained with a few variables is more likely to be correct than an explanation with a lot of variables. Think of it like this, there are two theories that can explain this; which one is more likely to be right? The one which requires 30 conditions to be met or 3? Odds say it is easier for 3 conditions to be met, and that is why it is almost always the case that simplicity wins. Keep it simple and short( like this explanation :))
9. Hanlon's razor
Hanlon's razor dictates that when something goes wrong, we must not look at it as a ploy or something that is intended to cause harm but just a mistake that was overlooked. It is beneficial for us to give the benefit of the doubt to someone or something when such a situation arises.
The mental model demonstrates that they are fewer true villains then we know and all humans make mistakes and fall into traps of laziness, bad incentives and bad thinking. Life becomes simple when we understand this.
This blog marks the end of the first volume of the great mental model. I hope it covered the essentials of the book and simplified the mental models to its first principles( already using them.) The following blog will aim to cover the rest of the volumes and help understand all the mental models. Until then, let me know which of these mental models fascinated you the most.
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