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Mental Models

Episode

What is a mental model? I think of it as a framework for an idea or thought process. Mental models are all around us, and help describe how the world works. One of the reasons I like them is because they are not only applicable to investing, but to so many other aspects of life.

The idea of mental models was popularized by Charlie Munger, particularly in his book Poor Charlie’s Almanack (an expensive book, but worth it).

It has also been covered extensively by people like Shane Parrish over at Farnam Street / The Knowledge Project (another great resource).

While I love mental models generally, my goal here is to not only breakdown the fundamentals, but to figure out each one’s application and context in the world of the individual investor. Although learning new ideas is wonderful, is is the connection to our lives that make them powerful.

32Mental
Models
STUDIED

Check out the mental models we’ve covered on the show below. I’ll update this page as we make progress.

Utility is what relates to something’s function or value. When something has utility, it has inherent or perceived usefulness to you.
Cause and effect is a generally understood principle - one thing happens and that causes another thing to happen. But, what about when the effect comes back to influence the cause? This is known as a feedback loop.
Facing conflict is always difficult. Facing conflicts on multiple sides is even harder. When companies face multiple headwinds and their attention and capital is diverted, we know as investors to take a close look at the risks. We can also apply this principle to looking at a company’s stock price through the lens of technical momentum (buyers and sellers are always fighting to change the current stock price).
If you multiply effort in any area by zero, then the effort is completely wasted.
By aligning yourself in a certain domain with favorable characteristics, you are more likely to have greater flexibility and reap more rewards.
What are power laws? Effectively, it’s when one variable changes substantially when another variable changes just a little. Put in business terms, a disproportionate amount of the rewards go to those at the top.
What is an order of magnitude? It’s a concept that defines how big or small something is, usually to the power of 10.