Charlie Munger popularized the idea of using Mental Models to broadening your understanding of a given topic:
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. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You’ve got to hang experience on a latticework of models in your head.
What are the models? Well, the first rule is that you’ve got to have multiple models—because if you just have one or two that you’re using, the nature of human psychology is such that you’ll torture reality so that it fits your models, or at least you’ll think it does. You become the equivalent of a chiropractor who, of course, is the great boob in medicine.
It’s like the old saying, “To the man with only a hammer, every problem looks like a nail.”
Mental Models for Fundamental Finance
Appling mental models to fundamental finance and more pointedly to investing in securities and stock picking is a way to tackle one’s own mind’s follies. It allows you to tackle your mind’s optimism and conformations bias and to approach a topic with what are often opposing mental arguments.
- Accounting and Double Entry Bookkeeping
- Compound interest
- Moral Hazard
- Decision Tree Theory
- Opportunity Cost
- Economies of Scale
- Capital Allocation
- Asset Classes
- Predictive Attributes of Outperformance
- Investing in Special Situations or Workouts
- Hedging and arbitrage
- The Silver Bullet Test
- The Desert Island Exercise
- The Punchcard Method of Stock Picking
- The Green Lumber Fallacy