Transcription
I think the best question is, "Is there anything I can do to make my whole life and my whole mental process work better?" And I would say that developing the habit of mastering the multiple models which underly reality is the best thing you can do (...) It's just so much fun - and it works so well."
Warren Buffett once said about Charlie Munger: "He has the best 30-second mind I've ever seen. I'll call him up, and within 30 seconds he will grasp it."
How did Charlie Munger develop his ability to think fast and effectively? One reason (could be, that) he built a system of mental models. While we may not all become like Charlie Munger, we can certainly try to. That's why in this video we will attempt to improve our mental processes by learning how Charlie Munger thought about and build his system of mental models. And we will do this by acquiring his most frequently used and talked about models.
This is video one out of the three video series. The introduction of this video will be here a little bit longer to explain the background of his system. If you want to jump directly to the Mental Models, feel free to jump to this 4:25.
"I've long believed that a certain system - which almost any intelligent person can learn - works way better than the systems that most people use." Charlie Munger built a system of acquiring, understanding, and using mental models to think better in life. We will attempt to rebuild his system in this video series making it usable for ourselves in order to improve our mental processes what I said before. But first let's start with the basics.
For those of you who are new to mental models, what is a mental model? Exactly about only this question I make a whole video you will find it somewhere here, but the essence of it is this: "A model is an idea that helps us better understand how the world works. Models illustrate consequences and answer questions like "why" and "how"." Mental models don't have the goal to be right 100% of the time but they should be practical enough to work often enough to be useful. Mental models aim at getting as close to reality as possible, enabling us to make better decisions. And since reality is not found in one single area of life we have to look at many areas of life to resemble reality with our models, so to speak.
"What you need is a latticework of mental models in your head. And you hang your actual experience and your vicarious experience on this latticework of powerful models. And with that system, things gradually get to fit together in a way that enhances cognition."
So, to understand and remember we have to put our mental models on a latticework where we can see their connections, how they influence each other, and have them ready in a usable form. During this video series we will build this latticework adding mental models step by step.
Where to acquire mental models? "Well, the first rule is that you have got to have multiple models - because if you just have one or two that you are using, the nature of human psychology is such that you will torture reality so that it fits your models or at least you will seeing it does. (...) And the models have to come from multiple disciplines - because all the wisdom of the world is not to be found in one little academic department."
What we normally do is to try and press all of reality into a few models and based on the outcomes of those models in our head we then make decisions, thinking that those decisions resemble all of reality. A better process could look like that we acquire many basic mental models from many different disciplines and trying to fit them to reality. And of course those models can from definition not totally resemble reality 100% because then they would be reality itself but I think (rather Charlie Munger thought and I resembled) the decision process could look much better when we have many mental models which at least try to resemble reality and based on that make decisions.
Now we could say but I have so little time and this sounds like so much work to acquire the basic mental models from many different disciplines like mathematics, engineering, psychology, and so on. Is it even possible? "You may say, "My God, this is already getting way too tough." But, fortunately, it isn't that tough - because 80 or 90 important models will carry about 90% of the freight in making you a worldly wise person. And, of those, only a mere handful really carry very heavy freight."
In this whole video series we will cover 50 mental models hopefully those which carry the heavy freight or the really heavy freight. We go through a talk that Charlie Munger gave titled "A Lesson on Elementary Worldly Wisdom" in which he mentioned many mental models but didn't really explain most of them. That's (the explanation part) is what we will do here.
In this first video of the series we look at mental models from the hard sciences. For many chapter you'll find extra links and resources in the description (including the transcript of Charlie Munger's talk) in order to dive deeper into some models.
"Which models are the most reliable? Well, obviously, the models that come from hard science and engineering are the most reliable models on this Earth."
Basic arithmetic concerns the basic arithmetic operations of addition, subtraction, multiplication, and division. It is important to know math basics, not just for math itself but because it is useful in everyday life. Also understanding percentages helps a lot and is fundamental for many other mental models. For example, while we are grocery shopping we can add up the cost in order to stay in the budget or quickly figuring out what 15% tip on our order would be. This is the only model I will not explain in detail because 1) I think that most of you are familiar with it and 2) there are some great videos out there from math teachers who explain this way better than I can. When you need some refresher which is in no way a shame to just refresh our basic understanding of some topics, I will put you a video playlist in the description below.
In short, permutation is how we count things when the order matters. Combination is how we count things when the order does not matter. The long form explanation which I will borrow here from Peter Bevin: "Permutations or rearrangements mean the different ways we can order or arrange a number of objects. We have three hats to choose from - one black, one white and one brown. In how many ways can we arrange them if the order white black and brown is different from the order black white and brown? This is the same as asking how many permutations there are with three hats taking three at a time. We can arrange the heads in six ways. black white brown, black brown white, white black brown, white brown black, brown white black, brown black white. Another way to think about this. We have three boxes in a row where we put a different hat in each box. We can fill the first box in three ways since we can choose between all three hats. We can then fill the second box in two ways since we now can choose between only two hats. We can fill the third box in only one way since we have only one hat left. This means we can fill the Box in 3 * 2 * 1 equal six ways. Another way to write this is three factorial. (...) Combinations means the different ways we can choose a number of different objects from a group of objects where no order is involved, just the number of ways of choosing them. In how many ways can we combine two flavours of ice cream if we can choose from strawberry, vanilla, and chocolate without repeated flavours? We can combine them in three ways. Strawberry vanilla, strawberry chocolate, vanilla chocolate. Vanilla and strawberry and strawberry and vanilla are a combination of the same ice creams. The order doesn't matter. Vanilla on the top is the same as vanilla on the bottom."
Now why does it matter for our day-to-day lives? Well, it is good to be aware of combinations and what factors are contributing to a complex system. How many different factors are at play, for example. Some things that follow now are permutated: Like in many careers the order matters. First this job then the next one, where we only got the next one because we had the first.
Another key point I borrow here from Nassim Taleb is survival comes first. "(...) you do not need science to survive (we have survived for several hundred million years or more, depending on how you define the "we"), but you must survive to do science." Here again the order matters. Everything is secondary to our survival. Maybe not everything because the survival of our families or humanity is more important than our own survival, but nearly everything. I think you get the point.
"Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things."
Compounding is often associated with the area of Finance in the form of compound interest. Staying in this area to explain the concept. Compounding is when an investment grows not just from the original amount we put in but also from the interest or returns it earns over time. This creates exponential growth for the investment. Looking at simple interest and compound interest. Both start with a 1000 currency initial investment and with a 10% interest rate. Simple interest affects only the initial investment. The 10% gets applied to our initial investment every year. Compound interest is based on the initial investment plus the accumulated interest or returns of our investment. The 10% gets not only applied to the initial investment but also to the earnings we had from the periods before. After 10 years you can already see a difference. At 30 years even more. Plotting this as a graph. We can see that simple interest has a linear function while compounding is exponential. This is in the beginning not so visible but over time more and more. Be aware that many things that compound have natural limits.
Compounding is mostly associated with Finance but since mental models can be used multidisciplinary we can transfer it to other areas.
"Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts ... Slug It Out one inch at a time, day by day, and at the end of the day if you live long enough most people get what they deserve."
There are two basic ingredients to compounding. First is time. The longer our time frame is for compounding the bigger it gets. Second, consistency. When compounding is interrupted it slows down or breaks down. Compounding can work also in a negative direction. In financial terms we can compound debt, which is growing in the wrong direction. Or taking the example of bad habits. Smoking every day will also compound, just negatively.
Quality control refers to the systematic process of ensuring that products or services meet specified requirements and standards. This is especially important in manufacturing. In automotive manufacturing each car under goes rigorous quality checks at various stages of assembly to ensure it meets safety and performance standards. Here's an example of the quality control of an assembly line. This is of course just an example to communicate the concept or to show the concept. It starts with the quality control of raw materials and finishes with a quality control of the finished car. This all leads to high standards of safety and performance which is for each one of us important.
Moving away from the area of engineering, how can we apply to our own lives? We can quality control our own work. For example, do we work with the standards we require from ourselves, ethical standards, etc. Do we do our routines to a certain standard we expect from ourselves? As you can see we can quality control many things.
Most systems will fail at one point or another and to be prepared for that scenario we have backup systems. A backup system is a redundancy measure to ensure continuity of operations or services in case of failure or disruption of the original system. It involves creating duplicates or alternative methods to mitigate the impact of failures. Backup systems are everywhere around us. Many critical infrastructure buildings have emergency electrical generators to ensure, in case of electricity shortage, the backup of still having electricity. Look at our phones. My phone constantly asked me to make a backup of my data on the cloud. In case my phone has some hardware issues which could lead to loss of all the data on the phone or let's say I lose my phone with a backup system of my data in the cloud I would still have all my data.
As I said before, a backup system is a form of redundancy. About redundancies I made an extra video if you want to know more about it feel free to check it out. Consider here that in nature we also find backup systems. "Nature likes to overinsure itself. Layers of redundancy are the central risk management property of natural systems. We humans have two kidneys (...), extra spare parts, and extra capacity in many, many things (say, lungs, neural system, arterial apparatus), while human design tends to be spare and inversely redundant, so to speak - we have a historical track record of engaging in debt, which is opposite of redundancy (50,000 extra cash in the bank or, better, under the mattress, is redundancy; owing the bank an equivalent amount, that is, debt, is the opposite of redundancy)."
Maybe you asked yourself now but what if you got all that extra which is most of the time or in some cases all the time, unnecessary? Just makes the system more inefficient. And yes, that can be the case. But think of the following: "Redundancy is ambiguous because it seems like a waste if nothing unusual happens. Except that something unusual happens - usually. Further redundancy is not necessarily wussy; it can be extremely aggressive. For instance, if you have an extra inventory of, say, fertilizers in the warehouse, just to be safe, and there happens to be a shortage because of disruption in China, you can sell the excess inventory at a huge premium. Or if you have extra oil reserves, you may sell them at a large profit during a squeeze." So redundancy in our case, in the form of a backup system, can be valuable. Even if it looks at the first side wasteful.
Here we can point out two types of redundancies Type 1: the defensive type, in order to be robust to shocks. Type 2: the aggressive type, in order to be antifragile to profit from shocks.
"A margin of safety is a buffer between safety and danger, order and chaos, success and failure. It ensures the system does not swing from one to the other too easily, causing damage."
A margin of safety is basically a buffer. The difference between a margin of safety and a backup system is that a margin of safety strengthens the current system, while a backup system is a completely separate system that activates when the original system fails. Both are types of redundancies and can be implemented simultaneously. Margin of safety is a widely used concept in finance, specifically in investing. In investing we have the market price at the stock market exchange. It involves everything from internal factors, like cash flow, to external factors, like emotions of investors, supply and demand and so on. Then we got what investors call the intrinsic value of a company. It is more of a subjective concept, has different ways to calculate. What they have all in common is that they focus only on the internal parameters of the company independent of Market fluctuations or investors emotions. Let's say the market price is $100, the intrinsic value is $120. When we would buy, we would have a margin of safety of $20. We try to buffer our investment, paying a cheap price to what it's really worth, (still subjective of course), in order to have some protection from downturns. This is different from a backup system. A backup system would be in our scenario here some cash on the side in order to protect us if all our investments would fail simultaneously. It is basically a different system, unconnected to our investment system.
MoS Example: Let's say we want to build a house with an estimated cost of 500,000. In order to calculate in some bad moments we can give it a margin of safety let's say 10%. So it would be 550,000 with what we would plan. Or even 20% of a margin of safety of a buffer planning with 600,000. There's of course always a risk of a large unexpected event which even kills our margin of safety making the house for example cost 1 million. Unlikely, but can be. Generally a Margin of safety can help us to be more robust or prepared for unexpected outcomes. Not for all, but for many. And an important point to remember: both margin of safety and backup systems try to make us more robust or even antifragile to the outcomes of risk. They don't reduce the risk (the likelihood of an event to happen).
"A small change may have no effect on a system until a critical threshold is reached."
Breakpoints refer to these critical thresholds. A critical threshold is a point at which significant changes occur. Breakpoints are often clearly defined and deal with quantitative changes. Let's have a look at some examples. "For example, a drug may be ineffective up until a certain threshold and then become effective or it may become more and more effective but then become harmful. Another example is from chemistry. When a system of chemicals reaches a certain level of interaction the system undergoes a dramatic change. A small change in a factor may have an unnoticeable effect but a further change may cause a system to reach a critical threshold making the system work better or worse. Another example could be an income tax system, where different tax rates depend on how much you earn. Let's have a look at the German tax system just as an example. Here's a simplified version of how the rates and breakpoints might look. So what we can see here now is at 9,745€ that this is a critical threshold. The one year difference from 9,744 to 9,745 changes from 0% taxes to 14% taxes. The same goes for 27463, 3% more. I would rather earn let's say 270,000 without that extra 3% tax."
In these examples the system's overall structure remains the same but specific attributes change significantly at the breakpoints. "A system becomes critical when it is on the verge of changing from one state to another. The final unit before the change, has a disproportionate impact. It is a proverbial straw, that breaks the camel's back." Or in other words: "When a system changes from one state to another we say it has achieved critical mass, also known as reaching the Tipping Point."
Shane Parrish in his book The Great mental models V3 gives an example of what reaching critical mass can look like. Water changes to gas at a specific point. 211 Fahrenheit and 212 Fahrenheit make a huge difference since both represent different states. When liquid water reaches the critical mass at 212 Fahrenheit it undergoes a qualitative change. This might sound familiar similar to breakpoints, right? Where a small change makes all the difference. However there's a difference between the two concepts. Breakpoints on the one side are typically predefined, they are quantitative threshold. The system stays the same but the attribute changes. Critical mass on the other hand refers to the threshold at which a system undergoes a fundamental change. The whole system is changing. So not only the attributes are changing but the whole system is changing.
I will add here one extra model from chemistry in which she talks off in another talk. "If you get a certain kind of process going in chemistry, it speeds up on its own. So you get this marvellous boost in what you are trying to do that runs on and on. Now the laws of physics are such that it doesn't run on forever. But it runs on for a goodly while. So you get a huge boost. You accomplish A and all of a sudden you getting A plus B plus C for a while."
Let's go through the process of autocatalysis Step by Step. First we have a process A that produces a result B. B acts as a catalyst speeding up process A. As more B is produced process A goes even faster. This acceleration leads to an unexpected benefit of C. Now you're getting A plus B plus C much more than you initially set out to achieve. This continues with each round producing more B further speeding up A and potentially increasing C. Eventually this boost will reach a limit due to physical constraints. In essence: autocatalysis is when a process produces something that makes the process self go faster, creating a self-reinforcing cycle of growth or production.
Example: You create a YouTube channel and start producing videos. Your videos attract viewers and subscribers. More viewers lead to more engagement like likes, comments, and shares boosting your videos in YouTube's algorithm. Your growing audience attracts sponsors providing you with resources to create better content. Now you have more viewers, better videos, and sponsorship income. Better content attracts more viewers leading to more engagement, better algorithm placement and more sponsors. Eventually growth may slow down due to Market saturation or competition.
Charlie Munger on another particular application of this mental model "Disney is an amazing example of autocatalysis ... They had those movies in the can. They own the copyright. And just as Coke could prosper when refrigeration came, when the video cassette was invented, Disney didn't have to invent anything or do anything except take the thing out of the can and stick it on the cassette."
"Evolution is change (structural, physiological, behavioral) - which occurs over time through interaction with environment." There are four mechanisms that can change the gene pool of a population which are mutation, natural selection, recombination, and genetic drift. In this video we will focus here on natural selection. "Any slight variation in traits that gives an individual an advantage in competing with other individuals of the same or different species on adapting to changes in the environment increases the chance that the individual will survive, reproduce, and pass along its characteristic to the next generation. Maybe they have greater resistance to disease, or can run faster, or survive climate changes better."
Also here let's have a look at an example to explain this better. Before the industrialization happened most moth were light colored in the UK blending well with lichen covered trees, like there were many white trees and the moth were pretty well adapted to them. Now some mutations happened. Some moth had a genetic mutation resulting in darker coloration. Now those moth with a darker coloration didn't survive so much because they were more visible for predators because there were not so good camouflaged on the white trees. Now the industrialization happened and industrial pollution killed the white lichen trees and darken other trees with its dust. Dark Moth were now better camouflaged on polluted trees because predators couldn't see them anymore so good. Light moth, on the other side, were more visible and more eaten frequently. Dark Moth survived and reproduced more successfully and over time the population shift to a more dark moth population. When the air improved again after some time the trees became lighter again. The light moth once more had a survival advantage and the moth population shifted backwards again to lighter coloration. And what's interesting here to see the moth didn't become stronger or faster, what we sometimes understand under evolution. But they only become better adapted to their environment. I mean not only this is like the key surviving point.
"Evolution as a mental model can be summed up as adapt or die. We think, however, it is not only important to think how we can adapt but what it is we are responding to when we do. Looking at Natural Selection and Extinction together pushes us to consider the parameters we evolve in. We either respond to the changing demands of our environment or we die out. Natural selection further teaches us that optimization for our environment is an ongoing and dangerous process. We are constantly trying to obtain advantages that are increasing our chance of survival and avoid extinction as a species. The word selection can be confusing, because its common usage implies choice. I'm selecting this over that. In reality, the concept means the more favorable a trade is for a particular environment the higher the chance of this organism to live long enough to procreate."
We can transfer this to the area of jobs. Many jobs are coming and dying. We as individuals can just change and try to adapt in order to not go extinct, in this case have no work. With AI disrupting many domains we have to adapt. It was always like that maybe not so fast as these days but change is a constant in life.
"In biology, an ecosystem encompasses a community of interacting species and their non-living environment. All components play a part and determining the characteristics. From the type of soil to the amount of sun or water available. Some animals cooperate, others compete. And changes in any component can affect both the fitness of the individual species and the health of the entire system. When you learn about ecosystems you gain insights into how diverse components interact in defined environments in a way that promotes the continued existence of the system. Individual species may gain and lose and the system itself expose to challenges that it must adapt to and recover from. But the web of interactions that has developed, supports the holistic functioning of the system."
Let's transfer the model of an ecosystem again to the area of jobs: "Just as in an ecosystem, people who narrowly specialize can get terribly good at occupying some little niche. Just as animates flourish niches, similarly, people who specialize in the business world and get very good because they specialize - frequently find good economics that they wouldn't get in any other way."
An ecosystem is a complex system. In complex systems we often can't see clearly the cause and effect relationships, it's too complex. But still, we try to intervene in those systems with sometimes catastrophic results. "The key point to understand about ecosystems is that they are systems. The different parts don't exist in isolation. They interact and interconnect in myriad ways. If we intervene in them we can't expect the outcomes to be predictable. We need to look at them as a whole and respect that it's sometimes better to leave them alone than to try improving them. But we often suffer from Intervention bias. The desire to always do something instead of leaving things alone. When it comes to ecosystems, we forget that they have evolved to manage quite well if we let them get on with it."
Let's shows this point in an example: "For instance, in areas that are prone to forest fires, the local fire department may attempt to put out every single fire they hear about as soon as possible, regardless of size. The problem is, that fire is a natural part of these ecosystems. It is only humans that view naturally occurring fires as a problem. As destructive as wildfires can be, they also have ecological benefits. (...) Perhaps most importantly, regular small fires burn up accumulating plant matter. If humans intervene and put these out, larger amounts of fuel build up and pave the way for fires that are beyond the scope of what the ecosystem can handle. Often the harder we try to control ecosystems, the harder they fight back."
What we seek by intervening is artificial stability. It looks on the surface that we put out a fire but we promote a risk of an even bigger fire in the future. Our economy, businesses, and our bodies are complex systems, in each of which we intervene. This is a topic for thought and I would say a good ending point of this video. Covering Charlie Munger's Mental Models from mathematics to biology. I genuinely hope that I could bring you the topic of mental models through Charlie Munger a little bit closer. This this is it for the first video from the three video series. This is how far we build our latticework. The next part, the second video, covers General mental models from Charlie Munger. And the third part covers psychological mental models from Charlie Munger, to better understand human behaviour. Thank you so much for watching this video today. As always I wish you a fantastic day.