How has Charlie Munger have such an extraordinary track record as an investor?
Charlie gives credit his ability to look at an investment through multiple mental models.
Mental models are the big ideas from the important fields.
“You have to learn all the big ideas in the key disciplines in a way that they’re in a mental latticework in your head and you automatically use them for the rest of your life.”
For Charlie, learning physics is just as important as learning the basics of accounting. This allows him to apply more mental models in each field when looking at a potential investment.
Since mental models explain how the world actually works, the more you acquire the better. This creates the “latticework in your head” which you can use as a checklist to make decisions.
As Warren Buffett has said about his partner Charlie,
“He 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.“
Charlie Munger Mental Models Explained
Charlie Munger has never laid out his entire list of mental models he used to make an investment. He’s only referenced certain mental models in speeches and his writings.
Moreover, mental models are not necessarily useful on their own.
As Munger has said,
“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.” And of course, that’s the way the chiropractor goes about practicing medicine. But that’s a perfectly disastrous way to think and a perfectly disastrous way to operate in the world. So you’ve got to have multiple models.”
Charlie Munger Mental Models | The Pareto Principal
If you’re in search for worldly wisdom, where do you start?
A smart way would be to use the mental model of the Pareto Principal.
The Pareto Principal explains the unequal relationship between inputs and outputs. For example, 20% of the customers driving 80% of a company’s revenue.
Munger applies that Pareto Principal to acquiring knowledge, saying,
“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…
So, 80-90 mental models, that’s doable right?
But, then again, where do you start? Acquiring 80-90 mental models isn’t as easy as Googling a list and reading the definitions.
You can apply another mental model, this time from math.
When something is fractal it is a repeating pattern.
“A fractal is a natural phenomenon or a mathematical set that exhibits a repeating pattern that displays at every scale” – Wikipedia
The Pareto Principle is a concept that’s fractal. The Pareto Principle doesn’t just say that 20% of the inputs equal 80% of the outputs. Since the pattern repeats itself, 4% of the inputs, will equal 64% of the outputs.
To finish Charlie’s quote from above,
“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.”
Charlie Munger Mental Models Explained | Next Steps
“You can’t spend 90% of your time becoming an authority on physics and biology because you’ve got work to do on valuing businesses, but you can spend a little bit of your time understanding the big models and how they work and how they may relate and that’s what we did in Investing: The Last Liberal Art was kind of give you a surface view of how these models work. You’ve got a working knowledge of physics, you’ve got a working knowledge of biology, evolutionary biology. Psychology now, thankfully, is much mainstreamed in our business and so we try to add a little bit more there on risk tolerance and things of that nature.”
The Pareto Principle and Fractals are two of the very important mental models which Charlie discusses.
If you want to start adding more mental models to form the “latticework in your head” the best place to start is Munger’s two books.
- Poor Charlie’s Almanac: The Wit and Wisdom of Charles T. Munger by Peter D. Kaufman
- Seeking Wisdom from Darwin to Munger by Peter Bevelin
My recommendation would be to start with Poor Charlie’s Almanac. This will allow you to understand how Charlie thinks through mental models.
Next, read Seeking Wisdom from Darwin to Munger.
While not an easy read, this book provides a better structure and lays out the big mental models to look for.
Keep in mind, to Munger, education is a lifelong pursuit,
“If you don’t keep learning, other people will pass you by. Temperament alone won’t do it – you need a lot of curiosity for a long, long time. The theory of modern education is that you need a general education before you specialize. And I think to some extent before you’re going to be a great stock picker, you need some general education. If you skillfully follow the multidisciplinary path, you will never wish to come back. It would be like cutting off your hands. It’s kind of fun to sit there and outthink people who are way smarter than you are because you’ve trained yourself to be more objective and more multidisciplinary. Furthermore, there is a lot of money in it, as I can testify from my own personal experience.”