Mental Models — Clarify your thinking.
In this post, I’ve summarised my learnings from the book — The Great Mental Models Volume 1: General Thinking Concepts by Shane Parrish and Rhiannon Beaubien.
The first time I picked up this book was in January 2020. The book was acclaimed by many to help make better decisions and is a Wall Street Journal best seller.
I skimmed through the first chapter and then promptly set it aside. It was not an easy read for me.
I picked up the book again at the start of this year, after reading posts about it on the Farnam Street blog. But this time with a view to improve my understanding of the world.
Now, after having read the book, my thinking process has become better.
By understanding the concepts behind the mental models, we can better understand the world and its nuances.
“I don’t want to be a great problem solver. I want to avoid problems — prevent them from happening and doing it right from the beginning.” -The author and explorer of mental models Peter Bevelin.
Understanding reality
Mental models are tools which help us in understanding reality for what it is, rather than what we want it to be. So that we can make better decisions.
When a builder looks at a plot of land, he focuses on the units he can develop. A potential buyer focuses on the location of the plot. An official will estimate tax collection.
Everyone’s incentives and thereby perspectives are different. However, none see the whole situation.
By having an arsenal of models, we can understand the situation in a holistic manner rather than through the lenses of our experiences. Reality is different for everybody. So, by understanding different views we can implement a better solution.
1- The map is not the territory
The description of the item is not the item itself.
A profit and loss statement is a compressed guide to understanding a company. However, by virtue of it being a ‘compressed’ guide, they have limitations, such as they might not reflect the true intention of a business.
A real-world example is one of McDonald’s, which is in the business of real estate management and not serving burgers.
A map or guide is a reduction of the territory. We run into problems when our knowledge becomes of the guide, rather than the actual underlying territory it describes. The guide is a snapshot in a point of time, representing something that might no longer exist.
An example of the real-world implications can be seen through what happened with the Franklin India (AMC) debt funds-
AMC debt funds were considered the best in their category. But, in April 2020, the AMC was forced to close its debt funds. At the time of winding down the funds, Franklin was managing ~28,000 crores spread across 6 different debt schemes. However, the troubles in debt markets in India started much before with the IL&FS crisis in 2018, DHFL, Yes Bank implosions. Credit risk inherent in debt mutual funds was rising and Franklin’s risky bets were backfiring. Unable to face the reality of coronavirus induced lockdowns coupled with a changing landscape of urgent liquidity needs the AMC was unable to pay back the investors.
The investors believed their money was secure as debt funds (territory) are considered safe. But they didn’t account for how the changing circumstances would affect the guide (AMC).
Our understanding must be updated with the times and reality is the ultimate update.
2- Circle of Competence
I’m no genius. I’m smart in spots — but I stay around those spots- Thomas Watson
Within our circles of competence, we know exactly what we don’t know. We can make decisions quickly and accurately. We can anticipate and respond to objections because we’ve heard them before. There is no shortcut to understanding. Building a circle of competence takes years of experience, of making mistakes, and of actively seeking out better methods of practice and thought.
For example, the bulk of Microsoft’s revenues comes from enterprise software services. They know their customers pain points and needs. By building on its strengths, it developed Microsoft Teams to ward of Slack — a competitor. Enterprise services are Microsoft’s circle of competence, making it difficult for a competitor to grab market share.
TSMC has a vision to be world’s dedicated semiconductor foundry. By replicating its know-how of fabless design across the world it is servicing all our technology needs. Scaling fabless design is TSMC’s circle of competence. It took years of expertise to become the world’s foundry.
There are three key practices needed to build, maintain, and extend our circle of competence: curiosity coupled with a desire to learn, monitoring, and feedback.
3- First principles thinking
I don’t know what’s the matter with people: they don’t learn by understanding; they learn by some other way — by rote or something. Their knowledge is so fragile! -Richard Feynman
When we start with the idea that the way things are might not be the way they have to be, we put ourselves in the right frame of mind to identify first principles.
First principles thinking is a tool to help clarify problems by separating the underlying ideas or facts from any assumptions; by breaking apart the problem to its foundations.
This process allows us look beyond conventional wisdom and see what is possible.
For example, the Kindle, it was made keeping in mind the users’ convenience and the act of reading. To avoid distractions the kindle only allows you to read. By pushing aside, the custom of reading from a physical book, they reinvented the reading experience.
Zerodha is a brokerage firm in India, which has grabbed a huge market share. Zerodha’s pricing reflects the marginal cost of servicing clients by charging a flat fee whereas the incumbents demand hefty commissions. By breaking down the problem they offered a better solution.
4- Thought experiment
Imagine the possibilities
By conducting thought experiments, we can take on the physically impossible tasks or re-examine history to make better decisions. But, within a predefined set of boundaries and parameters.
For example, if Subhas Chandra Bose had lived, would he have been India’s first Prime Minister? How would the India of today, been affected by the decisions made by him 70 years ago?
If Taiwan were a part of mainland China, how would it affect the landscape of the semiconductor industry?
If you bought Bitcoin today, and then it drastically fell, what are the chances of a return? Can we minimise the role of luck and what is the probability of the price falling to zero?
These experiments teach us about the limits of what we know and limits of what should be attempted.
Thought experiments require both rigor and work. But the more we use them, the more we can understand cause and effect.
The benefit of thought experiments (as opposed to aimless rumination) is their structure. In an organized manner, thought experiments allow us to challenge intellectual norms, move beyond the boundaries of ingrained facts, comprehend history, make logical decisions, foster innovative ideas, and widen our sphere of reference. - Farnam Street blog
5- Second order thinking
What happens next?
It is easy to anticipate the immediate reactions of our actions. Second-order thinking is, thinking farther ahead and holistically. Who would be affected by our actions, what are the incentives of the other party, what objections could be raised?
In 1958, Chairman Mao ordered that that all sparrows over China should be put to death. It was hailed as a necessary step by a strong leader. Farmers were suffering because sparrows tended to eat their grain seeds. Thus began The Great Sparrow Campaign. A countless number of sparrows were indeed wiped out -but there were unintended consequences. Sparrows ate locusts, and once the balance in the ecosystem changed, locusts proliferated and destroyed China’s crops. There was famine, hunger, starvation: no less than 45 million people died in the three years following Mao’s orders. — Amit Verma
Another example would be the Australia’s News Media Bargaining Code better known as link tax. By enriching the pockets of large publishing houses they are harming the interests of the readers as well as smaller media outlets. Read my take on it here
By utilizing second order thinking we stay aware of the consequences of our decisions on ourselves and others.
6- Probabilistic Thinking
What are the chances?
What is the likelihood of a specific event happening?
Successfully thinking happens in shades of probability. Identifying what matters, having a sense of the odds, doing a check on our assumptions, and then making a decision. But we can never know the future with exact precision. By thinking through the odds, we can evaluate how the world will most likely look so that we can effectively strategize.
For example, returns reflect that active US equity funds have historically underperformed the benchmark S&P. The probability of active funds beating the benchmark is low. Keeping this in mind, we can improve the chances of achieving higher returns by allocating more to index funds.
7- Inversion
Change your perspective
We tend to think only one way about a problem: forward. We can invert the problem, that is- what would make the problem worse? — We can then avoid doing that. This helps us see reality from multiple angles.
Say you want to improve innovation in your organization. Thinking forward, you’d think about all of the things you could do to foster innovation. If you look at the problem by inversion, however, you’d think about all the things you could do that would discourage innovation. Ideally, you’d avoid those things. Sounds simple right? I bet your organization does some of those ‘stupid’ things today. — Farnam Street blog.
Avoiding stupidity is easier than seeking brilliance.
“You should take the approach that you, the entrepreneur, are wrong. Your goal is to be less wrong.” — Elon Musk
Here is Charlie Muger, the Vice-Chairman of Berkshire Hathaway’s take on inversion-
When I was a meteorologist in World War II, they told me how draw weather maps and predict the weather. What I was actually doing was clearing pilots to take flights.
I inverted I said: “Suppose I want to kill a lot of pilots. What would be the easy way to do it?” And I concluded that the only way to do it was icing the planes so they couldn’t handle it or to get the pilot into a place where he’d run off fuel before he could safely land.
So I made up my mind, I was going to stay miles away from killing pilots by either icing or getting them sucked into conditions where they couldn’t land. I think that helped me be a better meteorologist in World War II. I just reversed the problem.
8- Hanlon’s Razor
Don’t assume the worst
Hanlon’s Razor states that we should not attribute to malice that which is more easily explained by stupidity. This model reminds us that people do make mistakes. It demands that we ask if there is another reasonable explanation for the events that have occurred. The explanation most likely to be right is the one that contains the least amount of malicious intent.
Consider road rage. When someone cuts you off, to assume malice is to assume the other person has done a lot of risky work. In order for someone to deliberately get in your way they have to notice you, gauge the speed of your car, consider where you are headed, and swerve in at exactly the right time to cause you to slam on the brakes, yet not cause an accident. That is some effort. The simpler and thus more likely explanation is that they didn’t see you. It was a mistake. There was no intent.- The great mental models book.
This extends to competition that businesses and people face as well. Most people or business owners aren’t waiting around plotting their every move to thwart you. They are simply driven by the incentives they have in front of them.
9-Occam’s razor
Keep it simple
Simple explanations are more likely to be true than complicated ones. That is the essence of Occam’s razor.
Instead of wasting our time trying to understand and fit complex scenarios, we can make decisions more confidently by basing them on the explanation that has the fewest moving parts.
If it quacks like a duck, moves like a duck it is a duck.
For example, the economy is stagnating however the markets are reaching a new high thanks to the money printing done by central banks around the world. The quantity of money has increased, and money chases returns thereby propping up the markets. It isn’t some complex underlying sense of demand or hidden profit centers propping up the market. It’s simply money chasing returns.
When politicians give you sops during election time, they don’t do it out of the goodness of their hearts; it’s more basic than that. During election time, their main driver isn’t promoting education or the well-being of the community. It’s more immediate and simpler than that. Your vote.
Using these mental models takes work and will represent a journey I will be on for the rest of my life. However, they bring clarity and a better understanding of the world to me and I hope they do to you as well.
If you have a favorite amongst these models or a new one, I should discover do let me know in the comments.
