From one thing you can know 10,000 things.
-Mushashi
These models detail the patterns of the universe.
They explain energy and rhythm.
By applying them to various situations, you can see the bigger picture.
Every principle is a microcosm of another – meaning, for something to be true somewhere, it must also be true everywhere. So when you see these principles in action, they will always apply to other areas of life in some way.
This allows you to draw more powerful conclusions and to “read between the lines”.
Both Munger and Buffett used these models to amass their fortunes. If they can do it, so can you. At the very least, they will greatly improve your quality of life (and save you from making stupid decisions).
Whether you’re starting your own business, or simply want to become a better strategist, these Charlie Munger mental models will help you get what you want out of life.
Accounting:
Balance Sheet
The summary of balances for a person or organization.
Split into 3 sections:
- Assets
- Liabilities
- Ownership Equity (Difference between assets and liabilities)
Cash Flow Statement
A document that shows how changes in the balance sheet affect liquidity. It’s main purpose is to identify the short-term viability of a company or strategy.
Depreciation
The decrease in value of assets. Up-front cost is typically allocated over time.
- Example: The difference from “new” to “used” car.
Double-Entry
A system of bookkeeping requiring a corresponding and opposite entry to a different account. The sum of debits and credits must be equal.
- Example: Earnings sent to debit as “cash” and to credit as “revenue”.
Generally Accepted Accounting Principles
The common global language for business affairs.
- Assets
- Liabilities
- Equity
- Income And Expenses (Gains And Losses)
- Contributions By And Distributions To Owners
- Cash Flows
This info is used to predict the timing and certainty of future cash flows.
Income Statement
A document that shows revenues and expenses over a certain period. It compares net income with expenses (including write-offs and taxes).
Sunk Cost
A cost that has occurred and cannot be recovered.
Biology:
Genetics
The study of genes, genetic variation, and heredity.
Natural Selection
The variation of survival and reproduction due to different traits. Phenotypes with an advantage tend to become more common. The most useful forms survive.
Physiology
The study of chemical or physical functions in a living system.
The field is divided into:
- Animal
- Plant
- Cellular
- Microbial
- Bacterial
- Viral
Business:
Moats
An industry’s barrier to entry or brand’s competitive advantages. Awareness helps you play to your strengths.
- Read: The Dip by Seth Godin
Five Forces
A framework used to analyze the level of competition within an industry.
- Threat Of New Entrants
- Threat Of Substitutes
- Bargaining Power Of Buyers
- Bargaining Power Of Suppliers
- Industry Rivalry
A change in one of these variables requires your business to re-assess the market.
Brand
A brand is a set of indicators used to identify your product.
Aspects of brand are:
- Identity (USP/differentiation)
- Communication (logo/trademarks)
- Awareness
- Loyalty
- Management
- Equity (total worth)
Chemistry:
Autocatalytic reactions
A single chemical reaction. Spontaneous order creation.
A decrease in system entropy (disorder) leads to an increase in the entropy of its surroundings (and vice versa).
Bohr Model
Model of the atom. Used for transition, mass, and energy calculations.
Kinetics
The study of motion and its causes. (Analyzing centers of pressure – the point of force application).
Thermodynamics:
Uncertainty Principle
A limit to the precision of which physical properties can be known. Measurements of certain systems can’t be made without affecting the systems. The presence of an observer may affect outcome.
Viscosity
The thickness of a fluid.
Computer Science:
Abstractions
- Closure – Data structure storing function in environment.
- List – Abstract data type representing a sequence of values.
- Monad – Structure that represents calculations defined as a sequence. Chains operations or functions together.
- Trigger – Code that automatically executes in response to certain events.
Algorithms
A self-contained, step-by-step set of operations to be performed.
If-statements
Programming which takes different actions based on conditions. This alters the control flow.
Recursion
When a thing is defined in terms of itself or its type. (Infinite loop within limits).
Example: Triforce
Economics:
Agency Problem
Where a representative is motivated to act in his own best interest, contrary to principal.
Asymmetric Information
When one party has more or better information than the other.
Oftentimes, we don’t get charged for labor. We get charged for knowledge.
i.e. Knowing what to draw. Knowing where to hit. Knowing what to avoid.
- Example: Mechanic taking advantage of your car ignorance to charge more.
Behavioral Economics
The study of psychological, social, cognitive, and emotional factors on economic decisions. Observing the impact of different types of behavior, in different environments, on outcomes.
Most important is *risk tolerance*, the willingness to engage in activity whose outcome is uncertain.
The 3 prevalent themes are:
- Heuristics – Decisions made on rules of thumb, not logic
- Framing – Anecdotes and stereotypes that make up mental emotional filters
- Market Inefficiencies – Mis-pricings and non-rational decision making
Cumulative Advantage
The long term consequences of early fortune. Advantages increase exposure to opportunity.
Comparative Advantage
Being able to produce a product at a lesser opportunity cost. We tend to produce more and consume less of what we have a comparative advantage in.
(Finding out how to employ something to its greatest strength).
Competitive Advantage
The attribute that allows an organization to out-perform. Often included in USP (unique selling proposition).
- Location
- High-entry barriers
- Access to a rare resource
Creative Destruction
A mutation that revolutionizes an old structure from within. This destroys it by creating a new one.
Diminishing Utility
The point at which an extra unit leads to a decrease in return.
- Eating Food
- Working Out
- Taking Medicine
Economies of Scale
Cost per unit of output generally decreases as scale increases. Fixed cost is spread over more units.
Elasticity
Ratio of change. How responsive one variable is to a change in another.
- Elastic variable: strong response to other variables.
- Inelastic variable: changes less proportionally to other variables.
If you lower the price, how much will it sell?
If you raise the price, will it affect the sales of other goods?
If the market price goes down, how will it affect the willingness of a vendor to supply the market?
Externalities
Costs not accounted for in the cost of a product. Just because they aren’t accounted for doesn’t mean they don’t exist. Someone always bears the cost.
Markets
A plane where parties make exchanges. Can be classified and regulated.
Marginal Cost
The cost of producing one more unit of a good.
Marginal Utility
The change in benefit from using a product or good. The first unit consumed typically yields the most utility.
Monopoly and Oligopoly
A monopoly is where one person or company dominates a market.
An oligopoly is where a few people or companies do.
Their abundance of resources serve as a MASSIVE moat.
These entities have significant market power. They can charge overly high prices.
- Example: Frito Lay adapting a new flavor released by a smaller company.
Network effect
The number of users makes a product more or less valuable.
- More: Phones/social networks
- Less: Traffic
Opportunity Cost
The loss of potential gain from other alternatives when a choice is made.
Price Discrimination
Identical or similar goods offered at different prices by the same provider in different markets. It relies on a variation in the customer’s willingness to pay.
It can be broken into:
- Personalized Pricing – selling to each customer at a different price
- Product Versioning – creating slightly different products for different price points
- Group Pricing – dividing the market into segments (student discounts)
Prisoner’s Dilemma
A situation in which the outcome depends on the choice made by another.
- A snitches and is released. B receives max punishment
- A & B snitch. Both receive medium punishment
- A & B remain silent. Both receive minimum punishment
Public and Private Goods
Public Good – Use by one person doesn’t affect another (i.e. Air).
Private Good – An item that yields positive benefits and is exclusive. Its consumption can prevent that of another.
Specialization
The separation of tasks in a system. By employing things to their strengths, you’re able to accomplish tasks otherwise impossible. This is the motive for trade.
- Read: Mastery – Book Review
Supply and Demand
The unit price for a good (or traded item) will vary until it settles. It’s the equilibrium between price and quantity.
Supply can be determined by:
- Production costs
- Expectations about future prices
- Number of suppliers
Demand can be determined by:
- Income
- Tastes
- Prices of related goods or services
- Expectations about future prices and incomes
- Number of potential customers
Switching Costs
Any impediment to a customer’s changing of suppliers (cancellation fee, etc).
This is why it can be difficult to dump things.
Transaction Costs
Costs occurred in making an exchange.
- Search and information costs (Looking for availability, comparing prices, etc)
- Bargaining costs (drawing contracts)
- Policing and enforcement costs (through the legal system)
Tragedy of the Commons
Where individual users act contrary to the common good of all in a shared-resource system.
Time Value of Money
The greater benefit of receiving money now rather than later.
This principle underlies investment. People are willing to spend now if they expect a favorable return.
Utility
The satisfaction experienced by the user of a good.
Engineering:
Breakpoints
An intentional stopping place in a program. It’s purpose is for the programmer to inspect the test environment. (To see if it’s functioning as expected).
Feedback loops
When outputs are routed back to inputs as a chain of “cause and effect”.
Strongly related to “confirmation bias”. (We see what we expect to see).
Margin of Safety
Never go all in with your finances. This protects you from unseen problems.
“Fools who live for the moment die from their silly mistakes”.
Redundancy
Duplicating critical components or functions to increase reliability or improve performance
- Electric Power Distribution
- Backup Hard-drives
- Cables On Bridge
Law:
Burden of Proof
The duty of a party in a trial to produce evidence that will shift the conclusion.
(Usually on the person who brings the claim).
Common law
The process of looking at past landmark decisions to guide current ones. If a current issue is distinct, it sets a new precedent.
Due Process
The state must respect all legal rights owed to a person.
Duty Of Care
The standards of reasonable care when performing acts that could harm others. The grounds for imposing liability.
Determined by:
- Forseeability of harm
- Degree of certainty of injury
- Closeness of connection between conduct and injury
- Policy of preventing future harm.
- Availability, cost, and prevalence of insurance.
Good Faith
The sincere intention to be open, honest, and fair without regard for outcome.
Negligence
Failure to exercise appropriate care.
Presumption of Innocence
The burden of proof is on the one who declares.
Reasonable doubt
A reasonable person would not doubt the outcome of the decision.
Management Science:
Occam’s razor
The hypothesis with the fewest assumptions is usually correct.
Parkinson’s Law
“Work expands to fill the time available for its completion.”
Process versus Outcome
Focusing on systems over results lets you learn faster, be more successful, and be happier throughout the process.
Mathematics, Probability and Statistics:
Agent Based Models
A model that simulates the actions and interactions of autonomous agents with a view to assess their effects on the system as a whole.
A key notion is that simple behavioral rules generate complex behavior.
The whole is greater than the sum of the parts.
Bayes Theorem
Identifying the probability of an event based on prior knowledge of conditions that might be related to the event.
- Example: If cancer is related to age, then a person’s age can be used to more accurately assess the probability thereof.
Central Limit Theorem
For most scenarios, their sum tends towards a normal distribution (bell curve), even if the original variables don’t.
Complex Adaptive Systems
A collection of relatively similar and partially-connected micro structures formed to adapt to the changing environment and increase its survivability.
Examples include:
- The Internet
- Corporations
- Any Ecosystem
Correlation versus Causation
Correlation is a class of relationships involving dependence. It’s the suggestion of a trend.
Causation is a connection between processes where one variable is partly (or fully) responsible for the other. It’s the confirmation of a trend.
Combinations
A way of selecting items such that the order of selection doesn’t matter.
Compounding
Decision Trees
A decision support tool that uses a tree-like graph of decisions and their potential consequences.
These could include:
- Chance event outcomes
- Resource costs
- Utility
Inversion
Asking the opposite question.
i.e. “What’s the best way to fail?”
Kelly Optimization Model
A formula used to determine the optimal size of a series of bets. The basic idea is to bet a pre-determined fraction of assets.
If losing, the size of your bet should get cut. If winning, the stake increases.
Examples:
- Effective advertising spend
- Dollar cost average into index funds
Law of Large Numbers
The average results obtained from a large number of trials should be close to the expected value. It will tend to become closer as more trials are performed.
Mean, Median, Mode
With regards to a data set:
- Mean = Sum over total
- Median = The value separating the higher half from the lower half
- Mode = The value that appears most often
Normal Distribution
Random variables tend to settle in a bell curve.
Permutations
Arranging the numbers of a set into some sequence or order. Different from combinations where order doesn’t matter.
- Example: Rubik’s cube
Power Law
A relationship between two quantities where a change in one quantity results in a proportional change in the other quality. One quality varies as a power of another.
- If the length of a square is doubled, its area multiplies by 4.
Regression Analysis
Using independent and dependent variables to determine unknown parameters.
Return to the Mean
If a variable is extreme on its first measurement, it will be closer to the average on its second measurement.
In any system, units move towards its center of gravity.
Scaling
A linear transformation that enlarges or shrinks objects by a scale factor that is the same in all directions.
Sensitivity Analysis
Uncertainty in outputs can be attributed to different sources of uncertainty in inputs. Attention should be focused on the inputs that cause significant uncertainty in the output. You can also search for errors by examining unexpected relationships between inputs and outputs.
The question to ask is, “Which variables cause deviations”?
Philosophy, Literature and Rhetoric:
Metaphors
A figure of speech that refers to one thing by mention of another. It may provide clarity or identify hidden similarities between the two ideas.
Similes
Where a metaphor directly relates things, a simile draws comparisons. (Using “like” or “as”).
Abduction
Seeking the simplest and most likely explanation.
(Making an uncertain assumption useful in orientating yourself to your surroundings).
Pragmatism
Pragmatists consider thought as an instrument or tool for prediction, problem-solving, and action. Topics are best viewed in terms of practical uses and successes.
Realism
The idea that reality is independent from perception.
(Your cognitive map isn’t reality).
Reductionism
Making connections between phenomena or theories by reducing one to another (making more simpler or basic).
- Ontological – the belief that reality consists of a minimal number of parts
- Methodological – the attempt to provide explanation in terms of smaller entities
- Theory – A newer theory does not absorb or replace the old, but reduces it to more basic terms.
Physics:
Critical Mass
The smallest amount of material needed for a sustained reaction.
Electromagnetism
The study of electromagnetic force, the interaction between electrically charged particles.
Equilibrium
The condition in which all competing influences are balanced.
Inertia
The resistance of any physical object to change in its state of motion.
Newton’s Laws
The foundation of classical mechanics.
- First Law – An object in motion stays in motion. An object at rest stays at rest.
- Second Law – Force = Mass multiplied by acceleration.
- Third Law – When one force is exerted, it’s met with an equal and opposite force.
Momentum
A rocket spends most of its energy to leave the earth’s atmosphere. After that it’s only a few bursts to keep course and enjoy the view.
In chess (and life), it’s easier to set the tone in the beginning of the game.
Quantum Mechanics
The branch of physics concerned with atoms and photons. Subatomic particles are neither particle nor wave, but have properties of each.
Relativity
The explanation of gravity to other forces of nature. Energy and mass are equivalent and transmutable.
Shannon’s Law
The maximum rate that info can be transmitted across a channel in the presence of noise.
Thermodynamics
The relation of heat to forces.
Want more mental models? Read:
Pingback: What Is The Key To Wealth Building? - Mister Infinite
Pingback: 3 Things Every G Believes - Mister Infinite
Pingback: How To Gain Access To Higher Quality Conversations - Mister Infinite