Mental Models: What billionaires use to make good decisions.

Written by John Kuder

Table Of Contents

Five examples of Mental Models we discuss in this video, starting about the 6 minute mark:

  • The Map is Not the Territory
  • Diversification of Risk
  • The 80/20 Rule (Pareto Principle)
  • Occam’s Razor
  • Margin of Safety

Partial Transcript…

Hi I’m John, I’m Connie. So tonight we’re talking about Mental Models: what billionaires use to make smart decisions. Oh, we need that. We all we all want to make smarter decisions, right? Yeah. Regardless if we got money or not. So, exactly. We make decisions all the time. We want to make the best decisions to make the best life So, okay, let’s break this down mental models. So mental. We’ll come back to that. What’s a model?

Well, a model was something that I strive for or a perfection maybe.

Okay, that’s interesting that yeah, it’s a representation of a standard is that what you mean? Yeah, a standard of beauty or a standard of quality or standard. Okay. But it’s, it’s in some way simplified. Would you agree? I would agree with that.

I was actually thinking more of it as the physical things, like an architectural model. I think everybody has seen, you know, whether it’s in a movie, you know, when they’re going to build a big shopping plaza or a skyscraper or whatever, you know, you see these models that they… that they show people as this is what the finished project is going to look like. Right?

An artist’s rendering is another, we see those, you know, when a thing was being built near us, you know, we saw a real pretty picture that looked like it was done again, you know, and so, but, but okay, so an architectural model. Let’s take it back. So the average architect, I’ve seen a few of those and I had some art… I went to school with architecture students. Yeah. And we also dealt with one and they, they used cardboard, and an Exacto knife and they glued it together and it was really rough. I mean, it was not it didn’t look like a real building and there was no no chance you were going to confuse it with a real…

No, it was it was cardboard, but but it has the shape and the and the relative dimensions and the the layout so you could look at it and can envision, to some degree, with the building was gonna look like. It wasn’t a perfect vision. It was imperfect. That’s the key. A model is an approximation. It’s imperfect.

Okay, so what about a sketch? So all the supermodel are?… What about a sketch? Like I like to say, a mental model. I’m coming back to the mental Oh is like the is the equivalent of me drawing a stick figure to represent a person because that’s about the level of quality of drawing I can do.

That’s true! But every artist, they generally start with a sketch, right? They have a rough sketch of what they’re going to draw, and then they fill that in. There was a very, very famous artist that sometimes just stopped at sketches and his name was Picasso. Right? And we’ve seen like Dale Chihuly do that with glass and things like that.

Yeah, those are very he’s Yeah, right. He would sketch something out and then paint it and then he would use that as his plan to then blow a beautiful piece of glass. Okay, so we have that idea. So it’s a simplified model, a simplified representation of mental work. Well, we’re still talking about the physical stuff because I want to go to…

I’ve got two more examples. A map. This is going to lead directly to a mental model. Okay, so a map, think about what a map is. Yeah, right. It’s it’s a piece of paper, and it’s got lines and shapes on it, and it’s got little symbols that represent landmarks, right, a river, a road or mountains. Right. But but that little gray line on a map? Yeah, you can’t drive your car on that. Right? That’s not a real thing. It’s, it’s a representation, okay.

Okay. And the the little blue line doesn’t actually have water flowing on it. Okay. Okay. So it’s just an approximation. Right. All right. Okay, now I’m with you. Okay. Now what? Well, so we’ll come back to that. And the last model, I wanted to bring up the idea of a mathematical model, a predictive model. Because we, we do use those and yeah, here in Florida, we have hurricanes. We have a hurricane season. Oh, yeah.

And so they have a model that that they use to look at the weather patterns around the world and predict how many named storms there will be in a particular season. Right. It’s never dead on. But it’s a model and it’s it’s an approximation, it tends to be more accurate than just wild guesswork, then he’s on typewriters. Okay. All right.

So that’s that’s some examples of kind of a physical and mathematical are okay. Okay. Now let’s go to a mental model. Okay. So the idea of a mental model that what a mental model is, is a thinking tool, thinking taking that marble concept of a simplified representation. Now let’s take something that’s complex that we need to think about and make decisions about where the, all the possibilities, there’s too many possibilities for us to imagine all of them and to play through all of them.

So we simplify this system to something and make some assumptions and then we, we make no decisions, right? We take their little shortcuts, basically their mental shortcuts or guides that will help us make better decisions. Okay, okay. Give me an example.

Yes, oh, cool. With a map. There’s a mental model that was created by a I just happen to have read this. I bought this book and read most of it. It was called the General Semantics. There’s a guy named Alfred Korzybski. I think he was account. Anyway, he, one of his most memorable statements, and that’s another thing about these mental models. They tend to be memorable. Okay, it’s “The map is not the territory.”

Yeah, I’ve heard that forever.

Okay. You’ve probably heard me say it a lot. And it’s a reminder, okay. So it’s a way of shaping our thinking, okay, that to remind us that when we’re looking at this map, this represent a simplified representation, but it’s not going to be perfectly accurate. It’s not the same as the real world. And you need to trust the real world ahead of the map. If the map doesn’t have a cliff on it, and you come to a cliff, it’s best that you don’t step off the cliff. Right.

All right. So I’m just I mean, that’s stupid, simple, but that is the idea of a mental model is to help us make better choices. Yeah, don’t just so and that’s the that brings up a point. About mental models, they are imperfect. Okay. They… and because of their… because they oversimplify things. Any simplification is gonna be over simplified in some ways.

Then they introduce either inaccuracy, or bias. We talked about bias before, like the fundamental attribution bias, but we’re going to… it’s gonna cause our thinking to lean one way or the other because of that simplification. Okay.

And so the benefit of… the guy who made mental models popular and famous, I guess, is Charlie Munger, who is Warren Buffett’s business partner. And his recommendation is to use a combination he calls it a latticework of mental models, so that by using them in combination, the biases will help to cancel each other out, though, right by using these multiple models together, okay. The framework a better framework and more complete framework, right? So the there’s a I don’t remember the name but there is a particular cognitive bias Okay, and it’s commonly expressed as if all you’ve got is a hammer everything looks like a nail. Okay, so if we only have one mental model, we try to apply it to everything. Okay. And that’s and that there, that’s actually a form of cognitive bias. So some of the mental models actually are cognitive biases. I mean, there there’s overlap between next Okay, so Okay, so we got it one. Here’s, here’s another mental model. That’s, I think, very commonly used regarding investing. Okay, diversification of risk. Right? Okay. We love that. The idea that you want to put you don’t want to put all your eggs in one basket. Could that be a mental model? Could be. It’s a little bit, you know, I mean, it’s a popular, it’s a it’s a simplified saying, right. You know, it’s also everybody understands it. Yeah.

I mean, you say that everybody goes, Oh, yeah, I’m putting all my stuff in different places. I’ve lost the word of what that actually is in terms of length language language construct, anyway. No, no, it’s not it’s not an aphorism, but it’s close. Okay, diversification risk anyway, the idea that you want to spread out your risk so that you know, if something goes wrong, you don’t lose everything. Right. Right. Right. Yeah, hopefully covered. See, why can we apply that to other things? Right. Right, right. Okay.

For example. If we were looking at the… well, the government has a plan for evacuating all the highest officers in government if we’re ever under attack, right? Well, I’m pretty sure they’re not going to put them all in the same vehicle. Right. The President is going to go in a different vehicle than the vice president than the Speaker of the House and so forth. So they diversify the risk: if one of them gets killed, they don’t all get killed at the same time. Right. Okay. I mean, that’s, that’s not the most pleasant thing to think about. But it’s an example of diversification.

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  1. The word I was grasping for at 9:15 was “metaphor”

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