Reading is one of the best ways to improve investment outcomes. Reading can not only improve one's understanding of different economic models and different sectors, but it can also help introduce different ideas. By combining these ideas, one may be able to reach different conclusions and see opportunities where others may not.
This principle is discussed extensively in "Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger." This unofficial biography of Charlie Munger (Trades, Portfolio) combines a range of different speeches and lectures from the billionaire investor, pulling out some of his most astute observations. A principle that really shines out in the book is the ability to combine different mental models.
Munger's mental models
Munger has always believed that the best way to understand the world is to understand it through a series of mental models, which explain various human behaviors and highlight psychological weaknesses.
I cannot explain all of the mental models in this article because there is just not enough space. The only way investors can build a detailed understanding of these models is to do the research and reading themselves.
In "Poor Charlie's Almanack," the author illustrates the benefits of combining mental models by using two example:, David Ricardo's theory of competitive advantage and Adam Smith's pin factory.
On the face of it, these two different mental models are "radically different." Smith's pin factory was based on a centrally planned model, while Ricardo's theory of competitive advantage "happens automatically as a natural consequence of trade."
However, when combined, these two models can produce a powerful combination. A centrally planned business, which is relatively controlled and not allowed to develop naturally, like a railroad, can flourish in a competitive environment. In this example, rigorous central planning is necessary to achieve the best outcomes for customers, which will help improve demand and, as a result, profits.
Another example is a competitive market for job seekers with a specialism. In "Poor Charlie's Almanack," Munger provided the example of a hotelier who wanted to buy a property no one else did because he had a unique business model whereby his clients would never leave the property, apart from going on tours.
"Obviously, that's an interaction of Ricardo and the pin factory examples. The odd system that this guy had designed to amuse seniors was pure pin factory, and finding the guy with this system was pure Ricardo. So these things are interacting," Munger explained.
Combining models
Combining mental models can produce interesting outcomes, especially when these models have desirable outcomes themselves.
Take the mental models of the advantages of scale and the cancer surgery formula. Companies can gain substantial economies of scale through growth, but this is not always guaranteed to produce positive results. They may experience diseconomies of scale, such as higher costs and extra bureaucracy.
The cancer surgery formula, whereby managers can cut out everything in the business that doesn't work, leaving only the productive divisions, can help remedy diseconomies of scale. This is an example of two mental models working together to improve outcomes for investors and companies.
Unfortunately, this could be a very fertile hunting ground for bad actors who may be able to abuse psychological mental models to take advantage of investors.
For example, a bad actor could use the mental models of and opportunity cost and deprival super-reaction syndrome to try and encourage an investor to buy into an opportunity they have overlooked.
However, if we invert this problem, it becomes easier for investors to know what to look out for in a potential scam. Scammers are well known for taking advantage of human weaknesses. Combining mental models to find these weaknesses before they become an issue could be a way to get around these problems.
