Charlie Munger, Behavioral Finance & Mental Models

The first time I had contact with mental models and decision making was during the class of Decision Analysis and Risk – one of the best I had during the engineering course, by the way. The topics and bibliography were just great: Tversky and Kahneman`s prospect theory, heristics, framing, biases, behavioral finance and so on. I still remember the first class which was just an introduction to this important topic in investing and it talked about the decision making by Kuribayashi, the japanese general responsible for the Iwo Jima island. The movie Letters from Iwo Jima depicts the the battle between Japan and U.S. during World War II, as told by the perspective of the japanese. In the movie and in real life we might notice how the human mind deviates us from the best strategies, i.e. the ones with the highest expected value.

That said, Charlie Munger is a great thinker of our world of value investing. He brings with himself his famous mental models which are basically general ideas or thesis from very different disciplines – from psychology and medicine to physics and math – that are readily available in his brain to be picked up if a situation appears. Last time I tried to put it as simple as possible for myself:

  1. a problem appears in front of you to be solved; 
  2. checklist the problem`s characteristcs and match them with your mental models;
  3. solve the problem with the correct mental model.

Ok, it sounds really tricky when we read it, although our minds do it all the time with us – unconciously. This last word is the really tricky part of this. But wait a second, what about our biases and how heuristics play us? At the same time one might argue value investors do not have much spare time to read topics ranging from psychology to physics – we are specialists after all, aren`t we?  Anyway, I found this transcription here from Whitney Tilson`s website. It is a speech of Charlie Munger at Harvard Law School in 1995 called The Psychology of Human Misjudgment. Munger lists over 20 bias our mind develop and give many examples and little stories like the man with a hammer, Fedex problem with incentives, Pavlov association and so many more insightful stories. Please do not miss the opportunity to read this paper.

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