Munger's Mental Models

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Charlie Munger is a master investor:

• $2.6 Billion net worth

• Warren Buffett's right-hand man

• Vice Chairman of Berkshire Hathaway since 1978: $1 Trillion AUM

Mr. Munger places a strong emphasis on understanding your psychological biases.

He once said:

"You think you're immune from these things, and you laugh, and I wanna tell you you aren't."

If you don't understand the machinery of your mind, you'll get wrecked.

Let’s get into it:

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Now back to Munger’s wisdom!

1. Man With Hammer

Munger says, "To the man with a hammer, every problem tends to look pretty much like a nail."

Once you discover a tool that works well, you start looking to use that tool for everything.

For example:

Say you make a bunch of money from a certain stock.

You may become fixated on that investment and miss alternative, better investments in the next bull run.

It's important to detach and make a sober appraisal of your portfolio.

2. Psychological Denial

In a 1995 Harvard Commencement speech, Munger told the story of a family friend's son who died unexpectedly.

The son's mother refused to admit he had died.

The mind can throw up blinders to reality.

This often arises when an investment goes poorly.

Instead of cutting your losses, you ride it to the bottom, always telling yourself its trend will reverse soon.

To combat this, institute a stop-loss strategy.

Determine the maximum losses you're willing to incur at the outset and place a stop-loss order.

3. Incentive Bias

One of Munger's most famous lines:

"Show me the incentives and I'll show you the outcome."

Human behavior often appears erratic, but if you pay attention to the incentives you can untangle seemingly inexplicable behavior.

This is critical to understand because the market is run by human action.

For example, the government gives tax incentives for EVs. They are encouraging individuals to buy electric vehicles by pulling the incentives levers.

This will likely drive EV sales, invest accordingly.

4. Lollapalooza Effect

Munger coined this term himself.

It describes the result of multiple biases and mental models compounding.

So, when incentive bias collides with psychological denial, the two combine to create an incredibly powerful impact on human action.

Understanding human psychology is critical to informed investing.

Mr. Munger would know, he's regularly beaten the market for over 50 years.

I highly recommend you dive deeper into his 1995 Harvard Commencement speech to learn more on this topic.

Now, let’s get investing!

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