The Mental Models of Charlie Munger

Charlie Munger was the business partner of Warren Buffett.  He passed away in November 2023 at the ripe old age 99, and with an approximate network of USD $2.6 billion.  Charlie was famous for asserting the importance of using mental models to assist with decision making in business and investing.  He drew from various fields including science, religion, philosophy, history, business, psychology and more, to assist him in building Berkshire Hathaway with Warren Buffett into the powerhouse that it is today.

A mental model is a heuristic, or a mental shortcut 'for solving problems in a quick way that delivers a result that is sufficient enough to be useful given time constraints.' (source: investopedia.com).  Whilst you may know a number of these, I think that is worth revisiting the mental models which Charlie used and seeing how they can be applied in your own business and in your life.  Naturally, the true value of them is in reflecting on your own thinking patterns, but they also help provide insights into the minds of members, staff and anyone else with whom you may interact.

Some of Charlie's main mental models can be found below.  Almost all of consulting or management support can be boiled down to using one of these heuristics, often framed as questions to prompt the other person to think rather than providing them with the answer:

Psychology and Human Behaviour

• Incentives matter: "Show me the incentive, and I'll show you the outcome."
• Bias from liking / loving, or disliking / hating: People tend to favour or reject ideas based on feelings rather than facts.
• Commitment and Consistency bias: Once a person takes a stand, they tend to stick with it, even if it's wrong.
• Social Proof (herd mentality): People follow the crowd, even when the crowd is wrong.
• Confirmation bias: We seek information that confirms our existing beliefs.
• Reciprocity bias: People feel obliged to return favours.
• Loss aversion: Losses hurt more than equivalent gains feel good.
• Availability heuristic: Overestimating the importance of readily available information.
• First-conclusion bias: Anchoring on your first conclusion rather than seeking alternative perspectives.
• Authority Bias: People defer to perceived authority figures, even when they're wrong.

Business, economics and investing

• Opportunity cost: Every decision has a hidden cost: the best alternative you're giving up.
• Circle of competence: Focus on areas where you have deep knowledge and avoid those where you don't.
• Margin of safety: Always build in a cushion against failure, especially in investing.
• Compounding: small, consistent gains lead to massive long-term success.
• Mr. Market: Markets are irrational in the short-term, so don't react emotionally.
• Network effects: A product or service becomes more valuable as more people use it.
• Economies of scale: Bigger businesses can lower costs and dominate markets.
• Law of Inversion: Ask the opposite.  For example: instead of asking, "How do I succeed?", ask, "How do I avoid failure?"

Science and engineering

• Entropy: systems tend to move toward disorder unless energy is put in.
• Redundancy thinking: Build backups and fail-safes to reduce risk.
• Feedback loops: Systems reinforce themselves (positive feedback), or self-correct (negative feedback).
• Leverage: small inputs can lead to large effects.

Mathematics and probability

• Bayesian thinking: Update your beliefs as new evidence emerges.
• Law of Large Numbers: Large sample sizes give more accurate predictions.

Power Laws

• 80/20 or Pareto Principle: A small number of causes drive the majority of effects.
• Price's Law: In any field or organisation, approximately half of the output is produced by the square root of the total number of contributors.
• Regression to the Mean: Extreme events tend to move back toward the average over time.
• Survivorship Bias: People tend to focus on winners and ignore the losers, leading to distorted conclusions.

Biology and evolution

• Darwinian selection: only the strongest ideas, businesses, and individuals survive over time.
• Natural selection: success depends on the ability to adapt.

Philosophy and decision making

• Hanlon's Razor: "Never attribute to malice that which can be adequately explained by stupidity."
• Occam's Razor: The simplest explanation is usually the best.
• Second-order thinking: Consider the long-term and indirect effects of decisions.
• Falsifiability: A claim must be testable and capable of being proven wrong.
• Via negativa: Instead of adding more, remove things that cause problems.

It's worth noting that he also was a fan of Robert Cialdini's book Influence, and would likely have liked his book Pre-suasion also.  The former gives people the key elements in Psychology that, if implemented within a business, overcome virtually all pricing increase objections.