Charlie Munger: These 3 Simple Mental Models Helped Me Become a Billionaire

Hey everyone! Today's video is about Charlie Munger and the concept of mental models. Charlie Munger is one of my favorite investors to study. He's vice chairman of Berkshire Hathaway, the conglomerate controlled by Warren Buffett. Buffett has described Munger as his closest partner and right-hand man.

One of the most important things I have learned from Munger relates to the concepts of mental models. Put simply, mental models are how we simplify complexity, why we consider some things more relevant than others, and how we reason. All these are critical to being a great investor.

So here's Charlie Munger talking about the particular mental models he finds most useful and how you can apply them for success both in investing and in life. Enjoy!

"My question is, you talk frequently about having the moral imperative to be rational, and yet as humans we're constantly carrying this evolutionary baggage which gets in the way of us thinking rationally. Are there any tools or behaviors you embrace to facilitate your rational thinking?"

The answer is of course, I hardly do anything else. One of my favorite tricks is the inversion process.

I give you an example: when I was a meteorologist in World War II, they told me how to draw weather maps and predict the weather. What I was actually doing was clearing pilots to take flights. I then reversed the problem. I inverted it. I said, "Suppose I wanted to kill a lot of pilots. What would be the easy way to do it?"

I soon concluded the only easy way to do it would be to get the planes into icing the planes couldn't handle, or to get the pilots into a place where they'd run out of fuel before they could safely land. So I made up my mind I was going to stay miles away from killing pilots through either icing or getting them into such conditions when they couldn't land. I think that helped me be a better meteorologist in World War II. I just reversed the problem.

If somebody hired me to fix India, I would immediately say, "What could I do if I really wanted to hurt India?" I'd figure out all the things that would most easily hurt India and then I'd figure out how to avoid them. Now you'd say it's the same thing; it's just in reverse. It works better too frequently to invert the problem.

If you're a meteorologist, it really helps if you really know how to avoid something, which is the only thing that’s going to kill your pilots. And if you can help India best if you understand what will really hurt India the easiest and worst. I'm sure it works the same way. Every great algebraist inverts all the time because the problems are solved easier.

Human beings should do the same thing in the ordinary walks of life. It's constantly about what you don’t want. You don’t think of what you want; you think about what you want to avoid. Or when you're thinking about what you want to avoid, you also think about what you want, and you just go back and forth all the time.

Peter Kaufman, who's here today, likes the idea that you want to know how the world looks from the top looking down, and you want to know what it looks like from the bottom looking up. If you don't have both points of view, your reality recognition is lousy.

Peter's right; an inversion is the same thing. It's just such a simple trick to think, "How does this look from the people above me? How does it look from the people beneath me? How can I hurt these people I'm trying to help?" All these things help you think it through, and they're such simple tricks like the lever. They really help.

And yet, our great educational systems and advanced degrees don’t teach people these simple tricks. They’re wrong; they’re just plain wrong.

"How much of your success can be attributed to outcomes, Risa and Kelly's formula?"

Well, Occam's razor is of course a good idea; it's a basic idea. This Occam's razor is like telling the fisherman to fish where the fish are. Of course, she'll do better! [Laughter]

I got another idea that was very useful. I always liked Occam's razor. Now that is a wonderful way to think. You can argue that Einstein's whole career was just a marvelous demonstration of Occam's razor. E=mc² is a pretty damn simple idea. But think of the power of it!

And then Einstein developed some people say a corollary, a counter corollary, to Occam's razor. This may be apocryphal because I've never seen it in any original source I trusted. But I've seen Einstein quoted with this observation over and over again: "Everything should be made as simple as possible, but no more simple."

Well, if I'm saying he didn't say it, he should have said it because this is a very sound idea. I later developed a supplement to that corollary. My supplement to Einstein's corollary was that in messy social science, if the result you're observing is a lollapalooza, look for a confluence.

The topic I'd like to talk about briefly is common sense, which isn't common. Yes, see? [Laughter]

What people mean when they say a man has common sense is uncommon sense. Usually, they don’t mean that the man has a narrow little activity he's good at, like knitting sweaters, and he sticks to that. What they mean is a man that can operate over a pretty broad range of human territory without making any big boners. And that is a very important thing to be good at.

The question is, how do you get it? I was very lucky in my own life because everywhere I looked at the pinnacle, there was a guy that was better than I was. One of my father's best friends was a great surgeon with vast mechanical ability. I knew what this man did with his mechanical abilities, inventing all these spreaders and things he used to do his operations. But I would never be as good as he was. And everywhere I looked, there was somebody like that.

There was all this folly out there, and I suddenly realized if I just avoid all the folly, you know, maybe I can get an advantage without having to be really good at anything. I kept doing that all my life, and it worked so well that I enjoy sharing it with people like you. It really works to tackle much of life by inversion, where you just twist the thing around backwards and answer it that way.

I have to give problems to my children. Once, when I had all of them together, I said, "Well, there's an activity in America. There's a one-on-one tournament and the national champion became the national champion on two separate occasions 65 years apart. Name the activity."

Seven of my children could not remotely do it. The eighth, a PhD physicist, did it very quickly. What he did was turn it around. He said, "Can it be athletic?" He realized that no 85-year-old was ever going to win an athletic thing with the neurological or other deteriorations that are so evident tonight on the stage.

So I said, "Well, it could be chess!" He's a chess player, and he realized that no 85-year-old was ever going to be the U.S. chess champion. He knows what a chess tournament is like. But that led him to checkers, a game that you could almost master with enough experience. And, of course, that was the correct answer! It took him about 15 seconds.

All kinds of problems like that that looked so difficult when you turn them around, they are quickly solved. And so this process that I've gone through life doing of identifying folly and trying to avoid it has worked wonderfully for me."