Focus Investing Series Part 3: The Munger Network of Mental Models
Richard M. Rockwood
“You’ve got to have models in your head and you’ve got to array your experience – both vicarious and direct – onto this latticework of mental models.” Charlie Munger
Mr. Charles T. Munger, Vice Chairman of Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B), is Warren Buffett’s partner at Berkshire Hathaway. He is famous for his cutting and insightful commentary on issues that concern him and he is a preeminent investor. He is a voracious reader and devotee of great thinkers such as Ben Franklin, whose wisdom he partially credits with developing his thought processes. Mr. Buffett has frequently given credit to Mr. Munger for providing him with key insights into the investment process.
Mr. Munger does not pretend that investing is easy. He advises that it takes sharp wits, strategy, and a lot of discipline to be successful in the investment field. Mr. Munger contends that more individuals could achieve better investment results than they actually do, if only they’d employ some of the basic “mental methods” he and Mr. Buffett have used throughout their careers.
“The number one idea,” he said in a 2001 Harvard Law Bulletin interview1, “is to view a stock as an ownership of the business [and] to judge the staying quality of the business in terms of its competitive advantage. Look for more value in terms of discounted future cash flow than you’re paying for. Move only when you have an advantage. It’s very basic. You have to understand the odds and have the discipline to bet only when the odds are in your favor.”
Mr. Buffett is clearly a master of betting only when the odds are in his favor. This excerpt from the Berkshire Hathaway 1980 annual report shows how he uses this concept to his advantage:
“GEICO’s problems at that time  put it in a position analogous to that of American Express in 1964 following the salad oil scandal. Both were one-of-a-kind companies, temporarily reeling from the effects of fiscal blow that did not destroy their exceptional underlying economics. The GEICO and American Express Company (NYSE:AXP) situations, extraordinary business franchises with a localized excisable cancer (needing, to be sure, a skilled surgeon), should be distinguished from the true “turnaround” situation in which the managers expect – and need – to pull off a corporate Pygmalion.”
This article will attempt to list a series of models that cover areas of knowledge that individuals have almost certainly amassed during their lifetimes. This article will also discuss how most individuals understand these concepts only as they relate to the task they are currently performing or pondering. For example, most engineers would never consider adapting their knowledge of breakpoint to the investing process.
It is my hope that, after reading this article in the focus investing series, the reader will understand how to develop and use his or her own system of mental models. I believe that developing the habit of examining problems using this multidisciplinary approach should not only help you become a better investor but, much more importantly, a better thinker.
Charlie Munger: A Network of Mental Models
The idea of developing a network of mental models is based on the concept that everyone should approach problem-solving from many difference perspectives. The traditional teaching method used in the typical American classroom revolves around the idea that topics should be learned in isolation from other topics. This inhibits students from learning that ideas from multiple disciplines can be used with great success when trying to solve problems. Focus investors should develop their own systems of mental models to help them make better investment decisions.
In the following section of this article the various individual areas of knowledge that Mr. Munger has discussed in several of his speeches will be covered on an individual basis. This information should help everyone develop and enhance his or her own system of mental models.