Psychological tendencies related to financial bubbles, booms and crashes

The following text about the most common psychological tendencies that are related to financial bubbles, booms and crashes is an excerpt from my book Cycles for Investors.

Bubbles, booms and collapses are social epidemics and follow their principles. Epidemics have three components: the right people, the right message, and the right environment. They are influenced by several psychological factors such as social proof, authorities, scarcity principle, excessive self-regard, and the illusion of availability. They increase both the attractiveness of the message and the effects of the environment on bubbles, booms and collapses. Different people have different effects on both individuals and large crowds.

The messages from the bubbles and booms are simple and engaging. They say everyone gets rich easily and quickly without much effort as long as they invest in new ideas. The message includes attractive predictions of a rise in the pattern “Bitcoin rises to $ 500,000 (now about $ 40,000)” “This time it’s different” is another message available in large-scale bubbles and booms. They often also contain a message of a carefree tomorrow and the prosperity of the nation. The message often has some truth in it, but its significance is exaggerated. The realization of the message is often far in the future, even though the masses believe in sudden enrichment and rapid change. One message is that those who do not participate in the boom are stupid.

Bubbles, booms, and crashes will not occur without massive social proof in which herd behavior is rampant. During booms, it produces a desire to buy the same investments or consume like large crowds. Crashes create a desire to sell and reduce consumption while others do the same. In them, many have to do so because they do not have enough money to consume. Roughly speaking, the closer and more people produce social proof, the more confident the individual becomes and acts like others.

Even large numbers of people can be made to act like a small number of people as long as the latter has credibility. People have an inherent belief in authority. In bubbles and booms, a small number of lucky fools can make millions while believing in the goodness of nonsensical investments because they have happened to succeed fabulously for a short time. Usually these ”authorities” tell the general public what they want to hear. They can get rewards from people like them or the media. In addition, the masses are demanding so-called anti-authorities who tell them they are wrong. They are most often people who have been enriched by the old rules and have not agreed to pay the prices produced by the bubble or boom. They are considered losers during bubbles and booms.

The scarcity principle means that the less a person has something or the harder it is to obtain it, the higher the value. In addition, it works in the other direction. The bubbles and booms in some investments have a shortage of supply relative to demand. Large-scale bubbles are mainly affected by the other side of the coin, i.e. the fact that money moves fast and enriches a large crowd. The above raises both the prices of investments and increases absurd consumption. At the same time, the real economy is growing strongly which raises the above. Too much money significantly increases stupid investment and consumption decisions.

The excessive self-regard manifests itself as excessive faith to one’s own beliefs, qualities, skills, and possessions. Faith of an increasing mass of investors strengthens with the bubble or boom to the heights rarely seen, which raises the prices of “hot” investments. At the same time, larger and larger sums of money find the above items. Faith is not even shaken by failures or losses. They are explained by bad luck or some other absurd reason, and in the worst case, the ego is further inflated. Losses and failures increase the need for investors to look for sources of information that emphasize their own beliefs and skills. One major factor in the bubbles and booms is that investments become more valuable in price as soon as they are purchased.

The excessive self-regard also increases booms and bubbles, with big money portfolio managers acting as one of the reinforcing factors. One of the truths of their work is this: "It's better to lose money like others than to do something different." Many of them protect their own jobs. This is reflected in the so-called hidden indexation of funds, where the investments of the active portfolio manager resemble the benchmark index, differing slightly from it. This also applies to other moments, but the phenomenon is at its strongest in booms due to reflexivity.

The overemphasis on egos is not limited to investors. It manifests itself in central bankers and other regulators. The majority of central bankers have had a long career believing in the theories they have learned and the models they have used. They work well most of the time while increasing regulators’ confidence in them and themselves. The performance of theories and models in the short term increases the excesses of bubbles and booms as well as the devastation resulting from crashes. It is important to ask whether the actions of central bankers and the models they use have a positive net effect?

The illusion of availability means that people give more value to stimuli that are better available. Availability can be both an external and an internal stimulus. It can be improved by an increase in the number of stimuli, recency, or characteristics. Examples of the latter are surprise, novelty, ambiguity, and threat. The illusion of availability is reinforced by the media reporting on fortunate individuals who quickly enriched and took advantage of the new message. The media is full of half-truths or misunderstandings about the basic principles of investing. The illusion of availability is at its strongest when a bubble or boom reaches euphoria. It is also strengthened by other psychological factors.

Avoiding the negative effects of the psychological factors of bubbles, booms, and collapses is not easy. There are a few good rules of thumb to reduce the effects. When you find that a security or asset class is more popular in your immediate circle than others, it is a likely sign of bubble prices. Combining the former with a new economy or investment vehicle should be seen as a bigger alarm signal. Never believe words that contain the message, “It’s different now,” whoever tells you so.

Don’t listen to people who do not have a proven track-record of investing at least a decade above the market average talking about future returns or losses, or who promise high double-digit returns on investment, even in the medium term. Their numbers in public will increase during booms and bubbles. At the same time, the number of people who are wrong is growing. During booms and bubbles, it is even more important to listen to people who have done better than average for several decades. The same is true during a crash. Also, don’t believe people who predict the “end of the world” during them.

Don’t believe yourself if you do not have a better-than-average return rate, or think you’ll be able to achieve high double-digit returns in the medium term. Don’t let your ego make you believe you are right when the price of an investment collapses well below the amount you paid. This is especially true of the losses caused by the crash. You don’t have to prove you’re right by immediately putting more money into a losing investment. This is a mistake because there is no need to quickly return an erroneous investment with the same investment target. It is safer to take a breather and think about what went wrong.

Do not look at the price of a security before making a cash flow statement. Your subconscious can steer the end result towards it when its availability is high. Do not look at the price you paid when making a new cash flow statement for your investment. Your investment does not know how much you paid. The price you pay may not matter at this time.

Common antidotes to psychological biases

Psychological biases can be working in any situation. This text is about common antidotes to all of them. Each of them also has some specialized antidotes which I will not go through today. Most people think they are more invulnerable against the tricks of persuasion professionals than average. Most people think they can be rational in any situation. This is not true. When the moments come that you think you are the best way prepared to ward off all manipulations, you have the highest odds to be vulnerable. This applies even to people who know about the ways they are manipulated. It can be the worst position to suffer from persuasion. It is the position that can have the largest possible bad effects on the decisions you make. Confidence in your abilities is the worst foundation for these moments. Be suspicious about your abilities.

Even though I mentioned that confidence is bad for you, you have to first recognize these situations in which you are vulnerable. And this can make you feel you can resist anything. It is better if you do it before you have to deal with them. Avoiding them is the best solution. One of the most common situations, when you cannot avoid the effects of persuasion professionals, is when your willpower is low. This happens when you are tired, stressed, have external influences like other people to lead you the way, etc. One of the best signs of these situations is your overreaction to stimuli, whatever it is.

Bitter pills can work. When you voluntarily expose yourself to less harmful persuasion professionals, you can recognize your vulnerability to them. This makes you less confident about your abilities to resist them. When professionals have deceived you with small things, you can have better odds in avoiding persuasion attempts in bigger things. For example, book salesmen are not as harmful as car salesmen. Analyze your reactions to salesmen, their tricks, and how they deceive you or try to do it. Plan in advance. Do not expose yourself to a situation that can cost too much. You can also see these professionals at work, but with other customers, if you do not trust yourself enough to be a customer. Go to a cafe that has direct access to a shop or two. Have a coffee and watch it. You do not even have to hear what they say and you can still learn. You will learn less, but with smaller problems.

You can also practice your reactions to these situations. If you like to wander in a mall or you have to go and buy something from them, you can use so-called if-then scripts. For example, if a persuasion professional approaches you to sell you something, then tell him your wife takes care of these things in your family. You can also tell him that you have a job interview and you have no time to talk. You can invent more of these scripts yourself. Use your imagination and I am sure you will find something to say.

Some situations are more dangerous than others. If someone creates new expectations and wants to fill them, you have to be smart. For example, a company sells you some sugary and fatty foods and it also sells diets to lose weight, you have to be careful about it. That company wins twice. First, it sells you an unhealthy snack, and then it sells you something that lessens the bad effects of it. The other sign of a hidden agenda is selling something you have not experienced before. Try this new product X and enjoy it. This can be something like a test drive, or a new service, etc. When new things are free, be extra careful.

Frame these situations in different ways if you want to avoid them. Distance yourself from them. Think like you are an outsider. For example, ask yourself what others would do if they were you. Would they say yes or no? Practice their answers. You can also find outsiders about their opinion in advance. Use your critics if you can. Try to be neutral. Think about finding the truth and nothing but the truth. Be aware of your prejudices. Be careful when your response is too strong for the situation. It is the best sign that something is wrong.

This is all for today,

-TT

Next text will be published after a fortnight

Hey all.

I have been on vacation. The next text in the blog will appear after a fortnight.

I will also continue my best investing lessons blog in the next week.

I wish you nice summer days!

-TT

Opportunity costs

Definitions

Opportunity costs can be defined as ”The loss of other alternatives when other alternative is chosen.” Or as ”The value of the choice of a best alternative cost while making a decision.”

Some opportunity costs are easier to understand than others

All the things you do have opportunity costs. You can´t have everything. When you choose something, other possibilities are not available in the present moment. For example, if you want to work, you cannot watch TV. You always need to compare the alternatives with each other. Opportunity costs can be different than the cost of acquiring things. For example, when you get something for free, your loss comes from lost time, space, effort, etc.

Counting or approximating the cost can be simple or extremely hard. Easy choices like choosing a brand label which costs 1.5$ or a similar product that costs 1$, make counting opportunity costs easy. The opportunity cost of choosing a brand label is 1.5$-1$=0.50$. Simple calculations about opportunity costs are useful tools. When complexity arises, opportunity costs are harder to calculate. For example, when you think about working over time or spending your time home with your family, opportunity costs are very hard to calculate. Calculations can become harder, when the options are plentiful or each of the two options have several factors that change or are harder to put any value on them. For example, choosing a laptop from different models, brands, and characteristics. In addition to them, you have to consider all the different prices.

”If cow had wheels, it would be delivering your milk”

Most opportunity costs have ifs. You have to consider the uncertainty, when you are trying to figure out them. If you are using statistics and/or probabilities, to calculate opportunity costs, you have to understand what you are doing. You cannot rely on averages, when they do not matter. For example, expected payoffs are not always the same as averages. For example, stock indices can give you real 7% of annual return, on average. Comparing this number with saving money and calculating opportunity costs gives you wrong results, when stocks are very expensive or very cheap.

Most often, there are some uncertainty in calculations. And when there is uncertainty, you have to understand the need for margin of safety. Ifs create errors. These errors can be way larger than you think. This is really important, when you are thinking about changes for things that work at least on average. The other opportunity has to be much better than a previous thing. A famous investor John M. Templeton talked about 50% better opportunity before changing an investment vehicle for a better one. I am not saying that you should do the same. 50% better is just an example about investing and about one person. You should figure out your own margins in different situations. They can be larger than you think.

Some instructions for calculations

Keep things simple. The more options you use, the harder the calculations become. You should leave the least probable options away from your calculations. In economics, you only calculate the opportunity costs compared to the second best alternative. This should work with simple options considering money. I wouldn´t use only the second best option all the time, but you figure out what is best for you. You also shouldn´t compare apples with oranges. You can´t calculate or estimate opportunity costs of two totally different options. If you think that you cannot calculate or estimate opportunity costs within fairly easy, forget them, especially, when you are talking about small decisions. Calculating opportunity costs have opportunity costs too.

Sources:

Poor Charlie´s Almanack, Peter Kaufman

Feedback Loops

Definitions

Donella A Meadows has defined a feedback loop in her book ”Thinking in Systems” as ”A closed chain of causal connections from a stock through a set of decisions or rules or physical laws or actions that are depended on the level of the stock, and back again through a flow to change the stock.” A little simpler definition can be ”A path by which some of the output of a circuit, a system, or a device is returned to the input.”

Balancing feedback loops

These loops are goal or balance-seeking. They try to keep stocks stable and within a certain range. They also resist the change in systems. If stock level gets too high, balancing feedback loop will try to get it lower. If stock level is too low it tries to get it higher. For example, you have a room in which you want to keep a temperature within a certain range. You have a balancing feedback loop that keeps the temperature within the range you want. There are always some losses of heat in the room, when the temperature outside is colder. Your balancing loop adjusts the heating depending on how much colder the temperature is outside. When the temperature outside is much warmer than in the room, the heat outside comes in. Then your balancing loop will cool the air inside.

These balancing loops are not always working properly. The information from them can come too late, be unclear or incomplete or hard to understand. The action they cause can be delayed or ineffective, etc. Stock-maintaining balancing loops must have their goals set for compensating the draining or inflowing processes that change the level of the stock. All these loops have their own breaking point. This is the point where the pull of other loops is stronger than the pull of the balancing loop. When your heating system is not having enough heating power compared to the leaks outside, your room temperature gets too cold.

Reinforcing feedback loops

These loops are amplifying or reinforcing. They can cause virtuous or vicious effects of healthy growth or complete destruction. It creates a bigger or smaller inflow to a stock than is already there. Reinforcing loops enhance the direction of the change in a stock or a system. When a system element can reproduce itself or grows as a constant fraction of itself, reinforcing loops are found in the system. Reinforcing loops produce an exponential growth. Growth gets faster all the time. For example, the bigger the interest in your bank account, the more money you will get into your account every year, because you get the interest for the interest too. These loops may not change the system until the path of least resistance is overcome. For example, the sales of the new product may not start growing faster until a certain amount of product is sold.

Feedback loops are mostly linked together

Single loops are seldom at work in systems. Mostly, there are complex patterns of interconnecting loops. A single stock can have many balancing and reinforcing loops pulling in many directions. A single interconnecting flow can be attached to many different stocks. This flow can increase the ouflow of one stock and at the same time increase the inflows of many stocks. These feedback loops create a system behavior which is hard to predict. When you change the functioning or a goal of one loop, you may create changes in many others. In other words, one change can produce combinations of changes instead of one.

Lets keep things simple and concentrate on one stock system like population with both a balancing and a reinforcing feed back loops. This is one of the most common and important system structures. Lets start by identifying the most important inflows and outflows of the population. The most important inflow is people born into the population. The most important outflow is people dying. This kind of system changes when the relative strength of the loops change. In a normal situation, more people are born than dying. This means that the net effect of these loops is increasing population. It also means that the net effect is self-reinforcing growth in population.

When there is a sudden humanitarian catastrophe or a civil war in some population, the change reverses into diminishing population and the balancing loop dominates the behavior of the system. When these changes in relative strengths of feedback loops happen, the behavior of the system changes. A stock governed by linked balancing and reinforcing loops grows exponentially if the reinforcing loop dominates the balancing one. Stock declines exponentially if the balancing loop is dominant.

Other things to know about feedback loops

You have to remember that the delivery of information through a feedback loop will only affect future behavior. Feedback loop cannot deliver signal fast enough to have an effect in present. There are three typical delays in the real world. First, a perception delay. For example, a shopowner doesn´t react to any small changes in sales. She normally reacts, when the sales have changed for a longer time period, like five days. Second, there is a response delay. A shopowner makes up some part of any shortage with each new order. Third, there is a delivery delay. A subcontractor delivers the goods with delay because he has to process the order and deliver it. Changing the length of the delay will likely cause a large change in the system. When the delay is too short, the system behavior will likely oscillate.

Physical, growing systems are going to encounter limits. Those limits are balancing feedback loops. When the limits are achieved, these loops start dominating the systems by either strengthening the outflows or weakening the inflows. These limits are temporary or permanent. Eventually, the system will adjust to the limit or the limit will adjust to the system. There has to be at least one reinforcing loop delivering th growth and at least one balancing loop limiting the growth in the physical, exponentially growing systems. One interesting and important thing about feedback loops is that systems with similar feedback structures produce similar behaviors. Physically different parts do not really change behaviors.

Sources:

Donella H Meadows, Thinking in Systems
John H. Miller Crude Look at the Whole

The path of least resistance

Definitions

The path of least resistance tells you the easiest way to continue a forward motion from a set of alternative paths. A person taking the path of least resistance avoids personal confrontation or pain. You also make the choice that minimizes the energy consumption from many possibilities. You can see this in the second law of thermodynamics which says that heat always moves from hotter to colder bodies unless external work is performed on the system.

Examples

River always runs down hill. It always follows the easiest path. Without conscious effort, you always choose the action which consumes the least energy. You like novelty. This means when you are confronted by many impulses, you choose the new ones which are the easiest paths. When you get lost, you choose the easiest path when you are trying to find out the place you are not familiar with. If you are somewhere uphill, the most probable path for you is downhill, when you don´t know where to go.

Always try to create the path of least resistance for the most desirable things

When I introduced inertia which basically means continue moving into direction where you are already going or stay in the position where you are. I talked about habits. In this case, your habits are the path of least resistance after they have been automated into our brains. You need to make your triggers for good habits as available as possible. The more exciting the prizes of your habits are the less resistance you have. These are the basic principles of creating good habits by using the path of least resistance into your advantage. Changing the existing habits is a lot harder.

You should also create some decision making systems where the path of least resistance is taken into consideration. Most people have a default option of making choices that are based on their opinions and beliefs. You may disagree with some people without making any research, because you just believe something is true. The reason can be that you just believe in something because you wish it is true. For example, you can believe in some promises from politicians and give your votes for them, because they tell us what we want to hear. They use your paths of least resistance. Truth is politicians can never keep all of their promises.

Always try to create the path of most resistance for the least desirable things

While it is important to create the path of least resistance for the most desirable things, you need to use inversion and also make it as hard as possible to choice the path of least resistance for things that are bad for you. This is as important as creating the path of least resistance for the most desirable things. When you are choosing from the alternative paths, you may have to make the worst paths disappear. When you are on a diet, you should keep all the bad food unavailable. Otherwise you may come to a situation where it is too easy to make a choice for eating unhealthy foods. It is probable that this happens when we are in a recovering part of the daily cycle. Feeling tired and emotionally drained will lead you to the path of least resistance, which in this case is unhealthy food. You suffer from availability bias. All the triggers to the wrong paths should be eliminated.

Avoiding all the harder paths will get us nowhere in life

You cannot always choose the path of least resistance if you want to achieve something great. If you want to get better at something, the path of least resistance is not enough to move us further. It will probably lead you to become less skilled. You have to fail, experience some pain and reflect. You need to think what you did wrong. And try to improve yourself. You cannot create new habits or change the existing ones without making conscious choices first. These choices are not your default options and you need to rewire our brains. Rewiring happens through repetition and takes more energy than doing things the way you did before. Things get easier after you have had enough repetitions and ultimately lead you to new or better habit. You have created a new and better path of least resistance. You can create this path of least resistance more easily, when You start creating it during the upper part of the performance cycle. Which means you have less resistance than in the recovering phase of the cycle.

The path of least resistance is not so useful mental model by itself. Understanding inertia, cycles, skills and availability bias helps you to understand it better. As you can see, all these mental models interact. When you understand enough models and how they are related, you create the whole latticework of mental models and using it every day becomes eventually the path of least resistance.

Sources:

Mastery, George Leonard
Peak, Anders Ericsson
The Power of Habit, Charles Duhigg
Be Excellent at Anything, Tony Schwartz

-TT

Cycles

There are many definitions of different cycles. The main definition for your purpose is: ”a course or series of events or operations that recur regularly and usually lead back to the starting point. Everything and everyone have their own natural cycles. You can also talk about natural rhytms. The longer the cycle, the less people are aware of its existence. The lengths of the cycles have lots of variation. One of the shortest cycles is breathing. Exhaling and Inhaling is a whole cycle. The longest ones can take decades like longer term debt cycles. There is a lot to say about cycles. And right now, we will cover only basics in terms of personal life, expertise, and other things, through the viewpoint of individuals. In this text, we are concentrating mostly on the daily cycle.

A typical cycle has it´s ups and downs

You can see a one normal sine wave cycle in the picture below. The purpose is not to teach mathematics or physics. The idea is to look at the wave cycle and think about what it really means in terms of individuals. Here is the link for the picture.

Picture 1. Sine Wave Cycle

What you really see is that every cycle has its starting point and the end point. In reality, all the cycles are not the same. Only principles stay the same. The length and the depth of the upper part and the lower part of the cycles vary. For example, focus on the day´s tasks has variation during the day. The wave in the picture is not a perfect description for it. What really happens is that after a good sleep, you probably still function below the mid point of our ability to focus. Without sleeping you would definitely be in the bottom of the focus cycle. There is no way of maintaining the highest focus throughout the day. If you try to do it too long, the fall from the top to the bottom will be faster and the recovery will be longer. The bottom of the cycle will also be deeper. The most important thing about performance cycles is that you need to maximize the usefulness and the lenght of the upper part of the cycle and minimize the damage done in the bottom of the cycle and it´s length. There are certain limits you cannot overcome and we need to be aware of them.

The upper part of the cycle is for the most important things, sleep is the exception

The length of the upper part of the cycle matters, but you cannot keep ourselves in the upper part of the cycle forever, no matter what you are talking about. Going too far in lengthening the upper part of the cycle will create the worst damage. And the bottom part of the cycle will be much longer. Practicing will make the upper part longer and the lower part shorter. Temporarily, you can stay longer in the upper part of the cycle. For example, you can work overtime for days or sometimes even longer. Eventually, the quality of the work will be so poor that you have already moved to the lower part of the cycle. You may have not noticed it and there is the danger of going too far. The result of this is lots of damage.

You need to maximize the good things during the upper part of the cycle. You should reserve the times for the most important things for it. The most important tasks at work should be done during the highest part of the cycle. The biggest decisions should be made only during this time. Buying a house or other big expenses should be considered then. Practicing a new skill should also be done only during the best hours of the day. The right nerve fiber chains need to be strengthened. The probability of this happening is the greatest during the best hours. If it is not possible during these hours, you should improve our skills during the next best hours like early in the evening after having a break from work.

The lower part of the cycle is for the less important things and recovery

You need to minimize the bad things during the lower part of the cycle. The lower part of the cycle is also for the less important things. You shouldn´t start anything important after utilizing the full force of the upper part of the cycle. Eventually, you will move to lower part of the performance cycle. You have some less important things to do during the day, or you are lying to yourself. When the ability to perform have diminished, you can start doing things that do not really matter, like watching TV, surfing the web, or checking our mails. You should do these things when we are not efficient. For most of us, this means during the last working hours or the evenings.

The lower part of the performance cycle should also be used for recovering from the performance of the upper part of the cycle. It is not the question of ”should you do it?” You must do it. The upper part of the cycle has a limited length. It depends on your mental and physical abilities, but even the people with the greatest abilities have their limits. Ninety minutes of full concentration is the natural limit. Then we need to have a break. It should be used for recovery This ninety minute cycle is called the Basic Rest-Activity Cycle (BRAC). People with greatest abilities need shorter breaks. Ability to recover faster is one of the clearest signs of an expert in any physical field. This works well with mental expertise too, but it is harder to notice.

The best way to recover is sleeping. You cannot always do that, but you should at least aim for it. Top performers sleep a lot. Especially, in any physical expertise like in sports. They need to sleep more to recover after their work outs. Most of the top performers in physical fields take naps and sleep longer hours than normal people. It is a necessity for them. Sleeping enough is good for you. Whether you are an expert in physical or mental field. It is one of the less well used tool for achieving better performance. Some other ways of recovering is getting your glucose level optimal by eating a correct amount of good nutrition and getting some fresh air during the day while doing some kind of exercise. Latter may not be possible, but the former is for everyone.

Planning your days by optimizing your daily cycles

This plan is for the people with normal daily cycles. Sleeping well and enough should be our top priorities. It is the best way to recover after yesterday´s loads. It is actually the only way. It boostsy our performance during the next day. You cannot be a top performer right after you have woken up. Your most productive hours are probably 2-4 hours after that. Before getting into the most productive hours, you should prepare yourself for top performance and you can also do some less important things, whatever they may be. You should use your most productive hours for the most important things. And you should have at least a small break or a lunch after ninety minutes of working with high intensity and focus. Then you can repeat the high intensity work for another 90 minutes.

Some people can still manage the high intensity work for a while after another break. For most people, the daily limit of productive high intensity work is only three hours. Most people do not really believe this and they think they can work longer with the same intensity and focus, but it is a lie people tell themselves. They can still work by doing the less important things, but the intensity won´t be the same. It is not so important what you do after working as long as it is not destroying the recovery period. The optimal way is to accelerate the recovery by exercising, relaxing and sleeping enough. Doing things that feel great is the best way after sleeping to recover from the working day´s efforts.

Sources:

Power of Full Engagement, Tony Schwartz
Be Excellent at Anything, Tony Schwartz

Principles, Ray Dalio

The Fourth Turning, William Strauss, Neil Howe

Take care,

-TT

Introduction to a latticework of mental models and the blog

”Knowledge is not the personal property of its discoverer, but the common property of all”

-Benjamin Franklin

I have been a fool for most of my life. I stumbled upon the mental models by accident. I was studying the best investors of all time. And I found Charlie Munger and his idea about the latticework of mental models by trying to find how to make better investments. I consider the best way to learn, is to study the all-time greats in their own fields and their ideas. Munger is one of them. It took me a while to understand the concept of the latticework, but I have found it useful in my life. 

Most of the scientific breakthroughs have been only mental models before their discoveries have been proven

A mental model is an idea of how something works in the real world. Most of the scientific breakthroughs have been only mental descriptions before they have been proven. These descriptions of the basic laws of the universe are, in essence, the laws of thinking. They are the basics of the past, present, and future. Mental models are the simplified versions of the laws of the universe. The laws of the universe are too complex to be explained with enough precision by using the exact laws.

You need to know all the big ideas from multiple disciplines like mathematics, chemistry, physics, engineering, psychology, and economics, and use them routinely. You need to have models from different disciplines because all the wisdom cannot be found from one academic department. You need to identify core principles from every department and understand them. And understand how they relate to each other. You cannot just remember isolated facts and think you know everything. You don´t have enough brainpower. You need to create a latticework of mental models to understand how things are connected. The best models are the most basic scientific principles like inertia in physics or combinations in mathematics.

The amount of useful mental models is around a hundred. You will probably need a lot a smaller amount of models most of the time. The amount of the most important models is between twenty and thirty. You don´t have to understand all the models deeply, but you need to understand how they work at the basic level. You also need to think out of the disciplinary boundaries. You can only be a good thinker by forgetting them and by applying different mental models in many disciplines. For example, the mental model of cycles can be used in mathematics, physics, economics, and even in enhancing productivity or learning new skills. This flexibility makes most of the big ideas so powerful.

Using a latticework of mental models is a skill

Using mental models and connecting them with each other is a skill. And like learning other skills you need time and lots of repetition to truly master it. You have to learn the right things, in the right way, in the right order, and at the right time. I have spent two years and I have just started. There are no short-cuts. You need a critical mass of understanding to use mental models with their fullest potential. Constructing a latticework of mental models is a complex skill. The latticework is constructed from smaller sets of subskills. Understanding a single mental model is one subskill.

Some models intertwine with each other. You need to understand these connections thoroughly. Some people are more talented in learning to apply mental models in their daily lives. Others may need a lot more effort and time than others. And in like other skills, if you did learn to do things in the wrong way, you have to unlearn everything. The younger you start the easier learning is because your brain hasn´t strengthened the wrong connections.

This skill-based, learn the right things, in the right order approach, is what separates me from the others who blog about mental models. My problem is that nobody has done this before. I will probably make some mistakes about in which order these models should be taught. People are also different, which means the order introducing mental models my way, will not apply to everybody.

You have your mental models and some kind of latticework(s) working all the time

Everybody has their own mental models. We have tens of models. For example, what you think will happen to your iPhone if you drop it, is a mental model. How you think you will react is another one. The combination of the models can be a small part of latticework or they can just be separate models without connection in your head. You have your own models and I have only one question for you: Why wouldn´t you want to have better ones? I will show you what those models are and how you can use them to your advantage. You have to understand that no amount of information will guarantee an understanding and no amount of understanding will guarantee wisdom to use it properly. Reading and understanding are not enough without the proper utilization of the models.

The optimal latticework consists of the most basic scientific principles and the detailed models in your perspective field.

The optimal latticework consists of the most basic scientific principles of the most important disciplines and their interaction, and those principles should be connected to the expertise of your own detailed knowledge in the area of your own discipline. These two latticeworks combined as a bigger latticework will make you a truly world-class performer in an intellectual field instead of a fool with a fancy title. What sets expert performers from everyone else is the quality and quantity of their mental models.

My purpose is to give you some tools for creating a better latticework of the general principles and help you utilize it better. Your responsibility is to connect it with your discipline. You have to understand that no amount of information will guarantee an understanding and no amount of understanding will guarantee the wisdom to use it properly. This chain is what I call the utilization of data, and it will be the first model I will introduce. I will deliver you the information and the knowledge I have and you have to do the rest.

The three main benefits of learning the latticework of mental models with purest scientific principles:

• You will get a better general education.
• You will learn how to be more efficient and more productive.
• You will need to gather less information to get better results. Mental models make it possible to process large amounts of information quickly and you will need less experiential understanding.

You need to understand many factors and use many models at the same time.

We are at the beginning of the era, in which we can apply the results of modeling through multiple models and factors more accurately than before. This is necessary because big things great people do are never the results of a single factor. They happen, because of the interaction of many factors from genes to upbringing, from education to the concentration of hormones between individual brain cells. Thinking through multiple models and many factors at the same time is necessary, but rare. I read at least one non-fiction book a week to make my understanding of the latticework better. Most of the authors of the books think the factor they are promoting is the only factor for something happening. This leads to an incomplete understanding of the big picture and worse results in what people are trying to accomplish. With a lack of synthesis, you will end up like a man who sees every problem as a nail, because the only tool he has is a hammer.

We need to analyze the big data to get more accurate results of the research in psychology. Most of the studies are, for example, still made by researching one or two psychological biases at the same time. In reality, most of the time, the number of factors is not enough and the results we get are not truthful enough. We need more resources and the big data will help. It will take some time, but in the end, we will get there.

I will start with the most important models and how individuals can use them

In this blog, I will start with the most basic and most important models. They are also the highest quality models. I will introduce one model per week. The rest of the time is reserved for discussion. I will try to keep the models as simple as possible. First, I will introduce the most important models separately and some of their interactions with each other. The amount of the most basic and the most important models is somewhere between twenty and thirty. These models will give you most of the information you need about the latticework. Then I may get further into details with them before going into the less important models. This order may change, depending on how things move on.

Everything will be seen from the viewpoint of an individual, but most of the models can be applied to a larger group of people or even to the big organizations. Later on, it may change. I have already written a book about personal finance in Finnish, in which I use the latticework of mental models in developing better ways of using money or understanding the economy. I may write a better book about those things in English later, but I have not made any decisions about it.

I will try to keep the number of models as small as possible. Sometimes this is not as simple as I would like it to be. Because of the interaction of the models. For example, consistency bias and status quo bias in psychology can be seen as inertia in physics. The names I use may vary with names the other mental model's bloggers or experts use. I will try to use the terms of the most basic disciplines like mathematics, physics, or chemistry. For example, I will use Inertia instead of status quo bias as I try to keep things as simple as possible. There is no need to use both. If you really understand the models, there is no need to complicate things by increasing the amount of them.

At least 90% of the things I publish will be free

All these blog posts will be free. Unfortunately, everything has an opportunity cost. You have to be willing to believe you get enough added value from reading my blog to justify the cost of using the most valuable commodity of yours, time. You will never get it back. Feel free to share all the information in this blog with all the people you think will get added value from it. I will probably publish some books about mental models and those will probably not be free. Books have a better user interface than a blogger, which I am using.

Do you consider yourself as a helpful person?

Could you give me some advice by answering two questions:

On a scale from 1 to 10, how useful is this information to you?

Why didn´t you give a lower number?

I hope you find this information useful and want to improve your mental models with me!

-TT