Too often in life, I come across crippling cases of people thinking in very simple terms, going through life auto-piloted to first level thinking. Howard Marks, the legendary junk bond investor, talks about first level thinking and second level thinking in his book The Most Important Thing: Uncommon Sense for the Thoughtful Investor. Too many people seem to lack the mental models necessary to interpret reality. Wait. Let me back up: what are mental models? I tend to get in the habit of reading benders, getting totally intoxicated and consumed with binging on my neverending pile of books, reports, and articles. Coming back from the 2015 Berkshire Hathaway annual meeting, I finally got my hands on Poor Charlie’s Almanack and a few other Munger books (Seeking Wisdom and Damn Right). While not the originator of any of the 100 or so major ideas spanning multiple disciplines, Charlie Munger synthesized the importance of a multi-discipline approach to life by becoming fluent in these major ideas, or mental models, and hanging these mental models in a latticework in his mind in order to avoid the man with a hammer syndrome. What is the man with a hammer syndrome?
To a man with a hammer, the world is a nail. It’s a problem associated with Howard Marks’ idea of first level thinking. Munger explains:
It’s like the old saying, “To the man with only a hammer, every problem looks like a nail.” And of course, that’s the way the chiropractor goes about practicing medicine. But that’s a perfectly disastrous way to think and a perfectly disastrous way to operate in the world. So you’ve got to have multiple models. And the models have to come from multiple disciplines—because all the wisdom of the world is not to be found in one little academic department. That’s why poetry professors, by and large, are so unwise in a worldly sense. They don’t have enough models in their heads. So you’ve got to have models across a fair array of disciplines.
An example might hammer home the idea. Imagine a doctor. Scratch that: imagine a surgeon who specializes in gall bladders. And now, imagine that this surgeon has spent all of his or her academic and professional career completely focused on the gall bladder. It might start to become tempting to think that, because “hey I know so much about gall bladders,” that you start to associate health problems to the gall bladder. Think that’s preposterous? Munger cites the case of such a surgeon who removed bushel baskets of gall bladders from patients for no rational medical reason because he had convinced himself that the gall bladder was the heart of all medical evil.
So why do we want to avoid being the man with the hammer? Simply put, in order to be wiser and to see the world as clearly as possible. Munger states in his speech on Elementary Worldly Wisdom in Poor Charlie’s Almanack:
What is elementary, worldly wisdom? Well, the first rule is that you can’t really know anything if you just remember isolated facts and try and bang ’em back. If the facts don’t hang together on a latticework of theory, you don’t have them in a usable form. You’ve got to have models in your head. And you’ve got to array your experience—both vicarious and direct—on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You’ve got to hang experience on a latticework of models in your head.
And you need multiple mental models because:
What are the models? Well, the first rule is that you’ve got to have multiple models—because if you just have one or two that you’re using, the nature of human psychology is such that you’ll torture reality so that it fits your models, or at least you’ll think it does.
Without a multi-disciplinary approach to life, you’ll have tunnel vision and get creamed. You’ll forever occupy the realm of first level thinking. And that is not somewhere you want to be stuck.
The other day at work, I was talking to a co-worker and the conversation went a little something like this:
Co-worker: “I remember shopping for my first house in 1967 and the house I was looking at cost $14,000. I never ended up buying the place but recently saw that it was for sale. I looked into what the selling price was and it was $400,000! That would have been such a great investment – I should have bought the house all those years ago.”
Me: “Well, actually, since you mention the word investment, we need to look at two things: inflation and opportunity cost. Using the Bank of Canada Inflation Calculator, we can see that inflation ran on average 4.15% every year over the 48 years from 1967 to 2015. $14,000 growing to $400,000 over 48 years implies a compound average growth rate (CAGR) of 7.23%. Taking inflation into account, that means you saw a real, net CAGR of 3.08% on your investment. Now, we need to take opportunity cost into account…”
Me: “Now, instead of buying this house as an investment, you could have put $14,000 into the stock market. To keep it simple, let’s assume you bought a S&P 500 index fund with rock bottom fees (which is hypothetical because it didn’t exist at the time). That $14,000 would have compounded at 10.34% on average over those 48 years and you would have around $1.5 million today. After taking inflation into account, you saw your investment grow at about 6% compounded every year.”
Co-worker: “I think I’m following….”
Me: “So you can see that you could have ended up with almost 4 times more wealth if you didn’t buy the house as an investment.”
Co-worker: “But it’s so much nicer not to think about it that way.”
Me: (Mental facepalm, in exasperation at the cognitive dissonance).
This was literally the conversation and I could not believe the closing line from my co-worker.
When you don’t use multiple, multiple mental models to analyze reality, this is the kind of thinking you are susceptible to fall into – you will be plagued with first level thinking. You will go through life making sub-optimal choices and end up wondering why things turn out so… mediocrely.
This is the importance of Charlie Munger’s concept of constructing a latticework of mental models.