Charlie Munger is one of the greatest investors of all time. How did he get there? Munger has offered a few clues; a key one is to build a latticework of mental models and essentially, become a learning machine.
I think we can all agree that Charlie Munger is an investor to learn from and emulate.
Aside from his fun and witty comments at the Berkshire Hathaway annual meetings, he also provides practical advice for investors looking to achieve the right temperament and knowledge base for sustained success.
A great book for learning all about Charlie Munger was written by Tren Griffin called Charlie Munger: The Complete Investor, and in it are summarized many of Munger’s great -isms and pieces of advice.
A great quote by Munger to get us in the ballpark to his keys to success:
“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 them 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”
Why does Munger believe so firmly about having worldly wisdom?
Munger has explained that many investors, macroeconomists, and people in the field attain training on a single model and try to use that on every problem they want to solve.
Like a man with a hammer who sees everything as a nail, this is a poor approach because every business is different, every industry is different, and so you must approach every investment slightly differently.
By having wide expertise among many domains, a latticework of mental models, one can increase their chances of limiting mistakes and identifying the truly great businesses—with the competitive moats that can continue to compound wealth over long periods of time.
So how does Charlie Munger suggest that we attain these mental models?
A few quotes by Munger, and a few about Munger, help clue us in. First he mentions a key to success in investing:
“I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading. I don’t think any one book will do it for you.”
He also says this about his daily habits:
“You’d be amazed at how much Warren reads – at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”
And, in regards to business reading:
“By regularly reading business newspaper and magazines I am exposed to an enormous amount of material at the micro level. I find that what I see going on there pretty much informs me about what’s happening at the macro level.”
Perhaps surprisingly, Charlie Munger spends most of his work-day building his mental models by doing this:
“Warren and I do more reading and thinking and less doing than most people in business. We do that because we like that kind of a life. But we’ve turned that quirk into a positive outcome for ourselves. We both insist on a lot of time being available almost every day to just sit and think. That is very uncommon in American business. We read and think.”
“The great example of Charles Darwin is he avoided confirmation bias. Darwin probably changed my life because I’m a biography nut, and when I found out the way he always paid extra attention to the disconfirming evidence and all these little psychological tricks. I also found out that he wasn’t very smart by the ordinary standards of human acuity, yet there he is buried in Westminster Abbey.”
Charlie Munger is known to have read hundreds of biographies, and he considers it a critical part of his worldly wisdom which was so effective at helping him make great investing decisions.
With all of these suggestions, we now have a big clue into how we, as average investors, can start to build our own mental models towards investing success. But putting this all together into a sort of mental model of its own, we can make a latticework of a mental model for creating our own mental models through our investing careers:
- Read a lot of annual reports like Charlie Munger and Warren Buffett.
- Read business publications like newspapers or magazines (today’s equivalent might be blogs and podcasts).
- Read many biographies in order to attain worldly wisdom to better understand the businesses we are analyzing.
Notice how none of these steps involve reading actual technical books about investing.
I found that early on my investing career that I spent much more time reading books about investing than I did analyzing businesses, and I feel that it was a mistake.
To be clear, you need to read the right foundational books to understand the basic principles of investing and personal finance success, but after that you need to start looking at the actual businesses and stocks themselves—and understand there’s no single formula that can help you analyze all of them well.
Instead, focus on building these mental models by acquiring wisdom on businesses and industries and applying those to the stocks you’re looking to invest in.
What’s the best approach to building mental models through reading?
I’ll tell you what’s worked very well for me personally, because I think it can apply for many investors looking to build a circle of competence and this type of worldly wisdom.
I made it a habit, even when I used to work full time as an engineer, to spend the first hour of my day investing in myself. In fact, Warren Buffett said this about Munger in an interview:
“Charlie, as a very young lawyer, was probably getting $20 an hour. He thought to himself, ‘Who’s my most valuable client?’ And he decided it was himself. So he decided to sell himself an hour each day. He did it early in the morning, working on these construction projects and real estate deals. Everybody should do this, be the client, and then work for other people, too, and sell yourself an hour a day.”
The way this has evolved for me today is by constantly doing the following:
- Find a business I’m interested in possibly investing in
- Read the 10-k (annual report) for that business
- Read the 10-k of a competitor in that same industry
- Build an industry map of all of the main competitors to that business. Search on Google for relevant blog articles, podcasts, or Youtube videos for more information
- Think about the true competitive advantage of these businesses
- Read biographies which can lend insight into this industry
- Stay immensely curious and follow the most interesting leads
I love the way that one of my business partners Dave Ahern talks about finding great investments—think of it like putting our Sherlock Holmes hat on like we are solving a mystery.
Because as you are developing new mental models, that’s exactly what you are doing.
And so, not one book or company’s annual report is going to build that mental model for you. You need to fill in the gaps of your competence, but you don’t know what you don’t know.
That’s why by exposing yourself to multiple sources of information—annual reports, business publications, and biographies—you build a latticework that fills in over time. You’ll start to connect the dots as you see parallels in industries or businesses; like a detective would when solving a case.
What biographies should an investor start reading?
I think the answer to this question is going to be different for everyone, and you should really hone in on your current passions and curiosities, and follow that rabbit hole.
Of course, you also want to find good potential investments, so make sure you’re checking the basic valuations of the businesses before you dive right in so that you’re increasing your chances of investing with a margin of safety.
I’ll share some of the best business biographies that I’ve stumbled upon during my path to building practical mental models for investment success, and why they worked so well in doing this for me.
How to build a mental model about distribution and the value chain of retail
I think the biography that really helped me see the light to the power of business biographies was the memoir from Phil Knight called Shoe Dog.
Phil Knight was the founder of Nike, and before it was a brand that was synonymous with athletic success it was actually a little shoe distribution business selling out of Knight’s parents’ garage and car.
Before reading this book, I never had a good understanding of how a basic consumer good, like a running shoe, went through the journey from manufacturer to customer.
I mean I knew the basics, like that it is probably manufactured in another country and imported to the U.S., but I didn’t know the important details and inter-workings within that particular journey. I don’t have an MBA, and had never come across it in my various jobs, so I didn’t know what I didn’t know.
But reading about Knight’s intimate journey of traveling to Japan to meet with a major shoe manufacturer, competing with other distributors in the United States, and eventually breaking that relationship to manufacture his own shoe gave me a good sense of that business.
It’s not solely about the manufacturer, or the distributor, or the retailer. And the power struggles and profit margins depend largely on many outside factors about those businesses and industries.
Seeing that firsthand, through Knight’s shoes, and seeing how a legal battle almost destroyed his company—really helps you build that mental model of retail and distribution and apply it to any retailer, distributor, or manufacturer that you’re looking to analyze.
How to build a mental model about technology disruptions and companies
As an example of how going down the rabbit hole and building a latticework of mental models isn’t a straight and linear path, I actually found great insights about technology leadership from two great books about the giant retailers Walmart and Amazon.
In Sam Walton: Made in America, the autobiography about the founder of Walmart, I learned how Walton was among the first people in his industry to rapidly adopt, and invest in, technology.
And it was this technology leadership which allowed his employees to drive extreme levels of inventory efficiency, which led to Walmart becoming the low cost leader in their space.
We also see the value in developing a proprietary fulfillment and supply chain process rather than outsourcing it, and how it can create serious long term competitive advantages.
In a similar light, the book about Amazon’s founder Jeff Bezos, called The Everything Store, showed just how aggressively Amazon fought to stay at the forefront of technology.
You see the struggles and failures that happened during Amazon’s path to greatness, and how they had to constantly stoke a culture of innovation and creativity—which eventually led to Amazon Prime, the Kindle, and their wildly profitable AWS (Amazon Web Services).
This book on Amazon led me to another fantastic book on technology called The Innovator’s Dilemma, which helped me further understand the disruptive nature of technology on a deeper level.
I’ll never look at technology companies the same after reading The Innovator’s Dilemma, and it was all because I took a mental model that I was interested in (retailing and distribution), and found other worldly wisdom about other types of businesses that I used to build a new mental model (on technology and innovation).
Final words about creating your own latticework of mental models
My point in this whole blog post is not to brag about my reading (though that is fun), but to show you how the path to building mental models is not linear.
And also, that it’s going to look different for everyone, because we are all looking at different businesses for potential investments, and that’s going to lead us down different rabbit holes.
But all of this knowledge builds on itself.
On a mental model I’m currently working to build, one about 3PLs (3rd Party Logistics providers), all of the lessons about the distribution supply chain from my previous mental model is helping immensely in decoding the relationships between all of these companies involved—from tech to software to transport.
You’ll only get there by continuously building on those mental models, and that’s how to truly understand the businesses you invest in.
I’ll let Charlie take it away because he said it best:
“Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day.”