Mingle with Powerful Models: Using Mental Models to Make Better Decisions

French Clock

Photo by slack12

Charlie Munger likes to say that 80-90 mental models will give you the bulk of the material you need to be a “worldly-wise” person.  Part of being worldly-wise is making good decisions, and although Charlie mentions 95 models in his book (by my count), they can each be used and combined for different purposes.

So, how do we combine them to create the ideal decision-making process?  Since I’m in love with the number 7 (figuratively), I’ve put together what I consider the seven most useful mental models in decision-making.  Good decision-making will involve an understanding of Statistics, Economics, and Psychology.  And the decision-making process becomes much easier if you take mental models from these disciplines and put them into a checklist.  To me, the following seven mental models are the best checklist available. 

  1. Opportunity Cost: Look for and gather together all of the alternative decisions that can be made. Deciding to do nothing is a decision, and should be included as well.  In fact, it’s often helpful to identify the alternative questions you could be asking before identifying what alternative decisions you can make.
  2. Cost-Benefit Analysis: As Max Bazerman says in Judgment in Managerial Decision-Making, “Unless the decision is very important, a simple and effective strategy is to use expected value as the basis for decision-making.” The expected value of a decision weighs the benefits that will arise from it against the costs that will be incurred from it.  Of course, these costs and benefits aren’t always explicit.  Often they’re intangible, but if a decision is important, intangible aspects should be explored as well.  This is where, under the scientific method, you would be developing a tentative hypothesis.
  3. Probability Theory: A lot of the time, it’s not realistic to research a decision to sufficiently obtain all the facts.  This means you’ll often be working with uncertainty.  And statisticians have a way of dealing with uncertainty called the theory of probability.  And so should you.  Assign a likelihood to each potential outcome, and weight that outcome appropriately.
  4. Disconfirmation: Humans (and I mean all of us) have this way of seeking out what they want to find.  This can be dangerous.  To balance this out, constantly ask yourself how you could possibly be wrong in each aspect of your decision-making process.
  5. Higher Order Effects: Decisions aren’t made in isolation.  There will be ramifications.  Work through how these higher order effects will impact each decision you are considering.  What are the consequences of the consequences?
  6. Feedback Loops: Very few people are likely to have enough information or knowledge to be consistently right the first time.  If you can agree that this is true, you must build feedback mechanisms into the decision-making process.  This way, when you’re wrong, you’ll know.  Besides, you can always make a new decision later (when more information is available).
  7. Cognitive Misjudgment: I have no idea what percent of human decision-making is emotional, but it has to be high.  Over 50% wouldn’t surprise me.  Because all humans are subject to making emotional decisions, you must check to make sure that your decisions aren’t being hijacked by the cognitive biases that haunt all of us.

This is really just an extrapolation of the scientific method.  The scientific method starts with a fact, and then suggests a hypothesis as the plausible cause for the existence of this fact; it’s the disspassionate development and testing of theories about how the world works.  And the sequential checklist of mental models listed above is no different.  If anything, it’s more instructive.

So if you were to put the decision-making process into a systematic process much like the scientific method, it would look like the checklist above.  Of course, aspects of these mental models aren’t truly measurable, which lessens the scientific aspect of it, but they do take into account the occassionally irrational nature of people.  And so, this checklist should serve you quite well.