Mental Models

Latticework of Mental Models: Lindy Effect

“Many happy returns of the day Anshul!” One of my old friend wished me on WhatsApp. Dropping a message on WhatsApp is more convenient these days than calling up. It was still better than the standard birthday wishes you get on Facebook, which you know have come as a result of constant pestering from Facebook notifications – “Hey! It’s Anshul’s birthday today. Write something on his wall.”

“Thanks man. I am glad you remember.” I replied. I still didn’t believe that he actually remembered my birthday. May be Facebook sent him a customized birthday wish to be forwarded to me from WhatsApp. After all Facebook now owns WhatsApp.

“You know what? You just wasted another premium of your life insurance!” He joked.

“Well, that’s an interesting way to look at it. But I am glad that it was wasted. After all life is perishable and can end at any moment – insured or uninsured.” I told him with a smiley.

But that got me thinking about insurance (especially term insurance) and life. On one hand, every additional year I live on, the insurance premium seems to go waste. But on the other, as I grow older, since my life insurance premium remains fixed, I get more and more value for each rupee spent on insurance. How?

For anything that’s perishable, including human life, every additional day in its life translates into a shorter additional life expectancy. Isn’t it?

Latticework of Mental Models: Cognitive Dissonance

I am sure many of you have heard the famous Aesop’s fable about the fox and the grapes. If not, here’s a quick recap of the story.

A fox sees some high-hanging grapes and wishes to eat them. When it is unable to think of a way to reach them, it decides that the grapes are not worth eating. The fox then justifies that the grapes are not ripe or they are sour (hence the common phrase ‘sour grapes’).

Every time I hear this story, I laugh at the delusional fox. However, I rarely imagine that a similar fox is inside me also. The fable is a classic illustration of what psychologists call Cognitive Dissonance.

Behavioural scientists define cognitive dissonance as the feeling of mental discomfort or tension produced by the combined presence of two thoughts, ideas, beliefs, attitudes, or opinions that are psychologically inconsistent. The greater the discomfort, the greater the desire to reduce the dissonance of the two cognitive elements. Dissonance theory suggests that if individuals act in ways that contradict their beliefs, then they typically will change their beliefs to align with their actions.

In case of Aesop’s fox, an inconsistency arose when the fox set out to do something and failed to accomplish it. He could resolve this conflict in one of three ways: (a) by somehow getting at the grapes, (b) by admitting that his skills are insufficient, or (c) by reinterpreting what happened retrospectively. The last option is an example of cognitive dissonance, or, rather, its resolution.

The cognitive dissonance theory was developed in 1957 by Leon Festinger, who observed in a series of experiments that people would change their attitudes to make them more consistent with actions they had just taken. Cognitive dissonance is one of many behavioural biases that evolution has wired into the human brain.

Latticework of Mental Models: Economies of Scale

“Do we have flexible working hours here?” That was the first question I asked when I joined my first job in IT industry.

“Yes. As long as you get your 40 hours in at the end of every week.” Informed my new boss.

That was a great deal considering the previous 9-hours-6-day job I had in a manufacturing industry. Forty-hour week was even better than the schedule I had during my school days.

In India the culture of forty-hour week became more popular with growth of IT industry. Have you ever wondered how this idea of forty-hour week came to be?

The credit for our 8-hour-5-day work week goes to an unsuspecting guy called Henry Ford, the founder of Ford Motor Company.

Until 1900 most industries used to have 100-hour work weeks. But in 1914, Ford Motor Company took the radical step of cutting the work-shift duration to eight hours. This was an unconventional move in those times but when this change saw an increase in Ford’s productivity, other companies followed suit and soon the 8-hour-day became the norm.

But the question is, how did the productivity increase with reduction in work hours?

Latticework of Mental Models: Bayes Theorem

A statistics professor who travels a lot was concerned about the possibility of a bomb onboard his plane. He determined the probability of this and found it to be low but not low enough for him. So now he always travels with a bomb in his suitcase. He reasons that the probability of two bombs being onboard would be infinitesimal.

Do you think he has really reduced the risk?

Even those who aren’t well versed with the basic concepts of probability can say that the professor’s logic seems absurd.

Well, the bomb riddle is a famous joke among mathematicians. Nevertheless, it’s a thought provoking joke.

So to help you think about the riddle, let’s explore another related thought experiment.

A man wakes up in the middle of the night with a splitting headache. He remembers that there are few aspirin bottles in the bathroom. He dizzily stumbles into his bathroom to grab one of the four bottles in the dark and pops a pill from that bottle. An hour later, instead of getting relief from headache, he starts feeling a terrible nausea. Suddenly he realizes that only three of the four bottles in the bathroom contained aspirin and the fourth bottle contained poison.

Latticework of Mental Models: Winner’s Curse

Consider this thought experiment –

A friend of yours is the Chairman of the Acme Oil Company. He occasionally calls with a problem and asks your advice. This time the problem is about bidding in an auction. It seems another oil company has gone into bankruptcy and is forced to sell off some of the land it has acquired for future oil exploration. There is one plot Acme is interested. Until recently, it was expected that only three firms would bid for the plot, and Acme intended to bid $10 million. Now they have learned that seven more firms are bidding, bringing the total to ten. The question is, should Acme increase or decrease its bid? What advice would you give?

Do you advise bidding more or less?

If you’re like me and seeing this case study for the first time you’d probably go with a higher bid. After all, there are additional bidders, and if you don’t bid more you won’t get this land. Isn’t it?

Latticework of Mental Models: Pari-mutuel System

You don’t win by predicting the future; you win by getting the odds right. You can be right about the future and still not make any money. ~ Will Bonner

The way to win in stock market, according to Charlie Munger, is to work, work, work, work and hope to have a few insights.

Now, the question is – how many insights do you need in your investing lifetime?

Not many, as Munger says…

…you don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it. And that’s with a very brilliant man—Warren’s a lot more able than I am and very disciplined—devoting his lifetime to it. I don’t mean to say that he’s only had ten insights. I’m just saying, that most of the money came from ten insights.

So you can get very remarkable investment results if you think more like a winning pari-mutuel player. Just think of it as a heavy odds against game full of craziness with an occasional mispriced something or other. And you’re probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It’s just that simple.

Munger uses horse racing’s Pari-mutuel betting system as one of his mental models to make sense of stock market investing. He is asking us to think like a Pari-mutuel player and look for the mispriced bets.

So what’s a Pari-mutuel system and how does one find a mispriced bet in such a system?

Latticework of Mental Models: Loser’s Game

In the hope of executing an impressive smash, I again sent the ball flying away from the table. Losing yet another game of table tennis to Navin, a good friend and a colleague in my previous job. It was probably 50th consecutive loss since I started playing TT with Navin.

“It isn’t that I am an extraordinary player,” explained Navin, “I just focus on returning the ball back on your side. Your unforced errors are just too many so you continue to lose.”

The idea of unforced error didn’t make much sense to me at that time. And the streak of losses continued for another few months until our employer decided to remove the TT facility from the office. They reasoned that some employees were spending more time on TT table than their workstation. I wonder who those employees were. 😉

It took another few years for the idea of ‘unforced errors’ to sink in properly. It happened when I learned about a concept called – Loser’s Game.

Latticework of Mental Models: The Two Systems of Thinking

“What’s 2 + 2?”

You can’t help but think of the answer instantly. Your mind throws the number “4” on your thought screen. It’s actually impossible to not think of the answer here, unless you haven’t learnt to count to ten.

The answer is almost like a reflex. It was an instance of fast thinking. In fact, you don’t even need to consciously think about it. It just happens to you. This is the result of what scientists call reflexive brain.

Now if I ask you, “What’s 38 multiplied by 27?”

For most of you, except if you’re a math wizard, your brain goes blank. It doesn’t give you any instant answer. You’ll have to take a pause and calculate the answer with some efforts, and if you’re like me you won’t be able to do it without pen and paper. Here you have to involve a part of your brain which is known as the reflective brain. You experience a slow mode of thinking as you proceed through a sequence of steps to solve this multiplication problem.

Reflexive brain is quick and it tends to jump to conclusion. Reflective brain is much slower, requires effort, it’s logical and, as we’ll see later, less prone to error.

Daniel Kahneman, a nobel laureate who is also known as the founding father of modern behavioural economics, in his book Thinking Fast and Slow, has termed these two modes of thinking as System 1 (reflexive) and System 2 (reflective).

Latticework of Mental Models: Active Reading

The summer season is here and irrespective of the fluctuations in the market temperature, the real mercury is rising everyday. In this sweltering heat, one of the things that brings an instant smile on my face is when I think about how I spent my summer holidays when I was a kid.

This thought sends me down the memory lanes of all those good old days when I played with friends all day, watched favourite cartoon programs on TV, and forgot all about school and homework.

My summer holidays were jam packed with activities like playing carrom, card games, checkers, chess, monopoly, cricket, and most of all – reading comics. I loved reading comic books. By the time I reached 8th standard, I had amassed a collection of more than 300 comic books. I even ran a small library which unfortunately had to be closed down after 10 days of operation.

The lesson learnt – kids like borrowing comics but don’t like returning them. 🙂

Anyways, when I look back at my childhood days, I realize that reading comics was one of the most pleasurable activity. I am sure many of you can relate to me.

When I entered college, those 30 page comic books were replaced by 500 page novels. But one thing remained unchanged about my reading habit. Most of my reading was for pleasure. Except of course college text books which I passionately disliked. For that matter, whenever I read anything which had a potential to challenge my cognitive resources, I forgot most of it by next evening. That explains my belief about studying for exams just a day before.

However, as I started working, my interest increased in the area of personal development, investing and personal finance, I found myself picking business and investing related books every now and then. But my years of poor reading habits – reading only for pleasure – had become a serious roadblock to derive any meaningful benefit out of these new kind of books.

Latticework of Mental Models: Checklist

Few months back, I was visiting a friend in the hospital. He was getting discharged after a minor surgery. While helping him pack his stuff I casually flipped through his discharge summary papers. Most of the medical jargon in the file didn’t make much sense to me but one particular thing caught my attention.

Under details of surgery, the last line read – “Mops/instrument counts were correct”. The first thought that came to mind was – are these guys so concerned about their instruments (and even cotton mops) that they count it after the operation? Many of those instruments are anyway disposable and can’t be used again. So what’s the big deal about counting them?

Later I came to know that counting all the instruments and mops is part of their protocol. It’s to make sure that they haven’t left any items inside the body of the person being operated. It was an important step in their written ‘list of things to check’. Made sense.

Hundred of people die every day because of unavoidable blunders (like leaving an instrument inside the patient’s body) by surgeons.

In US alone the number of deaths following surgery is 75,000 per year which is more than the number of road accident fatalities. And these are the cases which are avoidable because they emanate from human errors. The failure rate is disproportionately high and can’t be ignored.

But medicine has become a field of extreme complexity. And not just medicine but many other fields have grown so far beyond the usual kind that avoiding daily mistakes is proving impossible even for our most super-specialized.

So how do you approach this problem? This is the question that intrigued Dr. Atul Gawande, professor of medical surgery in Harvard Medical School, and his quest to find the solution ended at a totally unrelated place. The aviation industry.