“If a man does not know to what port he is steering, no wind is favorable to him.”
— Seneca
Return on investment is the central concept of capital allocation. As investors, we seek to obtain the highest return on investment available within the constraints of our personal risk tolerance. This concept is most clear-cut in the case of a United States treasury security. We know with certainty how much capital we need to part with today in order to secure a return that can be calculated with mathematical precision, at least in nominal terms. Once we enter into other commitments, however, whether we are dealing with corporate bonds, equity securities, real estate, the corner gas station, an apartment building, or a farm, we are only estimating our ultimate return on investment.
The vicissitudes of life often intervene and ruin our best laid plans. On the bright side, good fortune can create Lollapalooza results beyond our wildest expectations. The COVID-19 pandemic of 2020 clearly illustrates the wide variations of possible outcomes in life. Very few things are certain.
The return on a monetary investment is important, but there is no resource more precious than the limited time we have available. How we choose to allocate our time should also be based on some estimate of the returns we expect to receive for the time commitment. This, of course, is not always a financial return. Human beings derive massive returns from time spent with family, friends, and various non-economic pursuits and most people usually choose to devote significant time to those areas.
Whatever our goals, we do not want to waste time because we do not have an unlimited supply of it. The temptation can be to focus our limited time toward a goal with very specific and defined expected returns, making ourselves narrow specialists. But doing so can often leave on the table potential rewards that are harder to predict or define ahead of time, and narrow specialization can make us more fragile to unexpected shocks. We need to develop a general toolkit that provides the optionality to benefit from things that may not yet exist, things that we cannot even begin to fathom let alone for which we can estimate a specific return on investment.
Shane Parrish, Founder of the Farnam Street website, is on a mission to help people “master the best of what other people have already figured out”. Farnam Street, which is named after the street where Berkshire’s Hathaway’s Omaha headquarters is located, has long been a favorite resource for investors as well as many others. But rather than providing stock write-ups or economic commentary, Parrish has focused on helping readers increase their “worldly wisdom”, as long advocated by Berkshire’s Vice Chairman Charlie Munger. Volume 1 of The Great Mental Models book series, reviewed on the Rational Walk earlier this year, covers a number of “general thinking concepts” while Volume 2, the subject of this article, covers concepts in the fields of physics, chemistry, and biology.
The Great Mental Model books are not textbooks in any traditional sense. Volume 2 outlines a number of basic scientific concepts but does not attempt to delve into the subjects beyond the depth needed to provide the general reader with enough context to understand how the mental model might apply more broadly. This has both positive and negative implications. On the positive side, the material is presented in a non-intimidating manner accessible to any intelligent and curious reader and quickly turns the focus toward applying the principle in often surprising contexts. On the negative side, if a reader is expecting an extended explanation of a subject like thermodynamics, they will not find it. However, the book contains numerous references for further reading and the curious reader can find a wealth of free information online, such as the Feynman lectures.
Although many of the mental models discussed in the latest volume, as well as the first, are interconnected in numerous ways, Parrish does not attempt to connect the ideas explicitly, instead encouraging readers to build their own “latticework” of mental models through their own experiences. It is not enough to know one or two models, as Charlie Munger often reminds us. One must know many models and use them regularly. Over time, connections will develop through use that can lead to exponential returns. However, unlike investing in a treasury security, we must take a bit of a leap of faith. Let’s take a look at a few of the mental models discussed in the book and how they might be useful in our day-to-day decision making.
Routines form an important part of the structure of daily life for most people because doing the same things at specified times removes the need to make numerous decisions about what to do next. Every explicit decision we make requires brain power and the cumulative effect can be draining. When we decide to exercise at six-thirty every morning, for example, we remove the need to make a daily decision about when a specific activity will take place.
The tendency of all living beings to minimize energy output is one of the mental models categorized under biology. Energy conservation in most species is a matter of survival. Needless expenditure of energy is wasteful and can result in a lack of energy when an opportunity or crisis emerges. However, for human beings living in a modern society, it is not necessary to expend constant physical energy to survive. Due to this reality as well as the consumption of ultra-processed foods available in abundance in rich countries, obesity has become a major health epidemic.
Beyond the realm of physical activity, humans also tend to minimize energy output on mental tasks, which is why routines can be so helpful. Additionally, the use of heuristics, or mental shortcuts, can allow us to respond to numerous situations on “auto-pilot” without devoting the mental cycles needed to make an actual decision. In cases where the stakes are low and the situation is predictable, heuristics are invaluable in navigating our day-to-day life. But when the stakes are high or the situation is novel, the use of heuristics is a form of laziness that can have catastrophic results.
Routines also help counter inertia. Newton’s first law of motion states that “an object at rest stays at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force.” Applied to our daily lives, we need to be aware of the fact that inertia implies that when we stop doing an activity, getting started again is much harder than it would have been to continue the activity continuously. Going running every day at six-thirty in the morning, as a matter of routine, is easier than doing so at random times because the decision has already been made in advance.
Habits are the result of routines. Inertia can be a force for good if we use it to establish good practices and avoid bad ones, and the tendency for a habit to remain intact once we get it started can counter tendencies toward laziness. The longer a habit exists, the more inertia it has to remain in motion on “auto-pilot” and the more difficult it will be to change. Being cognizant of this fact is very useful.
How often have we heard something along the lines of “what catalyst is needed to unlock value” in the share price of an undervalued stock? Is has become something of a cliché to see investor presentations concluding with a series of slides on potential catalysts to “unlock value”. So the concept of catalysis is hardly unknown, but the subtleties may often be misunderstood or overlooked.
The current environment, in the spring of 2020, offers many opportunities to observe catalysts in action. Due to the COVID-19 pandemic, large sectors of the economy have been shut down for some time and the resulting economic turmoil is acting as a catalyst accelerating changes that were either already underway or only in the early stages of formation. There are numerous examples, but the impact of COVID-19 on retail stores and office buildings has been dramatic.
Ever since the dot-com era of the late 1990s, futurists have been predicting that “bricks and mortar” stores would be going the way of the carrier pigeon into extinction. However, the process turned out to be a long-term secular trend rather than a dramatic reversal for traditional retailers. The rise of Amazon.com and other online stores put pressure on “bricks and mortar” and killed many weaker players, but did not cause extinction. Enter COVID-19. With physical storefronts shuttered, consumers flocked to online retailers to fulfill their needs. The pandemic was the catalyst that accelerated financial distress for companies such as J.C. Penney, which is on the verge of bankruptcy. Neiman Marcus, long a destination for wealthy consumers, was pushed into bankruptcy and is in the process of restructuring.
The trend toward telecommuting began two decades ago and technical capacity has long existed to perform most office jobs remotely. However, force of habit and the human need for interaction with other humans has resulted in the traditional office model continuing for most companies. COVID-19 acted as an immediate catalyst when it forced nearly all office workers to either telecommute or face unemployment. While sentiment regarding telecommuting varies widely depending on an individual’s personality and job responsibilities, the pandemic has proven that it is possible for many jobs to be done from home. The temptation for companies to save money on office space will grow and this has implications for owners of office buildings. Although most office leases are long term and the shift may be gradual, it is reasonable to believe that COVID-19 has acted as a catalyst in reducing the long term demand for office space.
Exaptation is a concept in evolutionary biology that refers to a feature of an organism that is used to perform a certain function but was not necessarily produced for that use by natural selection. One example provided in the book involves the feathers that are useful to facilitate flight in birds. Although feathers help birds to fly, they were originally adapted in dinosaurs through natural selection to provide warmth as well as to signal health and vitality to potential mates. At a later point, feathers became an integral structure repurposed for flight in birds.
The concept of exaptation is fascinating because it is distinct from the more commonly known concept of adaptation. What it implies, outside the field of evolutionary biology, is that we can use skills and knowledge that we have obtained for one purpose in order to facilitate activity in totally unrelated areas and in ways that we may not be able to predict at the outset.
There is a distinction in science between basic and applied research. Basic research, also known as fundamental research, is meant to advance human knowledge for its own sake, to expand the level of understanding that we have about the world around us. In contrast, applied research is intended to use the knowledge we have in order to solve specific problems. Clearly, there are incentives to conduct basic research because even though we do not know what we will find, we know that this knowledge will become the “raw materials” for subsequent applied research.
As Jon Gertner describes in The Idea Factory, Bell Labs was arguably the best laboratory for new and often unexpected ideas in the world for many decades during the twentieth century. When given the time, facilities, and funds to pursue basic knowledge, Bell Labs researchers were able to develop numerous new ideas for the benefit of AT&T and society in general. While Bell Labs clearly had a mandate to pursue fields that could be remotely related to human communication, they were allowed an indistinctness regarding specific goals and practical applications.
As Parrish notes, “sometimes things that have no apparent purpose at the outset can later be co-opted into use. Having to know the benefit of everything before you begin leads to missed opportunities.” Numerous commercial products such as bubble wrap, Play-Doh, and botox were originally developed for one purpose and then, through a process of exaptation, leveraged in entirely new and surprising ways.
Why should you devote your most precious asset, time, in order to read about mental models in fields like biology, chemistry, physics, and many more if you earn your living as an accountant, run a small business, or work as a middle manager in a large corporation? What is the return on the investment of your time?
The reality is that no one can answer that question. Investing time to build the mental models that will live inside your brain is a leap of faith. It is entirely possible that you could go down a rabbit hole into a field that has no possible applicability to your life or career, not now and not in the future. But does the subject interest you in and of itself? If so, the pursuit of that knowledge is not a waste. Nor can you predict whether that pursuit might not lead to something applied and tangible in the future, whether it happens in a week or in twenty years.
The power of mental models rarely exists in one isolated model. Instead, the benefits compound over long periods of time as you add more and more mental models to your arsenal. Over time, connections will develop between the models that can lead to insights that otherwise would never be available to you. But perhaps all of that is beside the point. Learning is fun and a good use of your time just for the sake of learning. Farnam Street’s website and book series make mental models accessible and interesting for any intelligent person who wants to expand their horizons.