Applying Munger’s mental-model to financial planning – ValueWalk Premium

Applying Munger’s mental-model to financial planning

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Q3 2019 hedge fund letters, conferences and more

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If one were to participate in one of my company’s meeting, they would most likely hear a conversation surrounding Charlie Munger’s concept of mental models. Munger believes one should study and understand the fundamentals of multiple core subjects, such as math and physics. Fundamentally understanding those subjects develops new mental models to solve an array of problems. Let’s take Munger’s mental-model concept and applying it to financial planning, and how there should be a theory of relatively for wealth.

In the early 1900s, Albert Einstein stunned the physics world with his theory of relativity. He developed two core theories: the special and general theories of relativity. Einstein theorized there was no fixed frame of reference in the universe, and everything moves relative to everything else. One of the famous thought experiments to help explain such a concept is the story of two twins. One twin stays here on Earth while the other gets into a rocket ship that travels close to the speed of light. Each has a watch and times how long it will take for the twin in the rocket to come back to Earth from their travels. Because the twin traveling is moving close to the speed of light when they return, the time it took them to travel millions of miles may have only been a few days, while the lapse of time for the twin on Earth may have been multiple years. Time was relative to the rate at which the twin was traveling.

Relativity can be directly related to wealth. The conversation surrounding wealth is misunderstood. When someone asks us what it takes to be wealthy, we respond, “Do you want to be rich or wealthy? Because these concepts are vastly different.” Rich is absolute – to be rich, one must have a large amount of money. But wealth is a relative term – to be wealthy, one doesn’t necessarily need a large amount of money; it is relative to their lifestyle.

Calling someone rich or wealthy causes a different reaction. Rich comes across as flashy and affluent; it is the person driving the nice sports car with a mansion on the lake. Wealthy conveys a less aggressive tone; it is the person you would never suspect or know had money. Even though the two words can be interchangeable, they perpetuate a different feeling. Wealth encompasses a feeling of sustainability. Wealth is a relative term as sustainability has a different meaning depending on the household.

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