#3 Sanjay Bakshi: Why Mental Models
Shane Parrish interviews Sanjay Bakshi, a renowned finance professor and successful investor, about the power of mental models, multidisciplinary thinking, and reading. They discuss his approach to investing, using Kindle, and creating an environment conducive to better decision-making.
Deep Dive Analysis
15 Topic Outline
Kindle vs. Physical Books for Learning
Sanjay Bakshi's Reading and Note-Taking Process
Teaching Multidisciplinary Thinking and Asking 'Why'
Applying Multidisciplinary Thinking Beyond Investing
Evolution of Sanjay's Investment Philosophy
Impact of Mental Models on Daily Life
Berkshire Hathaway's Long-Term Business Approach
Creating an Environment for Rational Decision-Making
Filtering Noise and Focusing on Durable Competitive Advantage
Analyzing Different Types of Business Moats
Costco's Admirable Business Model and Advantages
Acquiring and Naming New Mental Models
Balancing Checklists for Error Reduction with Creativity
Different Entrepreneurial Styles: Data-Driven vs. Intuitive
Most Influential Book and Current Reads
6 Key Concepts
Multidisciplinary Mindset
This approach involves examining problems from various perspectives, drawing insights from different academic fields like economics and psychology. It helps in asking fundamental 'why' questions and discovering multiple, comprehensive answers beyond initial assumptions.
'Part of the Reason' Approach
A mental strategy to counteract cognitive biases like the availability heuristic and first conclusion bias. By beginning answers to complex questions with 'part of the reason is this,' one remains open-minded and actively seeks out additional contributing factors, acknowledging the inherent complexity of situations.
Shutdown Point (Economic vs. Real-World)
Economically, this is the point where a business should cease operations. However, real-world scenarios often show businesses continuing past this point due to psychological factors, such as the belief that competitors will fail first, or external financial backing, illustrating how human behavior can override pure economic rationality.
Risk-Averse vs. Loss-Averse
Risk-averse individuals or companies avoid taking chances in general, while loss-averse ones specifically fear incurring any losses, even minor ones. Successful innovators and investors, like Warren Buffett, are often risk-averse in managing overall exposure but not loss-averse, allowing them to make numerous small, potentially high-reward bets without jeopardizing the entire enterprise.
Boiling Frog Syndrome (Low Contrast Effect)
This mental model describes how gradual, slow changes often go unnoticed, akin to the myth of a frog in slowly heating water. In business analysis, it suggests that examining data with significant time gaps (e.g., 5, 10, or 20 years) helps reveal substantial shifts in competitive advantage that might be overlooked in frequent, short-term reports.
Deprival Super Reaction (Loss Aversion)
Charlie Munger's term for the psychological tendency where people react much more intensely to losing something they possess or expect to possess than to gaining something of equivalent value. This powerful human misjudgment highlights the disproportionate impact of perceived loss on decision-making.
9 Questions Answered
Kindle offers easy searching across an entire library, leading to serendipitous discoveries, and automatically syncs underlined passages and notes to the cloud, which is highly beneficial for professors and for later reference.
An effective way is to consistently ask 'why' when evaluating situations and to begin answers with 'part of the reason is this,' which promotes open-mindedness and the exploration of multiple explanations from diverse fields.
He began with Graham-style value investing in 1994, later discovered Warren Buffett, and in 2004, encountered Charlie Munger's ideas on multidisciplinary thinking and behavioral psychology, which profoundly reshaped his teaching and investment philosophy.
Sanjay suggests eliminating distractions like television and frequently checking stock prices. The ideal is a physical space free of electronics and disturbances, dedicated solely to focused thought.
Investors should disregard short-term fluctuations like quarterly results and instead concentrate on the long-term durability of a business's competitive advantage (its 'moat') and its capacity for growth, as strong moats are not easily eroded.
A low-cost provider model is often more sustainable because it minimizes waste, leverages scale, and allows benefits to be passed on to customers, fostering strong loyalty, as exemplified by Costco.
Costco achieves high returns on capital by offering low prices due to scale and fewer product choices, passing these benefits to customers (building loyalty and trust), and paying employees well, all supported by upfront membership fees.
New models emerge when recurring questions are answered in ways that challenge prior understandings, leading to a deeper comprehension of the world. Naming these models descriptively (e.g., 'boiling frog syndrome') aids in their recall and application.
While checklists are vital for minimizing errors in critical operations, creativity necessitates a willingness to experiment and make mistakes. The balance lies in being risk-averse (managing overall risk) but not loss-averse (willing to make small, potentially high-reward bets that won't harm the company).
16 Actionable Insights
1. Ask ‘Why’ Multiple Times
When evaluating something or trying to answer a complex question, consistently ask ‘why’ and look for answers from multiple disciplines. This approach helps uncover multiple reasons and second/third-order effects, leading to a more comprehensive understanding.
2. Start Answers with ‘Part’
When answering a complex ‘why’ question, begin your response with the phrase ‘part of the reason is this…’. This mental trick helps remove the ‘availability heuristic’ or ‘first conclusion bias’ by keeping you uncommitted to a single answer and open to exploring other contributing factors.
3. Prioritize Financial Independence
Strive for financial independence as a primary goal in your life. Once financially independent, you can view the world more objectively and think with a longer-term perspective, free from short-term pressures.
4. Eliminate Environmental Distractions
Actively remove distractions from your physical environment, such as giving up television or removing stock price bookmarks from your browser. This creates a more peaceful state, reduces noise, and allows for greater focus on important matters, leading to better decision-making.
5. Focus on Moat Durability
When analyzing a business, prioritize understanding its durable competitive advantage (moat) and its ability to scale, rather than focusing on short-term quarterly results. Moats are not eroded quickly, making quarterly results largely insignificant; focusing on long-term durability helps filter out noise and identify truly valuable businesses.
6. Favor Low-Cost Provider Moats
When evaluating business models, consider a low-cost provider advantage as a highly sustainable and admirable moat. This model often leads to less wastage, benefits consumers through lower prices, fosters customer loyalty, and can still generate high returns on capital while paying employees well.
7. Be a Learning Machine
Identify and admire entrepreneurs who operate as ’learning machines’ by making many small, experimental bets that, even if they fail, will not impair the company. This approach, combined with financial discipline (e.g., low or zero debt), allows for innovation and creativity without significant aggregate risk.
8. Balance Creativity & Error Reduction
Understand that while frameworks like checklists are excellent for reducing error in big decisions, creativity and innovation require a willingness to experiment and make mistakes. Both are necessary; you need the ability to generate unique insights (creativity) and the ability to minimize mistakes (error reduction).
9. Read Multiple Books Concurrently
Read multiple books (e.g., three or four) concurrently from different disciplines. This prevents boredom with a single subject, fosters a multidisciplinary mindset, and helps you associate ideas across different fields.
10. Reread Influential Books Annually
Reread highly influential books, such as ‘Poor Charlie’s Almanac,’ multiple times a year (e.g., three times). Each reread offers new insights, helps connect the material to new experiences, and enhances your thinking.
11. Name Your Mental Models
When identifying a useful mental model or concept, give it a descriptive name (e.g., ‘boiling frog syndrome,’ ‘deprival super reaction’). This helps with quick recall and retrieval of the model when evaluating situations, making it very helpful for organizing thoughts.
12. Analyze Change Over Long Periods
When analyzing a business, examine its data over long periods (e.g., 20, 15, 10, 5 years ago, and today) rather than focusing on short-term quarterly results. This helps overcome the ’low contrast effect’ or ‘boiling frog syndrome’ by making slow, significant changes in competitive advantage more apparent.
13. Read Books on Kindle
Read books on a Kindle rather than physical copies. This allows for searching across your entire library, serendipitous discovery, and easy syncing of underlined text and notes to the cloud for later use, while also being environmentally friendly and reducing eye strain compared to computer monitors.
14. Kindle Note-Taking Workflow
While reading a Kindle book, underline important passages and take notes on the fly; after finishing, extract all underlined text and notes to a separate document (e.g., in Evernote). This serves as a ‘second reading’ of the most impactful parts and helps in recalling information later.
15. Use ‘The Brain’ Software
Utilize ‘The Brain’ software to organize and connect your thoughts, emails, sound files, and documents. It replicates how the human brain works by creating new associations between different kinds of thoughts, acting as an ’external brain’.
16. Long-Term Business Ownership
If in a position to do so (e.g., as a long-term owner with structural advantages), avoid selling off underperforming businesses quickly. This approach, exemplified by Berkshire Hathaway, builds a reputation as a ’natural partner’ for business owners, creating a significant reputational advantage over decades.
7 Key Quotes
If you just do a search for a term across all your books in your Kindle library, it comes up in a flash. And the interesting thing is that you sometimes discover things that you didn't know existed.
Sanjay Bakshi
Whenever there is a complex question, which I'm trying to answer, I always start with the words, part of the reason is this, and which means that there must be other parts too.
Sanjay Bakshi
Most of economics is based on the idea that human beings are rational, but most of social psychology actually tells you that we are quite dumb. Very often we make, uh, very foolish mistakes.
Sanjay Bakshi
The first thing that they need to get is financial independence. Once they have that, then they can look at the world the way it really is and they can perhaps think much longer term.
Sanjay Bakshi
If you are focused on investing in a business, which you think has a durable competitive advantage, then quarterly results are going to be almost insignificant.
Sanjay Bakshi
Creativity is connecting things that other people haven't connected before. And if it works, you're a genius. And if it doesn't, you're basically in the madhouse, because people think you're crazy.
Sanjay Bakshi
Poor Charlie's Almanac... it never stops influencing me every time I pick it up if I read it it it gives me something more to think about.
Sanjay Bakshi
2 Protocols
Sanjay Bakshi's Reading and Note-Taking Process
Sanjay Bakshi- Read about three or four books simultaneously from different disciplines to avoid boredom and foster interdisciplinary connections.
- Underline important passages and write notes directly on the Kindle while reading.
- Once a book is finished, access the underlined text and notes synced to the cloud.
- Copy and paste these annotations into a separate document (or a master document/Evernote/The Brain).
- Allow the insights to reside in memory, then retrieve them when experiencing real-world situations that relate to the read material.
Sanjay Bakshi's Business Analysis Approach (Boiling Frog Syndrome Application)
Sanjay Bakshi- To understand competitive advantage and its evolution, analyze a business's data from 20 years ago.
- Then, look at data from 15 years ago.
- Next, examine data from 10 years ago.
- Review data from 5 years ago.
- Finally, compare with current data.
- This method helps to notice significant changes over time that might be missed by focusing on short-term (e.g., quarterly) information, revealing whether competitive advantage is increasing or decreasing.