Latest / The Dutch Investors / #92 | 3 Mental models for investors

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#92 | 3 Mental models for investors · The Dutch Investors

0:00
SPEAKER_00: Welcome back to another episode by the Dutch Investors Podcast, and I've got a great episode for you today.
0:06
SPEAKER_00: Part one of Mental Models for Investors was so well received that it deserved another episode.
0:12
SPEAKER_00: So today, part two of Mental Models, every investor should know.
0:17
SPEAKER_00: Because the quality of your thinking depends on the models that are inside your head.
0:22
SPEAKER_00: The solution to any problem becomes more apparent when you can view it through more than one lens.
0:28
SPEAKER_00: You'll be able to spot opportunities you couldn't see before, avoid costly mistakes that may be holding you back, and begin to make meaningful progress, whether that's in your investing career or life in general.
0:42
SPEAKER_00: Before we begin, I rarely ask it, but if you like the podcast, please support us by dropping a 5-star review or sharing the episode with a friend who might like this type of content.
0:53
SPEAKER_00: It's the single best and free way to help us grow.
0:57
SPEAKER_00: We want to reach as many passionate investors and people who want to learn a little more day by day.
1:03
SPEAKER_00: Thank you so much, and let's get into the episode.
1:15
SPEAKER_02: Could anyone do the same thing in the game?
1:19
SPEAKER_01: Are you done with it?
1:21
SPEAKER_01: Is it is it some early childhood explosion?
1:29
SPEAKER_02: And the second full investment is don't forget the first rule, and that's all the rules are up.
1:42
SPEAKER_02: What I needed to get ahead was to meet against idiots.
1:46
SPEAKER_02: And luckily there's a large supply.
2:00
SPEAKER_00: News, social media, charts, opinions, data.
2:05
SPEAKER_00: But it probably hurts more than it helps most people.
2:10
SPEAKER_00: So let's talk about three useful mental models, how they apply to the world of investing and in general, and how you can use them.
2:19
SPEAKER_00: And once you understand them, they'll quietly sit in the back of your mind, helping you spot problems faster, make smarter bets, and avoid shooting yourself in the foot.
2:30
SPEAKER_00: Let's start with the first mental model called First Principle Thinking.
2:35
SPEAKER_00: It starts with a very basic question.
2:38
SPEAKER_00: What do I actually know for sure?
2:42
SPEAKER_00: Richard Feynman, the American physicist who lived from 1918 to 1988, he said, and I quote, I don't know what's the matter with people.
2:52
SPEAKER_00: They don't learn by understanding, they learn by some other way, by road or something.
2:58
SPEAKER_00: Their knowledge is so fragile.
3:01
SPEAKER_00: Feynman was pointing out that most people don't actually understand what they know.
3:07
SPEAKER_00: Instead of breaking things down and thinking for themselves, they memorize facts, rules, explanations without really grasping the why behind them.
3:19
SPEAKER_00: That's why their knowledge is so fragile.
3:22
SPEAKER_00: Because when something changes or when the situation gets more complex, their surface level knowledge falls apart.
3:30
SPEAKER_00: They can't apply it anymore, they can't adapt it, or explain it in simple terms.
3:37
SPEAKER_00: First principle thinking is the opposite of that.
3:40
SPEAKER_00: It means breaking something down to its core and building your understanding from the ground up, not just going along with how everybody else is thinking and how everybody else is doing stuff.
3:52
SPEAKER_00: Feynman believed that if you can't explain something simply, you probably don't truly understand it.
3:59
SPEAKER_00: So rather than copying what others say or relying on assumptions, you should ask, what do I know for sure?
4:07
SPEAKER_00: What's just an opinion or habit?
4:09
SPEAKER_00: And what's the cleanest way to rebuild this idea from scratch?
4:14
SPEAKER_00: That's how you develop real understanding and durable knowledge.
4:18
SPEAKER_00: The idea of building knowledge from first principles has a long history in philosophy.
4:24
SPEAKER_00: In the Western tradition, it goes back to Plato and Socrates, with major contributions from Aristotle and Descartes.
4:32
SPEAKER_00: What they were all looking for was a kind of foundational knowledge, something that doesn't change, and it's something we can build everything else on, from our ethical systems to how we organize society.
4:47
SPEAKER_00: First principles aren't fixed checklists or truths.
4:51
SPEAKER_00: Our understanding of them evolves over time as we learn more.
4:56
SPEAKER_00: But they set the boundaries we have to work within in any given situation.
5:02
SPEAKER_00: If we don't learn to take things apart, if we don't test our assumptions, if we don't rebuild from the ground up, we risk getting stuck almost.
5:14
SPEAKER_00: We end up relying too much on what other people tell us, and staying trapped in how things have always been done.
5:22
SPEAKER_00: Alright, so I don't have any opinion on Elon Musk, and everybody can think what he wants on him, but there's a great story about Elon Musk that clearly captures the power of first principle thinking.
5:36
SPEAKER_00: It's not per se about Elon Musk, it's about the story behind it.
5:41
SPEAKER_00: Back when he was trying to build rockets for SpaceX, he realized just how insanely expensive they were.
5:48
SPEAKER_00: We're talking tens of millions of dollars for just a single launch.
5:54
SPEAKER_00: Most people would have just accepted that as the going rate.
5:58
SPEAKER_00: That's what rockets cost, right?
6:00
SPEAKER_00: So end of story.
6:02
SPEAKER_00: But Elon Musk didn't stop there.
6:05
SPEAKER_00: Instead, he asked a much simpler question.
6:09
SPEAKER_00: What are rockets actually made of?
6:13
SPEAKER_00: Well, it's actually quite simple if you break it down, and he did.
6:17
SPEAKER_00: It's aluminium, steel, copper, wiring, and a bunch of fairly basic raw materials.
6:25
SPEAKER_00: And when he added up the costs of those parts, it was just a tiny fraction of the total price.
6:32
SPEAKER_00: That was the moment he realized he didn't have to buy the rockets, he could just build them.
6:37
SPEAKER_00: And that's exactly what he did.
6:39
SPEAKER_00: That's the power of thinking from scratch.
6:42
SPEAKER_00: Instead of copying what's already been done, go back to the basics.
6:47
SPEAKER_00: You see this in investing all the time.
6:49
SPEAKER_00: People buy stocks just because someone else did.
6:52
SPEAKER_00: Maybe a newsletter mentioned it, or they saw a great pitch on X.
6:56
SPEAKER_00: They copied the idea and thesis without really thinking it through.
7:02
SPEAKER_00: But if you pause and ask the simple questions like, what does this business actually do?
7:07
SPEAKER_00: Or how does it make money?
7:08
SPEAKER_00: A lot of the time the story kinda falls apart.
7:12
SPEAKER_00: And the problem with that is when things get rough, when the stock drops or the story changes, you won't have any conviction.
7:20
SPEAKER_00: Because it wasn't really your idea to begin with.
7:23
SPEAKER_00: That's why bottom-up research matters.
7:26
SPEAKER_00: You need to do the research yourself.
7:29
SPEAKER_00: You need to build the thesis yourself.
7:32
SPEAKER_00: When in doubt, strip it back.
7:35
SPEAKER_00: Start with what's real, the business, the cash flows, the basic logic, and then reason your way forward from there.
7:44
SPEAKER_00: It's a pretty interesting mental model, if you ask me.
7:47
SPEAKER_00: So that was first principle order thinking.
7:51
SPEAKER_00: But as the name suggests, we also have second order thinking.
7:56
SPEAKER_00: First principles is about thinking from the ground up, second order thinking is about thinking a few steps ahead.
8:03
SPEAKER_00: Okay, so I might be saying the name totally wrong, but it's Barbara McClintock.
8:09
SPEAKER_00: She was an American scientist who was awarded the Nobel Prize in 1983 in psychology and medicine.
8:17
SPEAKER_00: She once said, and I quote, Technology is fine, but the scientists and the engineers only partially think through their problems.
8:25
SPEAKER_00: They solve certain aspects, but not the total, and as a consequence, it is slapping us back in the face very hard.
8:34
SPEAKER_00: What she's saying here is that solving a problem on the surface, the obvious immediate part, isn't enough.
8:42
SPEAKER_00: You also need to think a step further.
8:45
SPEAKER_00: What happens after we fix this thing?
8:49
SPEAKER_00: What are the unintended consequences?
8:52
SPEAKER_00: What chain reactions might this trigger?
8:56
SPEAKER_00: First order thinking is solving the problem right in front of you.
8:59
SPEAKER_00: Second order thinking is asking, and then what?
9:02
SPEAKER_00: What happens next, and what happens after that?
9:06
SPEAKER_00: It's the difference between patching a leak and actually figuring out why the pipe burst in the first place, and what fixing it might affect downstream, because you know, as an educator I like telling stories.
9:19
SPEAKER_00: In 48 BC, Cleopatra found herself in serious trouble.
9:25
SPEAKER_00: She was technically the co-ruler of Egypt with her younger brother, in a family where siblings had a habit of killing each other.
9:34
SPEAKER_00: She's been ousted from the palace, had little support, and her brother wanted her dead.
9:40
SPEAKER_00: At the same time, Julius Caesar had just arrived in Egypt.
9:45
SPEAKER_00: He was chasing his rival Pompeii, but Egypt, rich, fertile, and politically important, had his full attention.
9:55
SPEAKER_00: Cleopatra had a decision to make.
9:58
SPEAKER_00: She couldn't walk into the palace, so she famously had herself smuggled in, rolled up in a rug, and her goal was to align herself with Caesar.
10:09
SPEAKER_00: It was a very dangerous and bold move, and it didn't win her any popularity points.
10:16
SPEAKER_00: She triggered a civil war, she got trapped in the palace with Caesar under siege, and she had to constantly watch her back.
10:25
SPEAKER_00: She was playing the long game.
10:27
SPEAKER_00: She understood that short-term pain, chaos, conflict, risk, could be worth it if it led to long-term survival and power.
10:37
SPEAKER_00: And it worked.
10:38
SPEAKER_00: With Caesar's backing, she reclaimed her throne, removed her rivals, and ruled Egypt for many more years.
10:48
SPEAKER_00: That is second-order thinking in action.
10:51
SPEAKER_00: It's about choosing the pain that buys you a better future, in the case of Cleopatra.
10:57
SPEAKER_00: Almost everyone can anticipate the immediate results of their action.
11:01
SPEAKER_00: This type of first-order thinking is easy and safe, but it's also a way to ensure that you get the same results as everybody else.
11:10
SPEAKER_00: Second order thinking is thinking further ahead and thinking holistically.
11:17
SPEAKER_00: Very often the second level of effects is not considered until it's too late.
11:22
SPEAKER_00: This concept is often referred to as the law of unintended consequences for this reason.
11:30
SPEAKER_00: Second order effects even occur with something as simple as like adding traction on tires.
11:37
SPEAKER_00: It seems like such a great idea because the more you have, the more less likely you are to slide with your car.
11:45
SPEAKER_00: The faster you can stop, and thus the safer you are.
11:49
SPEAKER_00: However, the second-order effects are that your engine has to work harder to propel the car.
11:56
SPEAKER_00: You get worse gas mileage, and you leave more rubber particles on the road.
12:01
SPEAKER_00: You are going to have to deal with them anyway.
12:04
SPEAKER_00: The genie never gets back in the bottle.
12:07
SPEAKER_00: You can never delete consequences to arrive at the original starting conditions.
12:13
SPEAKER_00: In an example of second-order thinking deficiency, we have been feeding antibiotics to livestock for decades to make the meat safer and cheaper, and it worked.
12:24
SPEAKER_00: Only in recent years have we begun to realize that in doing so, we have helped create bacteria that we cannot defend against.
12:33
SPEAKER_00: Or let's take Trump's tariffs, especially the ones on Chinese goods or maybe even the European goods.
12:40
SPEAKER_00: At first glance, the logic actually does make sense, if you're thinking from a first principle perspective.
12:47
SPEAKER_00: The US imports a ton from China.
12:50
SPEAKER_00: China's been accused of unfair trade practices, intellectual property theft, and flooding the market with cheap goods.
12:59
SPEAKER_00: So step 1.
13:00
SPEAKER_00: Impose tariffs to make Chinese goods more expensive and protect the American industry.
13:06
SPEAKER_00: It sounds pretty logical.
13:09
SPEAKER_00: But that's where second order and third order thinking were either ignored or underestimated, or perhaps Trump doesn't even know.
13:18
SPEAKER_00: The basic idea made sense.
13:20
SPEAKER_00: We import too much from China, let's add tariffs protect American jobs.
13:26
SPEAKER_00: But then come the ripple effects.
13:28
SPEAKER_00: Prices went up for US businesses and consumers.
13:32
SPEAKER_00: China hit back with its own tariffs, hurting American farmers, and instead of bringing manufacturing back to the United States, companies just move operations to other low-cost countries, think of Vietnam or Mexico.
13:47
SPEAKER_00: And yes, you can also impose tariffs on them, but it's a cycle that just keeps repeating itself.
13:54
SPEAKER_00: So the end result is higher costs, global retaliation, more supply chain complexity, and no real long-term benefit or winner.
14:05
SPEAKER_00: It hurts everybody.
14:07
SPEAKER_00: It seems like Trump hasn't asked himself what happens next, and what happens after that.
14:13
SPEAKER_00: The policy will most likely backfire in many ways.
14:17
SPEAKER_00: I'm no expert, what do I know, but that's what I'm thinking.
14:21
SPEAKER_00: That's the difference between solving the service problem and actually understanding the system you're messing with.
14:27
SPEAKER_00: And you see the same thing in investing.
14:31
SPEAKER_00: A company announces layoffs, for example, say 10% of its workforce.
14:37
SPEAKER_00: The stock usually jumps after that.
14:40
SPEAKER_00: Because fewer employees means lower costs, which means higher profits for shareholders.
14:46
SPEAKER_00: But what's the second order effect?
14:48
SPEAKER_00: Perhaps the morale drops.
14:50
SPEAKER_00: People don't feel appreciated.
14:52
SPEAKER_00: Perhaps productivity takes a hit.
14:55
SPEAKER_00: Maybe top talent might walk out the door.
14:58
SPEAKER_00: That short-term boost of profits?
15:00
SPEAKER_00: It could turn into long-term damage if the business loses its edge or its culture.
15:06
SPEAKER_00: Again, first order thinking sees the savings.
15:09
SPEAKER_00: Second order thinking asks, what does this really cost us down the line?
15:14
SPEAKER_00: They think in consequences, not in events.
15:17
SPEAKER_00: It's not about being a psychic, it's just about slowing down and thinking things through.
15:23
SPEAKER_00: Warren Buffett used a very good metaphor once.
15:26
SPEAKER_00: He said, Once a few people decide to stand on their tiptoes, everyone has to stand on their tiptoes.
15:33
SPEAKER_00: No one can see better, but they're all worse off.
15:37
SPEAKER_00: Beautiful.
15:39
SPEAKER_00: Alright, let's talk about the last one, probabilistic thinking.
15:43
SPEAKER_00: And it's actually pretty simple.
15:46
SPEAKER_00: It's about embracing uncertainty and accepting that life is the great mental model Victoria explains it as, and I quote, Probabilistic thinking is essentially trying to estimate, using some tool of math and logic, the likelihood of any specific outcome coming to pass.
16:07
SPEAKER_00: For many, the world feels black or white.
16:10
SPEAKER_00: You either win the lottery or you don't.
16:13
SPEAKER_00: You either get hit by lightning or you don't.
16:17
SPEAKER_00: You either get hit by a meteorite or you don't.
16:20
SPEAKER_00: But the problem is that we just don't know until that moment arises.
16:26
SPEAKER_00: In a world where each moment is determined by an infinitely complex set of factors, probabilistic thinking helps us identify the most likely outcome.
16:37
SPEAKER_00: We all want to know what's going to happen next, but the truth is, we don't.
16:42
SPEAKER_00: Not exactly.
16:44
SPEAKER_00: So, instead of pretending we do, probabilistic thinking means asking, what are the chances of this going well?
16:52
SPEAKER_00: What's likely and what's unlikely?
16:55
SPEAKER_00: What's not?
16:56
SPEAKER_00: It's the difference between betting your house on a sure thing and saying, look, I think this investment has a 70% chance of doing well, and if it doesn't, here's what I lose.
17:07
SPEAKER_00: In other words, don't think in yes or no, think in odds, in bets.
17:12
SPEAKER_00: We know that the future is inherently unpredictable because not all variables can be known, and even the smallest error imaginable in our data very quickly throws off our predictions.
17:24
SPEAKER_00: The duration, along with the unpredictability of life, make valuing anything almost impossible.
17:32
SPEAKER_00: The best we can do is estimate the future by generating realistic useful probabilities, a range of outcomes.
17:42
SPEAKER_00: There are three concepts that can seriously help you how you think about risk and uncertainty.
17:48
SPEAKER_00: Bayesian thinking, fet-telt curves, and asymmetries.
17:54
SPEAKER_00: Alright, let's start with Bayesian thinking.
17:57
SPEAKER_00: Bayesian thinking is about constantly updating your view of the world as new information comes in.
18:04
SPEAKER_00: You start with what you already know, I like to call it your priors, and then just adjust those beliefs as fresh data appears.
18:13
SPEAKER_00: Imagine you're scrolling through the news on a Sunday morning, you have your coffee in your hand, and a headline jumps out to you.
18:21
SPEAKER_00: Stabbings double in the city.
18:24
SPEAKER_00: Okay, your stomach might tighten and you start thinking about your walk to the train station at night, or maybe the night runs to the store.
18:32
SPEAKER_00: Whether your neighborhood is still safe.
18:36
SPEAKER_00: And it sounds alarming because doubling feels huge.
18:40
SPEAKER_00: But if you take a moment to let it all sink and zoom out, you find out that last year the odds of being stabbed were 1 in 10,000.
18:50
SPEAKER_00: This year, it's 2 in 10,000.
18:53
SPEAKER_00: Yes, technically that's a double, but the absolute risk is still incredibly low.
19:00
SPEAKER_00: Violent crime has actually been falling for decades, and your city is safer today than it's been ever.
19:08
SPEAKER_00: That context, your prior knowledge, suddenly shifts your whole reaction.
19:14
SPEAKER_00: The story doesn't seem so scary anymore.
19:17
SPEAKER_00: This is Bayesian thinking in action.
19:19
SPEAKER_00: You don't ignore the new data, you simply placed it in a larger pattern of what you already know, and that's what helped you.
19:29
SPEAKER_00: Then we have fat-tailed curves.
19:32
SPEAKER_00: Most of us were taught to think in terms of bell curves, where the extremes are very rare, but the real world often runs on fat-tailed curves, where wild extreme events happen way more than you'd expect.
19:47
SPEAKER_00: Think about wealth.
19:49
SPEAKER_00: You'll never meet someone 10 times taller than the average person.
19:54
SPEAKER_00: But 10 times, 100 times, or a thousand times richer, that can happen.
20:00
SPEAKER_00: Or take terrorism versus slipping on the stairs.
20:03
SPEAKER_00: More people die from stairs, statistically, but terrorism lives in the fat tail, unpredictable, extreme and capable of massive impact.
20:14
SPEAKER_00: Planning for fat tails means preparing for rare, high impact events, not pretending they don't exist.
20:22
SPEAKER_00: In a fat tailed world, survival matters more than prediction.
20:27
SPEAKER_00: Lastly, asymmetries.
20:30
SPEAKER_00: Asymmetries show up when your estimates are more wrong in one direction than the other, and those wrong estimates hurt.
20:39
SPEAKER_00: Most investors wildly overestimate their odds of success.
20:43
SPEAKER_00: They aim for 20 or 40% returns and end up with 7-10%.
20:50
SPEAKER_00: Not because they didn't win, they did, but because they misjudged how often they'd lose.
20:57
SPEAKER_00: This is what Nassim Talep means when he says you're not just wrong, you're wrong by orders of magnitude.
21:04
SPEAKER_00: You thought something had a 1 in thousand chance of happening, but what if it's just 1 in 10?
21:11
SPEAKER_00: That's why Talep talks about being anti-fragile, setting yourself up not just to survive volatility, but to benefit from it.
21:21
SPEAKER_00: Instead of trying to predict rare events, you build systems that gain from chaos.
21:27
SPEAKER_00: You know who lives and breathes probability every single day?
21:32
SPEAKER_00: Insurance companies.
21:34
SPEAKER_00: They don't have a choice.
21:35
SPEAKER_00: They, if they get it wrong, they go broke.
21:38
SPEAKER_00: Now when we think of insurance, we usually picture the basics.
21:43
SPEAKER_00: Life insurance, car accidents, maybe a tree falling on your house during a storm, and they are pretty straightforward to model.
21:51
SPEAKER_00: There is lots of historical data, there's a large sample size, and it's easy to price.
21:57
SPEAKER_00: But the world of insurance goes way deeper.
21:59
SPEAKER_00: We're talking about policies on baseball players throwing arms, Victoria Secrets models legs, or even a country singer's breasts.
22:09
SPEAKER_00: Yes, really.
22:11
SPEAKER_00: So how do you put a price on that?
22:15
SPEAKER_00: Well, it all comes down to probability.
22:18
SPEAKER_00: Let's take the model's legs, for example.
22:21
SPEAKER_00: What are the odds she suffers a career-ending injury?
22:26
SPEAKER_00: One in 10,000, one in one hundred thousand.
22:30
SPEAKER_00: You can't predict it exactly, but you can estimate it well enough based on her lifestyle, health, history, and then phth you slap a price on it.
22:41
SPEAKER_00: And if you're right, more often than you're wrong, you make money.
22:46
SPEAKER_00: And that's what the insurance game is all about.
22:49
SPEAKER_00: It's not about saying yes or no to risk, it's about saying sure, but here's what it's cost.
22:56
SPEAKER_00: Sure, but here's what it'll cost.
22:58
SPEAKER_00: And that kind of thinking only works when you've got a good grip on probability.
23:03
SPEAKER_00: Successfully thinking in shades of probability means roughly identifying what matters, coming up with a sense of the odds, doing a check on your assumptions, and then making a decision.
23:16
SPEAKER_00: And that's that for part 2 of Mental Models every investor should know.
23:21
SPEAKER_00: At the end of the day, better thinking leads to better decisions, and that's what gives you an edge.
23:29
SPEAKER_00: If you got any value from this episode, please do us a favor, please share it with a friend who might enjoy it as well, and leave us a 5-star review by pressing on the three dots and then rate the show.
23:43
SPEAKER_00: It's the best way to support us and help us reach more curious long term investors like yourself.
23:49
SPEAKER_00: Thank you so much for listening.
23:51
SPEAKER_00: Until next time, stay curious, keep learning, and happy investing.