What if a Grand Slam Were Worth 100 Home Runs? — Mental Models in Investing

I am a big fan of mental models.

Charlie Munger, Warren Buffett’s older, smarter but poorer investment partner, has long focused on the importance of mental models.

Munger says he’s rich because he identified a set of human psychological biases and applied them to investing. You can listen to the speech “The Psychology of Human Misjudgement” by Munger at Harvard University in which he describes his favorite mental models.

By definition, these mental models are what I have called the “Critically Counterintuitive.” Thanks to the newfound popularity of behavioral finance, many of these models are much better known than when Munger made his speech in 1995.

These mental models include the “Pareto principle” or the 80/20 Rule; Robert Cialdini’s “levers of influence” discussed in his classic work Influence; as well as the Nobel Prize-winning work of Princeton’s Daniel Kahneman, as discussed in his 2011 best seller Thinking, Fast and Slow.

A Mental Model for Angel Investing

Today, I rarely come across new mental models.

I did find a compelling one in Jason Calacanis’ new book: Angel: How to Invest in Technology Startups — Timeless Advice from an Angel Investor Who Turned $100,000 into $100,000,000.

Jason Calacanis is one of Silicon Valley’s leading angel investors. Since starting about six years ago, Calacanis has invested in more “Unicorns” — start-ups that have achieved a valuation of $1 billion dollars — than anyone else in Silicon Valley.

There is a standard textbook definition of the distribution of returns that angel investors and venture capitalists can expect to make.

The model is as follows:

Make 10 investments. One or two of them will tank.

Six or seven will join the ranks of the “living dead” — stumbling around until the companies fold or sell themselves.

One or two investments will cover the losses in the others.

So far, so good.

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