Mental models are thinking tools that help us understand life, make decisions and solve problems.
Learning a new mental model is a key to seeing the world differently.
There are thousands of mental models but as with most things there are generally a handful that can really be phenomenally transformative, and these are the three that I think are game changers when it comes to money (and also life!)
First Model: Regret minimisation framework
Model: Project yourself into the future and assess what your future self would be missing out on or regretting based on the decision you are currently facing.
This mental model was used by Jeff Bezos when he faced the decision between giving up a lucrative Wall Street career or starting an online bookstore. In deciding Jeff apparently said he asked himself the question; “Will I regret not doing this when I’m 80” and the vision of not having tried spurred him to create the behemoth we now know as Amazon.
This is relevant when it comes to our money and being faced with the daily choices of spending on some shiny new thing now or investing for the future.
Would our 60 year old self care about those must have Louboutins we just had to have, or would they be happier with that juicy nest egg our investing created that lets them live their dream life ?
Second Model: Compounding
Model: This model looks at the process leading to an exponential increase in value over time. The simple formula to this is:
PV * (1+I)n = FV
PV: Present Value
I: Interest rate
n: number of periods (time)
FV: Future Value
This simply says the value you hold now increases exponentially based on the time you give it and the rate of interest you apply to it.
The formula applies to all areas of life, our money, our relationships and our knowledge.
As a starting point we need a present value. For money, this means an amount, big or small, to start investing with. In relationships, the starting point is a basis for trust and in knowledge, a willingness to learn.
Secondly, we need to give time, and this speaks to creating the habits of regularly investing our money over time, spending time with our loved ones and scheduling time to build our knowledge.
Lastly, the interest we apply over time is the fuel to the equation. As regards investing this means maximising the returns we can earn, through choosing low cost, well diversified investments as a starting point. In relationships, by being present with those important to us and with knowledge, studying the things that interest us with a high level of curiosity and diligence.
Third Model: Confirmation Bias
Model: What we notice and look for confirms our beliefs rather than contradicts them
There are countless biases we have adopted around money that are limiting us and our finances.
Money is too difficult.
I don’t have enough to invest.
I’m bad with numbers.
I’ll make mistakes.
Understanding that we operate under this behavioural limitation, is a powerful start to building a healthy financial picture because this is the point at which we can start to uncover our beliefs around money and challenge them.
Read, research, question and most importantly take action.