How to Become a Better Investor, Best Investment Tips 2023
Hello friends, When it comes to investing, psychology plays a bigger role than skill and knowledge. Nowadays everyone wants to be a better investor like Warren Buffet. Today we are going to talk about 5 mental models that can help you become a better investor. By understanding these points given below, you can become a better investor.
What is the meaning of the mental model?
A mental model is simply a representation of how something works. If we take investing, we can take the help of mental models to simplify our investing process. If you haven't invested ever, then things might be complicated and difficult for you.
You will feel as if you cannot keep all of
the details of investing ideas. So, you should use mental models to simplify
the complex which can be helpful for beginners as well. Even legendary
investors like Warren Buffett & Charlie Munger used mental models while
investing. So today we will tell you about the top 5 mental models for you. Best Stock Market Tips for Intraday and Long-term.
Circle of Competence
First is the Circle of Competence. Investing is all about knowing what you know and what you don’t know. In the circle of competence, we try to search for industries where we have better knowledge than other investors. We also check for sectors and industries which are not in our circle of competence.
Let's understand it with an example. If you have worked in the
IT industry and understand its works, You must be knowing facts that many investors must not be aware of. This will help you make better decisions and catch better opportunities. This is an advantage for you to select better companies. If you do not understand the steel industry, it is advisable to stay away from
steel stocks. So this was the first mental model.
First Principles Thinking
The second is First Principles Thinking. First Principles Thinking helps to clarify complicated problems with the underlying ideas or facts. Here we target the business' fundamental label. If you know the first principles of something, you can build the rest of your knowledge around them to produce something new. A First-Principles Approach helps in understanding the whys of a business.
If you think that FMCG businesses are overvalued and
one should not invest now, an investor following the first principles should
break it down to simpler variables. Like- What is a business model for an FMCG?
How predictable is the demand for their products? How confident are you that
their cash flows 10 years later would be significantly higher? Do you think
people will stop using FMCG products during the slowdown? If you are asked,
given all these conditions, what do you think about the current valuations of
the FMCG stocks? Will your answer remain the same? So, we should apply the
first principle of thinking in investing to make better decisions.
Second-order Thinking
Now let's talk about the third mental model. The third is Second-order Thinking. Almost every investor can anticipate the immediate results of their decisions. But to be a successful investor, you not only need to know what is going to happen now or next week. But also what is going to happen after four to six quarters.
Let’s understand by an example. If due to
Covid and lockdown-related restrictions, you are getting a good stock at a very
attractive valuation, the first-order reaction would have been to wait for
certainty and clarity. If you are a second-order thinker, you would understand
the attractive opportunity is because of uncertainty. When the situation
becomes better, the valuation will catch up and leave very little room to
invest. So you should use second-order thinking in investing.
Probabilistic Thinking
Forth is Probabilistic Thinking. In investing there are many choices with us. We select a few options from them. Few options can give us a profit and few can give loss too. We make mistakes and as investors, it's not necessary to make all correct decisions. But we can analyze the decisions probabilistically i.e, the probability of getting the decisions right.
For
example, if any business is going to be bankrupt and the share price goes down
significantly, it is easy to think that the price has discounted all the
negatives. But few may think of it as a correct choice. But during this also,
we should have a probabilistic view. Say, 100 companies reach that stage of
close to bankruptcy, how many of them eventually survive? It is less than 10
most of the time. Would you bet on one such company just because the price has fallen?
Then it would not be a wise decision. So while investing, we can have a
probabilistic view to make decisions.
Inversion
The last is Inversion. Legendary investor Joel Greenblatt says this: "My largest positions aren’t the ones I think I’m going to make the most money from. My largest positions are the ones where I don’t think I’m going to lose money". Whether he will profit or not is not important but it shouldn't give loss. This quote helps us to learn the meaning of inversion. The word inversion comes from “invert,” which means upside down.
It means approaching a situation from the opposite end of the natural starting point. Most of us tend to think one way about a problem: forward. Inversion allows us to flip the problem around and think backward. So, as an investor, rather than finding multibagger stocks, you should identify stocks that will destroy your wealth. With this, such stocks reduce in our portfolio and our wealth grows.
So these were the top 5 mental models you should be looking
at in investing. Let us know in the comments which mental model you liked the
best. Also, comment if you follow any of these mental models while investing. Thanks for coming on Happiest Post.
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