3 Mental Models That Will Keep You From Being Scammed

What is a Mental Model?

A Mental Model is an internal representation of an external reality. Mental models are the fundamental elements that make up a person’s worldview. It is the mental image that a person has of the object with which he is engaging.

Mental Models for Everyday Use:

1. Variable Reinforcement: A action is called reinforced response if it generates a reward. A person repeats an action if he/she gets a reward for same. If one receives a reward with unpredictable and irregular frequency his/her behaviour is reinforced even more strongly. This can be seen in gambling where the player has no idea when he/she is going to win. A horrific finding claims that many slot machine addicts wear adult diapers because they don’t want to get up even to answer the nature’s call. So the next time you notice an action with unpredictable reward make sure you think twice before you do it. Now you know why people still listen to the radio.
2. Contrast Tendency: Look around you and you’ll find that everything is relative. Humans cannot perceive things in absolute terms instead we must rely on something simpler. For example, we evaluate stimuli like temperature, loudness, brightness, health, status, or prices based on their contrast or difference from a reference point. Consider this experiment where a group of people was asked to choose between $6 cash and an elegant pen. Most choose the cash. Another group of people was asked to choose between $6 cash, the elegant pen, or an inferior pen. Most choose the elegant pen. By adding an inferior option, a decoy, which nobody chooses, people are subtly nudged towards the option which can be compared to the inferior choice. The story isn’t much different when we end up buying that overpriced leather accessory merely because the price is so low compared to our concurrent purchase of an expensive car.
3. Loss Aversion: Let’s try a thought experiment: Which of the following would have a greater impact on you: A profit of $50 or a loss of $50. Usually, it’s the latter. Humans are more afraid of loss than of prospective gain. Persuasion experts (salespeople and marketing professionals) know it very well that the easiest way to convince people is to take their focus on what they might gain if they don’t use the promoted service/product. Now you know what to do when you hear the relationship manager from your bank tells you, “You will miss a 3X return if you don’t invest in our new scheme.” Don’t panic and use this mental model. We can motivate ourselves to adopt good habits by focusing on the information emphasizing the possible negative consequences (loss of good health, longevity) of not performing certain activities.

This is part 1 of a two-part series; in the next part, we’ll look at different mental models.

As a reference, we used the wonderful book “Mental Models, Investing, and You” by Vishal Khandelwal and Anshul Khare.