12 Ways to Apply Munger’s Inversion Technique in Financial Services

We need new mental models to deal with the increased level of Complexity, Uncertainty, and the web of interconnectedness between the advanced technologies and the socioeconomic trends shaping the 4IR. A combination of tested mental models and new thinking is the way forward.

Let’s take Charlie Munger’s Inversion Technique, a mental model that involves looking at problems from the opposite perspective and how they could be used to improve financial services.

Charlie Munger popularized this technique which suggests approaching problems in reverse to uncover hidden risks and avoid potential pitfalls. This versatile mental framework is not only applicable to risk mitigation which is core in financial services. It also applies to innovation, experimentation, and business expansion. It can also be used in the decision-making process of financial services providers exploring ecosystem expansions that blur the lines with other services.

What is Munger’s Inversion Technique?

According to Munger’s Inversion Technique instead of asking, “How can I achieve success?” you ask, “What can I do to ensure failure?” By identifying and avoiding actions that lead to failure, you can more effectively navigate toward success.

Inversion Matters in Financial Services

The digitalization of financial services — Fintech umbrella term — is all about continuously improving Customer experience by making data-driven decisions.

The Munger inversion technique can be applied in three core aspects of financial services (independent of whether licensed banks, non-banks, or BigTech deliver them):

- Identifying and mitigating risks: By thinking about what could go wrong, you can develop strategies to prevent those scenarios.

- Enhancing innovation: Avoiding actions that stifle innovation can create a more conducive environment for creative solutions.

- Improving User experience: By understanding what frustrates users, you can design more user-friendly products.

Examples of Applying Inversion in different areas of Financial services

1. Fraud Detection Systems

Forward Thinking: How can we prevent fraud?

- Inversion: What could allow fraudulent activities to go undetected?

- Avoidance Strategy: Implement advanced AI algorithms that continuously learn from new data to detect patterns and anomalies indicative of fraud. Ensure real-time monitoring and quick response mechanisms

2. Regulatory Compliance

Forward Thinking: How can we ensure compliance with regulations?

- Inversion: What could lead to regulatory breaches?

- Avoidance Strategy: Implement AI systems to continuously monitor compliance with regulatory requirements. Use predictive analytics to anticipate changes in regulations and adapt accordingly.

3. Enhancing Innovation

Forward Thinking: How can we foster innovation?

- Inversion: What actions would stifle innovation?

- Avoidance Strategy: Reduce bureaucratic hurdles by streamlining processes to encourage creative thinking and encourage a culture of experimentation by allowing trial and error without fear of repercussions.

4. AI-Powered Credit Scoring

Forward Thinking: How can we improve credit scoring accuracy?

- Inversion: What could lead to inaccurate credit scores?

- Avoidance Strategy: Ensure diverse and comprehensive data sets are used to train AI models, avoiding biases that could lead to unfair credit scoring. Regularly update and validate algorithms to maintain accuracy and fairness.

5. Peer-to-Peer Lending Platforms

- Inversion: What could lead to high default rates on loans?

- Avoidance Strategy: Implement rigorous credit scoring and risk assessment protocols to ensure only creditworthy borrowers are approved. Regularly update and re-access the effectiveness of the algorithms used to determine creditworthiness and also to adapt to changing macro-economic conditions (especially tricky with LLM-powered credit scoring algorithms).

6. Cryptocurrency Exchanges

- Inversion: What could cause a security breach leading to loss of funds?

- Avoidance Strategy: Invest in advanced cybersecurity measures, such as multi-signature wallets, two-factor authentication, and regular security audits. Educate users on best security practices to prevent phishing attacks.

7. Robo-Advisors

- Inversion: What could lead to user distrust in automated financial advice?

- Avoidance Strategy: Maintain transparency in algorithms and decision-making processes. Regularly update and test algorithms to ensure accuracy and reliability. Provide users with educational resources to understand how robo-advisors work.

8. Predictive Analytics for Market Trends

Forward Thinking: How can we anticipate market trends?

- Inversion: What could lead to inaccurate predictions?

- Avoidance Strategy: Use comprehensive and high-quality data sets for training predictive models. Continuously update models with new data to improve the accuracy and relevance of predictions.

9. Improving User Experience

Forward Thinking: How can we improve user satisfaction?

- Inversion: What frustrates our users?

- Avoidance Strategy: By understanding user frustrations, financial services providers can simplify user interfaces and provide timely, excellent customer support.

10. Customer Sentiment Analysis

Forward Thinking: How can we better gauge customer satisfaction?

Inversion: What could lead to misinterpretation of customer sentiment?

- Avoidance Strategy: Use advanced sentiment analysis tools and regularly validate their accuracy. Use high-quality, comprehensive data sets and regularly update predictive models to avoid inaccuracies.

11. AI-Enhanced Customer Service

Forward Thinking: How can we improve customer service?

- Inversion: What could frustrate customers?

- Avoidance Strategy: Implement AI-powered chatbots to handle routine inquiries efficiently, freeing up human agents to tackle more complex issues. Ensure chatbots are capable of providing accurate and personalized responses.

12. Virtual Assistants

Forward Thinking: How can we enhance virtual assistant accuracy?

Inversion: What could cause virtual assistants to provide inaccurate responses?

- Avoidance Strategy: Implement rigorous testing and continuous learning protocols to keep virtual assistants accurate and up-to-date.

Conclusion

Munger’s Inversion Technique is a powerful mental framework that can complement other mental models used in decision-making as our world is in continuous flux.

In the rapidly evolving landscape of financial services, where complexity and uncertainty are ever-present, adopting new mental models is essential. Get started by ensuring you already use several different mental models in your business to gain experience, insights, and know-how from these diverse, tested approaches.

I`ve written before about 6 Thinking Hats: A framework for AI advancements using Edward de Bono’s Six Thinking Hats model thinking. Another popular technique is the First Principles Thinking which allows business people to break down complex problems into their fundamental elements.

Embracing a diverse set of mental models enriches decision-making at all levels — business, ecosystem, and customer level.

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`Thinking Like an AI-Native` is one of the chapters that I have co-authored with Hari Abburi

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