Are you making financial decisions with System 1 or System 2?
Mitchell Barr, Client Associate
When I wake up in the morning I mosey over to the coffee maker and turn it on before hopping in the shower. I comb my hair, brush my teeth, grab my coffee, and then I’m off to work. This morning on the way to work an object was on the road. I had to either swerve around it or drive over it. In a split second my brain made the decision to run it over. By the time I arrive to work on a typical day I’ve completed dozens of tasks with minimal mental effort. My brain has been on autopilot. This autopilot setting is the default for our brains because it requires less energy. Conscious thinking is a different setting that requires your brain to consume more glucose, which is why you will feel tired if you’re thinking critically for long enough. Researchers have dubbed these two settings “System 1” and “System 2” (creative, I know)1. I’m going to refer to System 1 as the monkey and System 2 as a rational human being.
The monkey runs on instinct, intuition, and habit. When I dodge an object in my car, the decision to swerve has already been made before I consciously comprehend the identity of the object. We make most of our daily decisions and actions using the monkey part of our brain. You don’t have to consciously tell yourself to breathe or blink or even answer the phone. Autopilot takes care of all of that. You would be constantly exhausted if it didn’t.
The monkey is located in the oldest parts of the brain that were used for survival. It triggers the classic fight or flight mechanism when we are in danger. And like a monkey, System 1 is hedonistic and shortsighted when making decisions. The rational human, or System 2, is located in the newer parts of the brain, specifically the massive frontal lobe that requires us to have large foreheads. We have to consciously fire up this system when we need its services, especially when making financial decisions.
The interaction between the two systems in our brains is at the crux of almost all behavioral biases and heuristics, but there’s a question as to how well we can control when to use each system. The monkey is the default and acts much quicker than our conscious rational mind. By the time I realized the object in the road on my drive to work was a plastic bag, my brain already made the decision to drive over it. Not a big deal, but this reflex has a larger effect on more important decisions. One study found that judges give more lenient sentences to criminal offenders right after eating lunch2. It takes more energy to examine evidence and reduce a sentence than it does to accept the default sentence. This finding suggests that a little shot of glucose during lunch allowed the judges to exert more mental strain and engage System 2 (rational human) in order to better examine the cases. Not only that, if the monkey is in control many of our decisions may be predetermined without any conscious thinking!
Similar to deciding someone’s fate in the court system, when you’re contemplating a new investment idea or business opportunity you don’t want the monkey making the decision. In order to use critical thinking and make rational decisions with our conscious minds, we have to take care of our brain and be aware of autopilot. Here are a few best practices to make sure you are making a thoughtful decision:
Sleep on investment advice
The monkey makes decisions quickly, but may not consider all of the facts. Take a day to make sure the rational part of your brain has time to deliberate and make a conscious decision. The venture capital fund that your Uncle Vito told you about will still be there tomorrow.
Get a quick nutrition fix
As I mentioned, the brain runs on glucose. You’ll be able to exert more brain power after lunch or a quick snack. (However, that doesn’t mean you should pig out at Cheesecake Factory so that you are in a food coma.)
Bounce ideas off a friend or advisor
We are often blind to our own biases. By discussing a financial decision with someone else, they may be able to spot when you are acting irrationally when you can’t.
- Kahneman, D. (2015). Thinking, fast and slow. New York: Farrar, Straus and Giroux
- Danziger, S., Levav, J., & Avnaim-Pesso, L. (2011). Extraneous factors in judicial decisions. Proceedings of the National Academy of Sciences, 108(17), 6889-6892.
Mitch writes the popular blog, The Money Monkey, where he focuses on common mental mistakes made by investors, how to avoid being your own worst financial enemy, and thinking about investing in new ways.