We have, in effect, two forms of thinking: fast and slow.
Fast thinking involves tapping into our experience, our habits, or our understanding of processes or things familiar to us. When we think quickly, we can often do other things simultaneously.
Slow thinking involves reasoning, mathematics or statistics. This takes longer and requires our full attention.
Our fast thinking works fine for most things, most of the time. A good portion of our lives functions through well-practiced habits. But most of the biases and mistakes that can get us into trouble – financially or otherwise – come from using our fast thinking in situations where slow thinking is called for.
Nobel Prize winner Daniel Kahneman and his colleague Amos Tversky made their careers by identifying and understanding these types of mistakes. In Kahneman’s book Thinking, Fast and Slow, he describes these mistakes in wonderful detail.
Let’s play with this, so you can experience the difference directly. Start by solving this question quickly…
A bat and a ball together cost $1.10. The bat costs $1 more than the ball. How much does the ball cost?
This is the kind of question that requires a little more thought. Therefore we must engage our slow thinking. Yet most people answer this quickly… and initially get it wrong.
Go back and think through that same question slowly before reading on.
Now, when people do this quickly, they usually say that the bat costs $1 and the ball costs $0.10. But if that were the case, then the bat would cost only $0.90 more than the ball.
If you said the ball costs $0.05, you’re correct.
Of course, not all math questions require slow thinking. Fast thinking is generally acceptable for something like 2+2.
That’s something you know by rote memory. Seeing 2+2 is identical to seeing the number 4. And you can easily solve it while carrying on a conversation.
But can you quickly answer 17×28?
Unless you’re an exceptional math whiz, that one requires more careful calculation.
Here’s where we can run into trouble…
We don’t like to stop what we’re doing. Slowing down to think more carefully about things takes energy and time.
In short, our minds are lazy. But lazy for a good reason…
Our brains use a tremendous amount of our metabolic energy. So it’s natural for us to conserve that energy rather than spend it on unnecessary tasks.
We are much more comfortable using our fast thinking. It’s easier and comes naturally. It doesn’t require extra energy we might need for other things. And there’s a flow to it, so it feels good.
That’s why we rely on our fast thinking in situations that require slow thinking.
When faced with a difficult question that requires our slow thinking, we often – without noticing it – replace that hard question with a much easier one.
That way our fast thinking can answer in a jiffy.
It feels like we’ve answered the question we’ve been asked. But since we answered the wrong question, we likely came up with the wrong answer.
For example, we may be asked, “How well do you expect this investment to perform over the next year?”
That type of question requires homework and calculations. So we’re likely to replace it with an easier question, like “How do you feel about this investment?”
You can see how that can lead to trouble.
Maybe your feelings about a stock happen to line up with the performance of the investment. But that’s really a matter of luck.
This is often what happens when we make investment decisions based on emotions. And while it may save some metabolic energy in our brains, it can cost us a lot of money in the financial world.
Whenever we look primarily for information that confirms our existing beliefs; whenever we hold on to an investment for too long; whenever we keep doing what’s familiar with our money but hasn’t actually worked very well for us; whenever we don’t sell a bad investment because we know it’s going to turn around any minute…
All of these are examples of mistakes we make by using our fast thinking when we would be better served by using our slow thinking.
Over the next several months, I’ll be taking a closer look at these kinds of thinking mistakes.
To put it bluntly, the more mastery you can gain over these, the more you’ll be able to deliberately apply your slow thinking where it’s needed. And the more that strategy of thinking becomes part of your decisions, the more money you can make and the less money you can lose.