Today we’re going to begin with a short story. In this story, there are 3 main characters. One of them is the problem, while the other two give advice to try to solve that problem.
(These characters come from Kahneman’s Thinking Fast and Slow)
Next, we’ll discuss when we are most vulnerable as investors, and why our evolution may have set us up for failure. Then, we’ll learn why we all need to change to become better investors, and some ways to do that (somehow involving lemonade…).
Finally, I give you 7 investing Practices you’re likely not using, but you should be (that I’m currently working on implementing myself).
Let’s begin.
The Traveller
Imagine that in your brain, every decision, problem, or choice that you make, is a traveller walking down the street, looking for directions. This traveller has many possible destinations, some much more pleasant than others, but it needs help deciding. At the end of the street, blocking the road, is a single house. In this house, live two roommates. To get directions, the traveller must always go to this house to seek help, every time, no matter what the circumstance. The answer the Traveller receives will determine its destination (the destination here is the answer to a decision, problem or choice). This house is always very busy giving out directions. It gets thousands of travellers everyday, all looking for directions to a possible destination.
As you may have already guessed, (if you read my last post…) the two roommates who call this place home are:
- The Fast but Crazy System (FCS) &
- The Smart, but Lazy System (SLS)
These are the two systems of the brain that handle all quandaries you may have. They are what’s responsible for every decision you make, and problem you solve.
Now let’s step inside this process, and imagine that you are that traveller.
I should probably warn you now... The wrong directions here could lead to disaster, while the correct directions, could lead to bliss.
Meet the Fast and Crazy System
Now, we return to you, our traveller. You’re still walking towards the house. You reach the front door and knock. Before the sound of the knock even reaches your ears, The Fast, but Crazy System (FCS) answers the door.
Note: Many Travellers have been here before, hundreds of thousands of times, and every time they knock, FCS answers. It’s always the first to answer, in fact, it’s so fast that sometimes it comes to give the traveller advice before it even gets a chance to knock. FCS is like the happy dog that waits at the window, staring out, looking for any sign of the owner's return. FCS is waiting there, dancing back and forth from foot to foot, waiting for the next traveller to arrive to ask for directions.
So here you are. Face to face with the FCS. (I picture the FCS as an individual wearing workout clothes. It’s energetic and always ready to go go go! Happily handing out advice on the fly all day, never tiring.) It smiles and seems to know the problem before you even get a chance to tell it. As I said, the FCS is fast. It quickly, effortlessly, intuitively, and automatically gives you directions. It literally can’t help itself. It’s extremely easy for you to stop here, and follow the directions given (a possible decision). But, you must keep in mind that the FCS has two names. Sure, it’s fast, but more importantly, it’s crazy. Sadly though, most the time, this is as far as you get. After all, It’s answers are very convincing. This is because FCSs’ judgements are based on similarity, familiarity, and proximity (in time). In fact, for it to believe that it’s answer is the correct one, it simply needs to wish that it were so (are you beginning to see the crazy side?). It’s also extremely vulnerable to a whole host of behavioural biases that we need to learn to avoid.
Not only is the FCS always the first to answer the door, but the FCS is also blocking the way into the house (where you’d find the Smart, but Lazy System- SLS & a more thoughtful answer). FCS thinks it’s answer is the right one, and it doesn’t think you need to further burden yourself with another opinion on the matter. This is because, to do so would require a conscious effort. Do you think you have what it takes to make that extra step? To slow down, and get past FCS and go deeper into the house for a more thoughtful answer?
Note: before you make your decision to stop here, you should know this… It’s called the Fast and Crazy system for a reason. It is very biased, and doesn’t give its response a second thought. It’s able to take in large amounts of information simultaneously, and therefore can be approximately right, rather than precisely correct. You should also know that this is the system that causes most (if not all) of our investing biases.
I’ll be honest here, most of the time, you don’t make it past the front door. In fact, most of the travellers don’t. But, if you do manage to get past the FCS, you may be rewarded. Because, lurking deep within this house is a system better suited to give you correct directions, increasing the chances of a desirable destination instead of a disastrous one... The problem is, it’s also slow and extremely lazy.
Waking the sleeper.
So, it turns out, you’re a patient traveller, and you decide to move deeper into the house. You say to the FCS ‘thanks, but I’m going to get a second opinion on this one’, and walk past him into the house. It’s dark here, and you can hear a faint snoring sound. As you approach, you notice that the snorer is the Smart, but Lazy System (SLS) fast asleep on the couch. (I picture this system to be a baggy shirt, sweatpant wearing individual with glasses who tires easily). Now, to wake the SLS, you must effortfully call on it for help, because It takes time, and deliberate effort to receive directions from the SLS.
It also, quite literally can’t help you until you’ve already received advice from the FCS, and it won’t take the time to greet you unless you purposefully and deliberately ask for its help. Once you’ve woken the FCS, and ask it for directions, it slowly gets to work. It uses a logical and deductive approach to solving the problem, and must move one step at a time. It requires time, evidence and logic to believe that something is true, and gives a much more thoughtful response than the FCS. After weighing all the facts, the SLS gives you the best possible directions. You exit the house, follow the directions given by the SLS, and arrive at an excellent destination.
Can you see how this may affect our investment decisions? If we don’t get passed the door and meet with our SLS than we are likely to be making all sorts of mistakes.
Let’s quickly recap the two systems, and their individual attributes.
The Fast and Crazy System (FCS)
This is the default system. In other words, every decision you have to make, first gets advice from the FCS.
it’s automatic.
Intuitive
Effortless
More importantly, it’s involuntary (meaning you really can’t control it).
Its judgments are based on:
Familiarity, Similarity, and Proximity (in time)
It deals with large amount of information at one time
It’s the Quick and Dirty ‘Satisfying’ system. This means it gives approximately correct answers, instead of precisely correct ones.
Vulnerable to a plethora of behavioural biases.
For the FCS system to believe that something is valid, it may simply wish it were so.
Operates on biases that may not be accurate.
This system is evolutionarily much older than the SLS
Was originally evolved to make quick judgements to survive.
This system is used anytime we don’t have to actively think about what we’re doing.
Eg: What is your age? What’s 2+2? It’s also used most of the time we’re driving.
The Smart and Lazy System (SLS)
Logical
Deliberate
Deductive
One step at a time
Requires deliberate effort to activate
It’s a Slow and Serial way of dealing with information.
It requires evidence and logic to believe that something is true.
Revolutionarily much younger part of the brain
Requires you to slow down
Requires time
Evaluates the biases, but is prone to errors.
It’s used for:
- Deliberating - Problem solving
- Reasoning - Computing
- Focusing - Concentrating &
- Data consideration
- & It doesn’t jump to quick conclusions.
It’s easy to see that his system requires actual effort. Here’s an example… If you’re out for a walk with a friend and you’re chatting normally, you can keep up the pace. If they were to ask you a difficult math problem three things would likely happen. 1. You’d stop walking and focus all your energy at solving the problem. 2. Your pupils would dilate. 3. Your brain will use more energy.
This is how we need to treat more of our decisions. We need to literally stop, and think about it, decreasing our risk of error. We can do this by learning to activate the SLS more often, and to listen to the FCS much less in our daily lives. This is especially true when it comes to our investments, and we’re much more vulnerable than you may realize…
The FCS and Investing
Gary Klein, a psychologist from Cambridge discovered that we are much more likely to use the FCS under certain conditions. He found that we use the FCS more often when:
The problem is ill structured and complex.
When the information is incomplete, ambiguous, and changing.
When the goals are ill defined, shifting, or competing.
When stress is high because either time constraints or high stakes are involved.
When decision rely upon an interaction with others.
You may want to read that list one more time while thinking about our daily lives. It sorta sucks. That list pretty much covers any and every decision of consequence that we’re ever likely to face. And the worst part is, that’s the time when we should be using our SLS, but instead, we’re much more likely to only rely on our FCS.
The same is certainly true when it comes to making an investment decision.
Let’s go through the list and see if it applies…
The problem is complex? Check
Information may be incomplete or changing? Check and check.
Stress is high? Check
There are time constraints? Check
The stakes are high? And Check...
We basically have every instance covered when investing. In other words, every investment decision we are likely to make, is perfectly suited for our Fast and Crazy system to handle on its own. Therefore, we’re likely extremely vulnerable to all the biases and quick decisions that go along with it. Yikes!
Evolution is slow...
But, it’s not really your fault, it’s your ancestors. let me explain... Evolution is slow. Actually, it’s beyond slow, it’s glacial, and our minds have not yet evolved to the fast-paced lifestyle of our time; The age of technology. Frankly, our minds haven’t even adapted to the industrial age of 300 years ago. We may be physically living in this time, but evolutionarily speaking, our minds work like they did 150,000 years ago; back in the African Savannah.
Back then, it made perfect sense for you to act instead of think. After all, your life would have literally depended on it. However, since the dawn of technology (some 2.6 Million years ago,) our minds have been trying to adapt to the use of tools. At the time, they were just pointy rocks with sticks attached. Our brains had literally millions of years to adapt to these relatively small changes. Today, this is rarely the case. More often, it would benefit us to slow down and think the problem through instead of just acting with the first thought that came to mind. But alas, our minds have been so deeply ingrained with the ‘act first and think later’ mental model (relying solely on the FCS) that is takes real effort to stop and think.
We need to change
I think it’s obvious that we need to do our best to protect ourselves from allowing the FCS to take over and make our investment decisions for us, don’t you? We need to learn to control the FCS, and better yet, utilize our SLS when the decisions we make are of any consequence. As Warren Buffett said ‘We need the temperament to control the urges that get people into trouble’, or in other words, we must stop relying on our FCS to make the decisions for us.
How can we change?
Well, what about self control? That can work, but it does have its limitations. Remember the cookie and radish experiment from the previous post? Well, researchers found that our willpower is like a muscle. In other words, it tends to deplete after heavy use, leaving us more vulnerable to mental errors in judgement. But don’t fret, there is good news as well. Researchers found that just like a muscle, our will-power can grow with continual training. ‘The important thing is to practice overriding habitual ways of doing things, and exerting deliberate control over your actions. Over time, that practice improves self-control’.(Baumeister & Tierney 2012)
Side note: It appears that the act of using willpower literally causes our brain to consume more glucose (sugar), depleting our bodies supply much more quickly. Ever get Hangry? (as in angry because you’re hungry), well this is likely because your blood glucose is low, making your brain glucose low as well, causing you to have much less self control. A study was done to prove the depletion of glucose lowers one’s self control. They found that the simple act of sipping full sugar lemonade (vs artificial sweetener) replenished the subjects stores of willpower making them more adept at using willpower in the near future. (If you’re interested, you can find out more here).
What this tells me is that I should always have some candies nearby, you know, just in case... (I like Skittles… mmm Skittles…). Well, the researchers found that sipping lemonade can help replenish your blood glucose, and thus keep up your willpower. So, anything with a little sugar in it will suffice. Just don’t overdo it…. (I’ll actually be using green tea and honey).
7 investing practices you should use
The other, and possibly more effective way that we can arm ourselves against our FCS is to ingrain better behaviours into our investment approach. We need to be like the turtle above, and slow down before we make any investment decision. Following these 7 practices will help.
1. Don’t look at stock prices during the day
- This can help you stay away from emotional trades caused by the daily swings of the market. The moves during the day trigger our emotions, and will likely cause you to make an investment mistake (It’s also Guy Spiers advice in his great book: The Education of a Value Investor).
2. Do your research on a company prior to making any investment decision.
It helps if you have a watch list of all the companies you like. That way you can keep up with them, and see if they’re getting close to your buy price. Keeping your emotions out of it.
3. Have a game plan for when to buy, sell, and what percent of your portfolio you are willing to put into the investment.
- This is a good way to keep the emotion out of it. That way, when the company hits the price you want to pay, you don’t have to worry about all the noise and you can stick to your plan. (This advice comes from John Templeton, from his daughter's book: Investing The Templeton Way).
4. Have an investment checklist
- Having a checklist prior to making any investment is a good way to keep our emotions at bay. It’s important to always follow your own specific rules for each investment you make.
- The checklist should have all of the most important characteristics you think are necessary for making a sound investment.
- Should be no longer than 15 items long (ideal is around 11). This comes from Atul Gawande’s book: The Checklist Manifesto. (I also want to read his other book: Being Mortal. It currently has 4.8 out of 5 on amazon from 5,940 reviews!)
-This will help us eliminate our FCS biases and improve our investment results because of it.
- You can sign-up to get my person Investing checklist here.
5. Have a trusted partner in crime
- It helps to have someone you can bounce your investment ideas off. Charlie Munger always encourages us to ‘Invert, Always Invert’. He means that you should always look at the negative side of your investment story. (he also has Warren Buffett to bounce his ideas off)
- It helps to have someone play devil's advocate, just in case you’re missing something. This is where your ‘partner in crime’ comes in to help shoot holes in your idea. (I’m here for you if you need a second set of eyes! Just email me or message me. That little mail button on the right there goes directly to my email. And I’m happy to give you a second opinion).
6. Learn to recognize our own biases.
- This is what we’re going to be working on over the upcoming posts. We’ll learn what mental shortcomings we may have and the underlying psychology behind them. Most importantly, we’re going to learn how to protect our portfolios from these biases, which is just learning to protect ourselves, from ourselves…
7. Keep a Journal of all your trades and reasoning behind them.
-This will help you when you need to do a ‘post-mortem’ on an investment decision. It can become invaluable. We tend to sugar coat the past, and adjust it as time progresses. A journal will help you to avoid this, and give you much greater insights into your thought process at the time, so you can avoid making the same mistakes. If we can avoid making mistakes when it comes to investing, we won’t be able to stop ourselves from becoming very wealthy. (Siegfried Eggert recently reminded me of this one).
- It’s also a good idea to write down why you’re buying or selling the company, before you make the transaction. This will help you slow down, and use your SLS creating a better opportunity for investment success.
Summary
Alright, so we went through quite a bit today. We learned that we need to try to activate the SLS more often, and try to ignore the FCS when it’s right to do so. We learned when we’re more vulnerable to relying on the FCS, and to avoid it, we must actively engage our SLS. we learned that our Investment choices are very vulnerable to the FCS, and must take certain steps to avoid it.
We then went into short history lesson on our brains and learned that we are not properly equipped to deal with the fast pace lives we live.
Next I gave you a bit of a bonus; Seven effective ways to arm yourself against the FCS, and to make you a better investor overall.
So, here’s the main takeaway from this little thought experiment. If the decision you must make is complex in any way shape or form, take the time to call on the SLS for advice. It is much less biased, and therefore, much less prone to bad decision making. Remember, before you make any investment decision, slow down, and write it down. This will surely help you make better choices into the future.
Challenge
If you don’t use it, you lose it. Remember that one? Well it’s kind of true. Studies have found that the best way to retain something you have just learned, is to immediately put it into practice. So, I’m throwing down the Gauntlet here and challenging you (and myself) to practice two things TODAY:
1. Activate your SLS before making any important decision. (in other words, slow down and use those 7 practices mentioned above. I promise you’ll be better off for it.)
2. Practice using will power (it can be a simple as using your non-dominant hand to open doors, anything that makes you actively adjust to do a task.)
Thanks for reading,
We’ll talk again soon.
~Ryan Chudyk~
Further reading:
I stumbled upon a great post on my twitter feed (@ryanchudyk) that was on the same subject I’ve been working on. It comes from Siegfried Eggert, and this guys really knows his stuff. Check it out:
https://geoinvesting.com/protect-portfolio-mental-biases/
Also, If you missed it, and want a copy of My Investing Checklist:
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