This week I’ve been reading Thinking Fast and Slow by psychologist Daniel Kahneman. The author received the Nobel Memorial Prize in Economics for his work on cognitive biases in decision-making.
Where finances are concerned, we all like to think we make rational decisions, based upon well-considered reasoning. The studies examined in this book suggest otherwise. What is really behind our financial decisions?
Here’s a personal example – my “lettuce story.” I am standing in front of the produce section at the grocery store, eyeing a beautiful head of organic romaine. But I’m frozen. The organic is $2.49. I love to cook, want to support the local farmers, and would prefer to avoid pesticides. But a voice in my head is saying, “Buy the non-organic for $1.49! Save a dollar!” Which lettuce I choose is often based on emotional factors, not a rational argument. So, who is in charge here? More on this later.
Systems 1 and 2
In the book, Kahneman proposes that we have two modes of thinking which he calls “Systems.” System 1 is fast and intuitive. For example, consider the information we gather by looking at someone who is angry with us. We automatically process cues from the person’s expression, voice, and general body language. With minimal exertion of conscious mental energy, we assess this information and arrive at certain conclusions about the situation.
System 2, on the other hand, deals with the realm of conscious reasoning, computation, and complex decision-making. This is the “slow thinking” mode. How much will we save with a 40% discount on a purchase? We humans like to think this conscious cognitive system is the one running the show. It is the one I think is deciding which lettuce to buy.
System 2’s Many Weaknesses
However, System 2 is vulnerable. It requires concentration, mental effort, and energy. It is easily distracted. And it is, by orders of magnitude, slower than System 1. It is also lazy, preferring to run on low energy, getting by with the least amount of exertion. Think of it as having a limited budget of attention. If System 1 can come up with an easy answer to something that System 2 deems reasonable, System 2 may not even step up to work on the problem. The famous example given is as follows:
A bat and a ball together cost $1.10. The bat costs one dollar more than the ball. How much does the ball cost? System 1 has the “easy” – but incorrect – answer.*
In studies where subjects were given mentally challenging tasks and then offered a choice of cookies or a healthy snack, the cookies won hands down. When energy is low, self-control also declines; we are likely to make decisions we might not otherwise make. It is as if System 1 says, “cookies!” and System 2 is too tired to argue.
System 1 Is A Key Influence On Decisions
According to Kahneman, System 1 is “effortlessly originating impressions and feelings that are the main sources of the explicit beliefs and choices of System 2” (page 21.) In other words, much of what we would like to believe constitutes “thinking” is actually automatic stuff we generate based on learned patterns, emotions, and memory. This aggregate of impressions then becomes a key source of the information that we use to make decisions, unless System 2 is brought into play.
Who’s In Charge?
Kahneman’s conclusion is alarming; we like to think that System 2 is in charge, while in reality System 1 seems to be pulling the strings. System 2 gets tired, is easily distracted, and sometimes lazily accepts what System 1 is telling it. Bringing conscious decision-making to our finances, or any area of our lives, can be enhanced by an awareness of these natural tendencies.
Before I understood the connections to these ideas, as exemplified in my lettuce dilemma, I would often make the emotionally based decision to save a dollar. Now I recognize that this choice arose from a place of worry and fear that there would never be enough money. That System 1 influence kept me from making the more conscious choice to buy something that aligned with what I cared about most. Making conscious choices with money, and seeing our money applied to what matters most to us, is an important factor in achieving financial success. Be aware of who (and which System) is in charge of your finances.
* Correct answer is five cents.