Easy Decisions vs Good Decisions

We make decisions using two methods that behavioral economists call System 1 and System 2. 

  • System 1 operates automatically and quickly, with little or no effort and no sense of voluntary control.
  • System 2 allocates attention to the effortful mental activities that demand it, like complex calculations or decisions.

System 1 uses shortcuts and rules of thumb that usually lead to good choices. People may also refer to it as “intuition” or “gut feeling.” System 2 allows us to make better choices when System 1 shortcuts lead us to errors. 

We default to System 1 because our brains try to conserve energy (i.e. we think the easiest way possible for the situation). We couldn’t possibly use System 2 to concentrate and think through every decision we make in a day.

What common errors does System 1 lead people into?

  • Overspending and not saving enough
  • Bad risk assessments
  • Overly emotional decisions
  • Solving difficult questions with an answer to an easier, but different, question
  • Filtering out ideas that don’t match our beliefs
  • Making future decisions based on irrelevant past investments (i.e. “sunk costs”)

I’ll give examples and give more detail on some of these mistakes in future emails. I’ll also give tips on how to prevent them or reduce their impact so you can make better decisions. 

Here are general tips from Daniel Kahneman, who pioneered this concept with Amos Tversky:

  • Recognize signs that you are in a cognitive minefield (i.e. susceptible to a system 1 error)
  • Slow down
  • Ask for reinforcement from System 2 
  • Tip: Other people are better able to see when we are in a minefield making mistakes

I wish you clear thinking and good decisions. I wish you well.

- Rob Stephens

Further Insight

CFO Perspective Resources

  • Video: How To Avoid Business Decision-Making Mistakes - I explain some common business decision-making mistakes and how to overcome them. Learn more about dozens of decision mistakes and how to avoid them in my behavioral finance program.
  • Course: Behavioral Finance - Overcome your destructive financial impulses by understanding common thinking mistakes. With my Behavioral Finance course, you can avoid these costly financial decision-making mistakes. The course will help you to learn science-backed ideas to make better financial decisions.

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