When it comes to making investment decisions, our natural decision-making style carries enormous weight. We are, after all, talking about our life savings. The stakes are high – right up there with decisions we make about our health, our children’s welfare, and our careers.
If you are in your 20’s or 30’s, you may think that taking lots of risk with your modest nest egg is ok because you have lots of time to recover from bonehead plays every investor makes along the way. We learn from our mistakes, and that’s how we evolve as decision-makers.
A Foolish Consistency is the Hobgoblin of Little Minds – R.W. Emerson
But not everybody learns from their mistakes. Character traits such as commitment, consistency, conviction, doggedness, loyalty, and fidelity are highly valued in modern society. And they should be. But in the realm of managing our money, and making decisions that will have profound and lasting consequences for our financial security later in life, these traits can be counter-productive, if not downright harmful.
How many times have you heard someone praise a public figure with phrases like:
- He’s got the courage of his convictions
- He never wavers from his principles
- He’s been saying the same thing for his entire career
- He has a single-minded passion for his cause
Admirable qualities to have, right? Well, maybe. When it comes to investing, it’s actually better to have an adaptable mind and a flexible belief system. Rigid thinking can be harmful to your investment success.
Kirk or Spock?
Today I’ll look at two very different decision-making styles – Captain Kirk’s and Mr. Spock’s. They each have merit, and each is useful in certain realms of modern life. But what about in the realm of investing?
Star Trek’s two main characters illustrate the strengths and weaknesses in pop psychology’s models of emotions, intuition, logic, and rationality. Spock’s decision-making style is based on the rationalist ideal that “reason is more powerful than emotion,” that it “triumphs over emotion.” But cognitive science shows that there are exceptions to this decision strategy.
Kirk’s style is based on feeling and intuition. He makes decisions much more quickly than Spock. But his decisions are more prone to being wrong than Spock’s.
Logic and emotion aren’t opposites. They each tap into a different part of our brains when a decision is at hand. One is not better than the other, but when combined, they can produced better results than either can produce independently.
Thinking Fast and Slow – Daniel Kahenman
Kirk operates primarily on what Nobel Laureate in Economics Daniel Kahneman calls System 1 thinking. In his book, “Thinking, Fast and Slow,” he makes a distinction between the fast, or intuitive System 1 that Kirk uses to make decisions, and the slower, more deliberative System 2 that Spock favors.
Kirk’s intuitive, gut-feel decisions are very effective under battle conditions, when things are moving quickly and decisions must be made in split-seconds. But “intuition is nothing more and nothing less than recognition.” Kahneman says an experienced firefighter can know, “without knowing how he knows” that a situation is unsafe. (System 1 recognizes cues, but System 2 evaluates what they mean.)
Spock’s thoughtful, rational System 2 can evaluate Kirk’s feelings only indirectly. Since Spock lacks a System 1, he must rely on the assumption that the pronouncements coming from Kirk are influenced with emotional and cognitive biases. This doesn’t mean that Kirk is wrong, it only means that Spock must vet Kirk’s ideas by running them through his own System 2 logic processing program in order to evaluate their practicality. This is why one of Spock’s most memorable catch phrases is “illogical, captain.”
Combining Kirk’s System 1 and Spock’s System 2 enhances our “natural” or “default” decision style. Tapping into both systems when a decision is at hand can help us use our minds more wisely.
A Simple Case Study
A decision that’s familiar to anyone who has lived through a bear market is the “should I stay or should I go” decision. “Should I Stay or Should I Go” is a song by the English punk rock band the Clash, from their album Combat Rock. It was written in 1981, and it captures perfectly the angst of this type of decision. (Yes, I know I’ve used these lyrics before. But I can’t help myself – I like The Clash.)
Should I stay or should I go?
If I go, there will be trouble
And if I stay it will be double
So come on and let me know
Should I cool it or should I blow?
This indecision’s bugging me…
To frame this decision, let’s imagine we’re in a market that is in turmoil. It’s already down by 15% and still dropping. Kirk is feeling anxiety that’s manifesting viscerally. He feels like he’s been punched in the gut. He imagines that the market is going to keep going down, and with only two more years left on his Starship Commander contract, he worries that his financial security will be destroyed. This is Kirk’s System 1 brain at work. It’s being driven by emotion and instinct.
But Kirk is a wise captain. He resists his inclination to “go” and turns to Spock for advice. Spock looks at the data and concludes that selling now would be irrational. The economy is growing, corporate earnings are increasing, interest rates are reasonable, and unemployment is low. Spock’s carefully considered opinion is to “stay.” He argues that the only reason for the market decline is a threat by the most notorious bad guy in the galaxy – Khan- to destroy the Earth. Spock knows that this is an empty threat, and when it blows over, the market will recover and go on to make new highs.
Use your Kirk brain and your Spock brain
The most accomplished investors I’ve met and read about, have taught themselves to use both systems together when a decision is at hand. They use their Kirk brain to sense danger, imagine opportunities, and detect when they are being manipulated. Then they go a step further, and call on their Spock brain to analyze and verify that the instincts coming from Kirk are viable, and not just an emotional reaction to a perceived threat or opportunity.
Here’s the hard part. Invoking your Spock brain takes a lot of effort. It’s hard work, and it’s time-consuming. But that’s what it takes to become a highly accomplished investment decision maker.
The moral of this story is that when you are being pressured by your emotional instincts to “go,” stop for a minute and consult your inner Spock. If you determine that the threat is real, then go. But in most cases, the correct move is to stay, and perhaps look for some bargains to add to your portfolio.