To survive, we sometimes need to react automatically, like dodging a speeding taxi in traffic or running away from the undead in a zombie apocalypse. Having fast, automatic thoughts and reactions to situations is an excellent first strategy, but it makes mistakes that our slower, rational mind needs to correct.
Israeli-American psychologist Daniel Kahneman describes the mistakes your mind is prone to make through these 2 modes of thinking as “System 1” and “System 2”:
System 1 (fast thinking) is the mental state in which you drive a car or buy groceries. It relies heavily on intuition and is fantastically capable of misleading and also of being misled. It’s unconscious, fast and easy.
The slower-thinking System 2 is the mental state that understands how System 1 might be misled and steps in to try to prevent it from happening. It’s conscious, slow, and high effort. The most important quality of System 2, however, is that it is lazy; the most important quality of System 1 is that it can’t be turned off.
I am human. Hear me (and my lizard brain) roar.
Yes, I know, you think your brain is a beautiful and mysterious unicorn, capable of great things – unfortunately, it isn’t a flawless piece of machinery. Due to decision-making fallacies, it’s also capable of some mental tricks that can lose you serious money. It’s not about IQ. It’s just the wiring of our wonderfully human brain.
We make decisions on what to buy and how much to spend on a daily basis. Unfortunately, decisions about money are often based on System 1 thinking and we don’t always act in our own best interest.
When confronted with difficult decisions, or a limited amount of time, we apply simplifying rules, referred to by academics as heuristics, which are various internal references and responses that people use in assessing things, developing views, and making decisions. They help us quickly find answers or solutions that may not be optimal or perfect, but are sufficient for our immediate goals.
Heuristics are unconscious ways that we process information more quickly than if we were to think about it deliberately. The vast majority of our daily decisions are taken up by heuristic decision making. We use heuristics when we don’t have time to think more, which is almost all the time.
The problem with heuristic thinking is that it tends to be personal, emotional, subjective, and instinctive; often led by assumptions and resulting in knee jerk reactions.
The good news? Once you’re aware of these decision-making shortcuts, it’s easier to not fall into their traps.
Don’t budget on the bright side of life – why optimism is bad for your wallet
For example, when people mismanage their household budgets by spending too much of their monthly salary in the first couple of weeks of the month, this is typically due to the optimism heuristic. They hope their money will last, rather than budgeting and controlling spending.
Why your brain is so bad at planning for the future
One of the reasons we fail at long-term planning is that we view our future selves as strangers. For example, when we pay with a credit card, it’s easier to spend more (or to spend money we don’t have) because we’re not physically parting with the money immediately – and our brains feel like that money is an issue for the future, not today.
How a few mediocre decisions can be turned into long-term habits.
Another heuristic we often use is to look at our own past behaviours for guidance and simply repeating those decisions. This would be a great strategy, assuming that our past decisions have always been sensible and reasonable. However, it prevents us from examining our long-term habits.
We go through life on the receiving end of partially reliable information that we only occasionally have time to evaluate thoroughly. On a daily basis, we are getting bombarded with more information, choices, and offers than ever before and it’s only going to get worse. By understanding how we make decisions we can step back when it comes to really important choices in life, and avoid being caught out by the quirks of our brains, hopefully helping us make better decisions.
At 22seven, we use Nudges* to help our customers explore and understand the impact of heuristic thinking on how they behave with their money, specifically uncovering the heuristics that are unhelpful.
Some of our Nudges are encouraging insights into good behaviour, highlighting positive habits.
Others give you better clarity of how you are spending, spotting trends that you might not be aware of (turning Money No-Nos into Money Know-Knows), ultimately enabling better financial decision making.
*Nudges are suggestions, tips or insights – not mandates. For example, putting fruit at eye level counts as a Nudge. Banning junk food does not.
Have you come across any interesting mistakes you make in the way you think about your money? Do you have thoughts on how to turn money no-nos into know-knows? We’re looking for ideas on how we can make 22seven motivate you to reach your goals and help you spot opportunities to save and grow what you have.