Thinking Fast and Slow

The Nobel prize for economics isn't given out casually, like a slice of Kulcha or Bhature. When Daniel Kahneman acts, it's worth paying attention.

In his 2011 book, "Thinking Fast And Slow," the author explores the two systems in our brain that often clash, leading to errors and false decisions.

It helps you identify when to trust your instincts and when to be more mindful to make improved decisions.

Lesson 1 : Your behavior is influenced by two systems in your mind: one conscious and the other automatic.

Kahneman categorises the two systems in your mind as follows.

System 1 is automatic and impulsive.

It's the system you use when a suspicious person enters the train and you automatically turn towards the door. It's also what causes you to eat the entire bag of chips in front of the TV, even when you only intended to have a small bowl.

System 1 is an essential remnant from our past that is vital for our survival. Isn't it useful to instinctively jump away from a car when it honks at you without having to think?

System 2 is highly conscious and considerate.

It aids in self-control and intentional focus. This system helps you recognise your friend in a large crowd by recalling their appearance and filtering out others.

System 2 is a relatively new addition to our brain, only a few thousand years old. In today's world, our priorities have shifted from basic needs to earning money, supporting a family, and making complex decisions. This is what helps us succeed.

However, these two systems do not alternate or work together perfectly. Frequent power struggles determine your actions and behaviour.

Lesson 2 : Your brain's laziness leads to intellectual errors.

I'll show you how the conflict between two systems affects you with a simple trick called the bat and ball problem.

The cost of a Cricket bat and a ball is ? 1.10. The bat is ? 1 more expensive than the ball. What is the price of the ball?

I'll give you a moment.

Understood?

If your immediate response is ? 0.10, I regret to inform you that system 1 has deceived you.

Please recalculate the maths.

What else?

After a brief moment of consideration, it becomes clear that the ball must cost ? 0.05. If the bat costs ? 1 more, the total comes out to ? 1.05. When combined, the total is ? 1.10.

Isn't it fascinating? What occurred here?

System 1 calls on system 2 when it encounters a difficult problem it cannot solve, to handle the details.

Sometimes your brain simplifies problems more than they really are. System 1 overestimates its ability, leading to errors.

Why does the brain do this? Like habits, it aims to conserve energy. The law of least effort states that your brain minimises energy usage for each task.

System 2 is not activated when system 1 is capable of handling the situation. In this case, it prevents you from utilising all of your IQ points, even though you should, thus limiting our intelligence due to laziness of the brain.

Lesson 3: When making financial decisions, avoid letting emotions influence you.

Milton Friedman's economic research laid the groundwork for modern work in the field. However, we have come to realise that the homo oeconomicus, the individual who only acts rationally, as introduced by John Stuart Mill, does not accurately represent us.

Consider these two scenarios:

You have ? 1,000. You can choose to receive a fixed ? 500 or take a 50% gamble to win an additional ? 1,000.

You have ? 2,000. You can either lose a fixed amount of ?? 500 or take a 50% chance of losing an additional ?? 1,000.

Which option would you choose for each?

Most people prefer the safe ?? 500 in scenario 1, but are willing to take a gamble in scenario 2. The chances of reaching ? 1,000, ? 1,500, or ?? 2,000 are equal in both cases.

The reason is loss aversion. We fear losing what we have more than we desire to gain more.

We perceive value based on reference points too. Beginning with a ? 2,000 starting point gives you a sense of being in a stronger position, and it is something you wish to safeguard.

As we have more money, we become less sensitive to it (known as the diminishing sensitivity principle). Losing ? 500 from ? 2,000 feels less significant than gaining ? 500 from ? 1,000, making you more inclined to take a risk.

Stay informed about these matters. Understanding how your emotions can cloud your judgement when discussing finances can lead to improved decision-making. Consider statistics and probability, and act accordingly when the odds are in your favour.

Avoid letting emotions interfere where they are unnecessary. Rule number 1 for a skilled poker player is to "leave emotions at home."

Kahneman's thinking in "Thinking Fast And Slow" is reminiscent of Nassim Nicholas Taleb's "Antifragile." Highly scientific, supported by mathematics and facts, yet easily comprehensible. I strongly recommend this book!