Investing without understanding how your mind is making decisions is a waste of time. It’s also a waste of money.
Our mind has two systems that process information. It affects how we think, come up with decisions, act, and judge situations. This is crucial when you’re investing. The first is system one. I like to think of it as our “lazy brain.” System 1 is the part of the brain that reacts on intuition. It’s impulsive and automatic. It’s non-conscious.
For example, you might buy stock in a company just because they have a sexy new product out. You think it’ll change the way consumers behave. You don’t care to dig into the company’s financials or history right away. Your system one mind is drawn to the story and leads you to make an impulsive, lazy decision.
To explain this a little further, I’ll use the example from the book Thinking Fast and Slow:
A bat and a ball cost $1.10. The bat costs a dollar more than the ball. How much does the ball cost?
More than likely, you said 10 cents. This is your system one working, but it’s incorrect. If you take a moment to do the math, you’ll find that the answer is five cents. So what happened? Your system one relied on impulse to answer the question you thought was simple.
How might this affect your investment decisions.
The second type is system two, and it’s more conscious. It requires effort. It’s the part of our brain that will allow us to focus our attention. We can then make deliberate, thought-out decisions. But it also requires that you set your impulses aside and concentrate.
Let’s take another look at the example above. If you’re using your system two, you may make a different decision on the stock. You may stop yourself from buying the stock after analyzing the company’s financials. Or you may notice they have many competitors and a small, unsustainable profit margin.
Source: Understanding Your Mind Will Make You A Better Investor – Money Under 30