Behavioral Investing

System 1 and System 2: Investor & Advisor

The way you think through a challenging economic event such as high inflation or volatility can depend on your role—investor or advisor.
06/17/2022
Balancing scales.

Social scientists sometimes say that we have two separate systems of thinking. System 1 is often fast, emotional and impulsive. System 2 is slower, more reflective and deliberative; this way of thinking recognizes the need for planning and why it's good to stick with that plan.

Behavioral expert, author and Harvard Professor Cass Sunstein shares his thoughts on the two systems of thinking, which investors lean toward versus advisors, and how combining both can lead to better outcomes.

Conversation Can Combine the Best of Both Systems

Investors, even sophisticated ones, often exhibit prominent System 1 tendencies. Their System 1 thinking can be on fire during challenging situations.

Advisors, due to the nature of their professional role, typically apply System 2 thinking more. They’ve trained to slow down their reactions to economic events.

A conversation that balances these systems can be extremely productive and strengthens the relationship between the investor and advisor. Investors in a more emotional System 1 frame of mind can experience the calming effects of System 2 by speaking to their advisor.

Slowing Down System 1

Fortunately, investors don’t always act on their System 1 impulses. Inertia—the human tendency toward inaction—can often be their best friend. It can save some investors from the pull of action bias when something happens or from the tendency toward loss aversion that tempts them to make too many investment moves.

The advisor can be the deliberative, reflective system that understands when inertia can help prevent rash decisions. And when it’s clear that overcoming inertia is the best course of action, the advisor can provide thoughtful direction that considers the investor’s underlying mindset.

When the Advisor Is the Investor

Investment professionals can be subject to System 1 thinking when they’re investing for themselves—and sometimes for their clients too. But because they’re accustomed to using System 2 thinking when supporting their clients, they’re often aware of their psychological tendencies and able to take steps to counteract them.

Studies of investment professionals have shown they can be subject to loss aversion, overconfidence and action bias.

Strengthening System 2 Thinking

One way to practice more deliberate System 2 thinking, whether you’re an investor or an advisor, is to use a checklist of things you consider before you make a decision. Doing so can help inspire you to make better decisions about investing or anything else.

Headlines and global events can feed System 1 behaviors, making it hard for investors to stay on track. Investment advisors must have a good understanding of their role, especially in turbulent times.

Get more tips and insight on inflation.

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Behavioral content Cass Sunstein ©2022 All Rights Reserved

This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.