02 – Conflict, Illusions and Useful Fictions

Posted on October 25, 2020 by Jimit Zaveri under Behavioral Finance

Conflict

System 2 is an in-charge of self-control. It helps us while we are losing our control, focus, emotions. While we are reading a book and found something boring in it and start losing focus towards continuing with a book then system 2 bring back our focus to the point. When System 1 indicates that it’s boring then system 2 brings back our focus.

When we have invested in business and stock price of that company not moving then we start getting boring with time. But system 2 help us to guide that business has improved in performance and there are not any fundamental issues. Focus on our process and sticking with it is the work of system 2.

Illusions

At the first instance, we have reached the conclusion that the second line is larger in size compared to the first one. But when we measured both the horizontal lines, we found that both are identical in size.

Here, system 1 has accepted view of the second line is larger than the first one and when we have measured, system 2 took control. But system 1 prevents us from believing that both lines are equal, it’s illusions. Though we have measured and know the size of both the line, we cannot stop system 1 from performing. When we can work on accepting that both lines are identical, we will not again get fooled by multilayer illusions.

There are illusions of thoughts along with visual illusions and that called as a cognitive illusion.

Many times, a person does not accept the reality and try to stay in the illusion, means their system 1 only works and they do not accept what system 2 indicates. System 1 has intuitive errors and biases which system 2 is not aware of. Errors can be prevented only by the enhanced monitoring and effortful activity of System 2. But it seems impractical to continue monitoring of thoughts and go slow on routine works. It will be inefficient if we replaced system 1 by system 2. We have to identify where mistakes are likely to happen and then have to give control to system 2. It’s difficult to identify your own mistakes compared to others.

Example – when we analyse the company and see a few characteristics which we like about the company then we stop focusing on others which can have a negative impact on the future prospects of the company. Dividend-paying companies are good which is stored in system 1 so that when we look at the company which is continuously paying out a dividend. We do not focus on other aspects and make an investment. But when system 2 take control, it will analyses whether the company has the ability to keep dividend continue in future, does company paying dividend from free cash flow or from raising external funding.

We should use system 1 where rules are predefined such as we are not eligible to get a dividend if we purchase shares on or after ex-date. But analyzing the longevity of dividend, we need to use system 2.

Useful Fictions

System 2 required a mental calculation so that we should not use it with other tasks.

When we are driving on a similar road frequently since long, our system 1 works automatically. It will suggest that when to take turns, at which area have slowdown speed, etc. It will not be going to ask for system 2 helps. We can drive on a known road while making a conversation. But the same does not happen when we drive on an unknown road. Our system 2 take control and if we make conversation while driving on an unknown road, we may meet accidents or miss with target place.

Anything that occupies our working memory reduces our ability to think. So that we have to be careful to perform multitasking. When people get involved in both trading and investment than both require the involvement of system 2 so that it will become difficult for the human brain to make a wise decision to cover all aspects. And that can result in missing out of something at both the area.

01 – The character of the story

Posted on October 11, 2020 by Jimit Zaveri under Behavioral Finance

We all know that temperament is one of the most important quality not only in the investment field but also in our life. If we work on our emotional biases then we can win any battle. To excel in temperament, first, we need to be aware of the various biases. So now onwards, I will illustrate various biases and how we can excel it and use it in our life. This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

When we look at the face of woman, we immediately responded that she is angry and we also assume that what she can do next. This thinking is known as fast or intuitive thinking.

But what happens when any mathematical problem comes?

17*24

Now, we come to know that we have to do a calculation to reach out with a true answer as well as to reject a false answer.

Here, we realize that this problem is of multiplication and then we start implementing it. This step by step procedure slows down our response. Deliberate, effortful and orderly procedures are the prototype of slow thinking. When we face such problems then not only our mind works but heartbeat changes, blood pressure rate changes, etc. So that body also experiences it. When we are into known situation or problem, we can easily handle it and our mind, body, heartbeat does not change so rapidly. But when we are into the unknown situation which requires huge mental efforts then our mind starts processing it slowly, heartbeat, the body will feel that unknown situation.

Why does such a difference happen?

System 1 works on patterns and system 2 works on thoughts construction in an orderly manner. So that when we have seen the face of woman, our mind has searched for different patterns which we have experienced in the past and our brain throw matched pattern quickly which comes as a conclusion that woman is angry. While the mathematical problem is not storing under our mind and that requires to perform a calculation which slows down brain work.

We have been kept on learning about various things over a period, those learning got stored under memories and it comes out automatically when a similar recognizable pattern occurs. Such memories come as a conclusion without any intention and efforts.

System 2 also have abilities such as system 1. For that, we have to set our mind. For example, when we search our name in the merit list, we search with our initial. Those activities demand our efforts, we generally do not perform it with other activities. And which activities are automatically coming, naturally happens, we can perform other activities with it.

When some situations demand our attention, we generally do not see or hear anything else.

For example – We need to count ball passes by one to another person in below video.

Video

Majority of us have missed something unusual which has occurred in the video, come out of a gorilla. Majority of us have not noticed because we have given a task of counting passes. This counting requires an effort and that makes us blind to focus on coming out of a gorilla. This event indicates that we can be blind to the obvious, and we are also blind to our blindness. We are not aware of our inability to observe things happening surrounding while we perform some task which requires mental efforts.

When we have put efforts on price moments of particular stock then we going to be blind with what happening towards the business side. Management of the company who is engaged towards the stock price then he will lose focus towards the business and that will fail in business.

System 1 runs automatically with giving suggestions to system 2 and many times system 2 accept the suggestion of system 1. But when system 1 faces difficulties, it calls system 2 for support. System 2 continuously monitor our behaviour and work on control it. It comes in attention when it finds error about to happen. Arrangements of system 1 and 2 works on minimizing efforts and optimization of performance.

SIMPLE IS BETTER – ISSUE -6 – HEALTH IS WEALTH

Posted on March 29, 2017 by Jimit Zaveri under Simple is Better

In the last five issues, I have discussed regarding compounding and its power and how we can able to take benefits of compounding for a longer period of time. But for taking a benefit of compounding, we need a time – a long time; with a good health. Otherwise, we cannot able to enjoy our wealth or might not be there to enjoy our wealth. So, that, in issue 6, I am going to discuss on our real wealth which is our health and how it is as similar as we make an equity investment. Also, additionally to improve our health and wealth which can help us in a longer period of time.

257-Health-and-Wealth-Quotes

By getting the benefits of compounding our money, we can be able to become a wealthy person, but if we do not have a good health then that compounded wealth is of no use. So, that we also need to compound our strong health for enjoying our compounded wealth in a longer period of time.

For Detail Issue, Click here —> SIMPLE IS BETTER – ISSUE -6 – HEALTH IS WEALTH

Irrationality

Posted on March 30, 2014 by Jimit Zaveri under Behavioral Finance

Irrationality is thinking, acting, behaving or talking without inclusion of rationality.

Rationality is the quality or state of being reasonable, based on facts or reason. We evaluate each and every possible steps, cost and benefits from doing something or not doing that activity. Come up with proper reason and select or avoid decision.

So irrationality doesn’t involve rationality. As tradition economic believes that people always behave rationally in every situation. But is it really happen????

Ex:-

You are roaming at forest and lion comes and stand in front of you. At that time what will you do?

Do you think about all options, cost and benefits? What’s the cost of running? What’s the benefit of running?

We just start running as fast as we can.

Thus, at that time our emotion replace on our thinking system and order to run as fast as you can.

So Irrationality is about the forces that drive our behavior that can be economic forces, social forces.

As when we come to the policies, we just can’t consider only standard economy. We think about society’s care and take a broader picture, broader perspective that just not included only rational. We also have to include what we know about human nature.

We had seen stocks bubbles (Sub-Prime crisis, IT bubble, etc.), people over extending limits of credit cards, taking mortgages, etc. in which where we can see the rationality???

Rationality says that people are strong enough to calculate everything, consider all options then make decision but in real world people are confused, have an emotions, not every time thinking about future, fall in love and so on.

So that people behave irrationally most of the time which not included under standard economic and pre-assume that people behave rationally.

We rely on contextual information to make all sorts of judgments and decisions. Illusion under us is that we know the answer, we know the right thing to do. But in fact we are wrong. That is just a mental, visual illusion many a time which shape our decision and judgments.

Ex:-

See the below picture…… at top what color is it look like?????

Your answer is its look like brown.

Now, at the bottom one what color is it look like????

Your answer is its look like orange.

You can’t see both the color as an identical.

Let’s see now….. Cover all side and what both color is it look like???? Is it identical????

Now, our answer is yes both the colors are identical.

It is a visual illusion which drives our decision of those both colors are not an identical.

But is it really????

No, In fact those both colors are identical. Thus, illusion which drives our decision.

Many times we took decisions which are driven by some of the forces and those are not be a rational. We are human and we makes some mistakes repeatedly again and again but benefit of being the human is that we can identifies our mistakes and can take steps for improvement.