The average person makes about 35,000 decisions every single day.
Each of these 35,000 decisions are made with System One thinking or System Two thinking.
In today’s episode, you will discover exactly what each of these thought processes mean and how you can utilize the concept of Behavioral Finance to create a better, more stable financial future for you and your family.
Topics covered include:
*System One thinking vs. System Two thinking.
*How to apply the concept of Behavioral Finance to your day-to-day life.
*The strategy behind the Honest Conversations exercise, as well as alternatives to it.
*How financial advisors can utilize the above strategies to keep their clients both happy and engaged.
If you enjoyed today’s episode, make sure to share it with a friend or family member!
Transcript:
Hey, thanks for tuning in today to retire in Texas. My name’s Darryl Lyons, CEO and Co-Founder of PAX Financial Group. And this information is general in nature only. It’s not intended to provide specific tax, investment, or legal advice. Visit PAXFinancialGroup.com for more information. And I want to remind you to text the word Texas to the number 74868.
Or you can go to our Website, under Contact Us. We do have the absolutely best financial advisors in the entire country. I’ve been working very closely with them over the past year in various capacities, but also just taking inventory of their skill sets and their care. And I’ve got to tell you, I’m impressed. I really think we’ve got a great group working over at PAX Financial Group, and I think you will as well.
So, with that being said, I want to talk a little bit about what I’ve been working on. So, we have this tool called Honest Conversations, and if you’re a client, you’ve probably been through this exercise. I’ll share with all listeners what this exercise is. It’s a very important exercise for our client experience, Honest Conversations exercise. But it may not live with PAX forever because it’s actually owned by Goldman Sachs.
And Goldman Sachs and PAX are kind of going in different directions. And so, I have to have a backup tool just in case we lose access to our lease of this tool called Honest Conversations, because we leased out the tool from Goldman Sachs because they put all the research behind it and the technology pieces. So we you know, for a small firm like us, it would take us a lot of money to build out something.
And it’s just much easier to lease from these big companies. So that’s what we do for this specific tool. But I can’t imagine that Goldman Sachs can allow us to lease it forever, specifically since the companies are going in different directions. And it’s incumbent upon me to find a replacement for this tool Honest Conversations. So that way, if they pull the plug, we have a backup.
But why even have a tool like Honest Conversations? I have some clients that say they don’t like it, but I’d say that’s less than 5%. I’d say 95% of our clients and our prospects really like going through this exercise called Honest Conversations. And it’s tricky because I could let the 5% dictate the direction of our organization and abandon this particular tool.
But the reason this tool is so important is because as I’ve done research over the years, you absolutely have to have a way to take inventory of what is most important to a client. And you say, well, just ask them. Of course, we could just ask what’s most important to you. But we’ve gone two or three steps deeper and said, is there a better way to ask?
I actually went on this journey of trying to understand is there a better way to ask what’s most important to a client. Several years ago, might have been five years ago and I went down this journey and I hired a coach, a Harvard guy, and he coached me specifically. And I in turn passed along a lot of the content to my team in this specific area of study called behavioral finance.
Behavioral Finance is a collision of psychology, neuroscience, and traditional finance. The traditional finance in which I learned at undergrad with Henry Markowitz kind of stuff, asset allocation kind of stuff. But it takes upon the basic premise of traditional finance and adds the element of human to it, which is only slightly more important than the numbers. But the numbers matter.
But for years I discounted the human element, kind of brushed through them, and then it hit me that I had been discounting the human element way too much and I needed a better process as an organization to really capture the heart of our clients what’s most important so that when we capture it, we can not only help them make better decisions, but also ensure success on what whatever goal that they have and make sure that goal is aligned with what’s most important to them.
And this is this process of understanding people’s goals and really, really understanding them extremely well and memorializing them, actually documenting them and referencing them and mapping the decisions that we make to them can get very deep. And that’s what’s called behavioral finance. A whole area of academic study that exists today. I was inspired not only for going down this route at an inflection point in my career, but also through a book that I read that had sat on my desk for four years because it was so stinking thick.
And it’s called Thinking Fast and Slow by Daniel Kahneman. And Daniel Kahneman is a Nobel Prize winning author, and he did some incredible research in this space. And I want to talk a little bit about this research, and you can certainly check him out online. You can read his book, or you can find summaries of this book, but he has become the grandfather of nearly all things behavior today, not only in the area of behavioral finance, but almost anything cognitive related.
I think I was I was referencing James Clear, and I would bet that Daniel Kahneman is in the book Atomic Habits and most anything today you’ll read about Daniel Kahneman. So now that I have brought that name to your attention, you’ll find him almost everywhere, his book is remarkable. And also let you know, just have this point of reference.
Kahneman’s work is a built upon another man, Viktor Frankl, who wrote The Man in the Mirror. I’m thinking real quick, Viktor Frankl, Man in the Mirror. I might be getting that confused. I’m so sorry. I wish I could go back and edit this because I don’t want to mislead you, Viktor Frankl’s book is not Man in the Mirror.
Anyways, Viktor Frankl. I’m laughing at myself because I have a getting all my books crossed. But Viktor Frankl’s work was rooted in his experience being in a concentration camp. So, I think about this. Kahneman’s work was built off Viktor Frankl, Viktor Frankl’s experience in the concentration camp was built upon the word of the Lord. So, you see how God has kind of used all these people today and everything that they come up with in behavioral finance is rooted in God’s Word, so it can all be traced back.
So that’s fun for me to kind of trace those things back. But let’s look at Kahneman’s work for the sake of time. I want to make sure that you understand there’s two parts of our thinking that you really need to be aware of. System one thinking and system two thinking. Now, system one is, they’re two different ways of thinking.
System One is very fast, it’s unconscious, it’s automatic, it’s effortless. What you see is what you get. It’s 98% of all of our thinking. It’s our system one thinking. I mean, it’s really, it’s effortless. Think about opening your financial statement and seeing it have a negative or you lost money and then you freak out. That’s a system one thinking like, oh my gosh, I’m losing money.
And then maybe even you act on it, and you call your advisors say, get me out. That is system one thinking or looking at the TV and seeing red numbers. The Dow down 3% today. You freaking out, you getting sick, you losing sleep. That is System One thinking. Going a few steps deeper here even if you see an airplane crash and say I’m never going to fly again, that’s system one thinking, that’s anchoring to a recent event that has a low probability of future outcomes.
A school shooting. I’m never going to put my kids in public school because of school shootings. Those are system one. And media is oftentimes irrational thinking, not rooted in probabilities or logic. And again, it’s 98% of our thinking. And we make 35,000 decisions every single day, 35,000 decisions every single day. And so, we have to have this system one thinking because we can’t sit there and just whiteboard out all the probabilities of success and various situations.
Should I have ice water or not ice water? Should I have room temperature, water? Should I put lemon in it, or should I put lime? You know, like we don’t have time for all that stuff. We’ve got to use this System One thinking, and that’s why it’s 98% of all of our thinking. But there’s this other part of our thinking called system two thinking.
And this System Two thinking is deployed based on everyone’s unique wiring at certain events in life, oftentimes with kids and marriages and hopefully with money. But this is more controlled, it’s more logical, oftentimes skeptical. It does take effort. Sometimes you can feel the wheels turning. I mean, it’s a little bit more calories that you’re burning using this system two type of thinking.
And it and it can be, you know, rational. It could be very rational. It’s not just automatic. It’s just not on autopilot. But we need both. Like, you know, if I’m going to go buy toothpaste, I think about if I were to turn this system two the logical, rational toothpaste, deliberation exercise, and you see thousands of variations of toothpaste, I mean, Aquafresh alone has, you know, ten different variations.
If I were to turn to system two thinking I would never get out of the grocery store and neither would you, right? We would spend all this time deliberating in the aisle, maybe even deliberating before our prep time, before the grocery store. So, we have to use the System One thinking on a lot. And then every now and again we turn it on for System Two thinking, maybe it’s when we’re buying a steak, maybe it’s when we’re buying milk or something.
There might be certain events in our grocery experience that we turn on the system two thinking, but we use something called heuristics, oftentimes that are just rules of thumb that just lead to shortcuts. And it’s healthy. But we have to be aware specifically when we’re dealing with a lot of money and financial decisions that these two types of ways of thinking exist.
Because otherwise, if we don’t recognize them, we can act on this System One thinking which is considered the fast brain versus the slow brain. We can act on this fast brain. And those decisions could be very expensive. And I think that we also have to recognize that that the marketing environment tends to cater to our system one thinking like all of the marketing efforts out there right now, they want you to avoid the System Two for a logical, unemotional thinking.
They want you to make an impulse buy, right? We’ve heard of impulse buy, and they’ll do it in so many manipulative ways. I’ve seen, you know, they’ll give you dark chocolate in a high-end furniture store because they know that increases the probability of buying. But there’s a ton of different ways that they can manipulate you.
You just have to be aware of those. You can look you can look these up. They’re called cognitive biases. You can nerd out on them all day long if you want. Anchoring, availability bias, loss, aversion, framing, sink costs, sunk costs, bias, all kinds of biases that all of us give. Let me give you an example. As an example, anchoring is one that is done all the time.
So, if I were to ask a group of people, you know, was Gandhi more than 114 years old when he died? And then I asked them, okay, so, you know, some people said yes, or some people said no. And then I said, okay, well, how old was he when he died? And let’s say the average answer was 90.
Okay. But then I asked another group of people, I said, okay, was Gandhi more or less than 35 years old when he died? They answered, yes. Now, okay, how old was Gandhi when he died? And they said, well, I guess on average he was 50. See, I manipulated the outcome of those answers just by anchoring one group of people to 114 in another group of people to 35.
So, it’s really not uncommon for organizations and marketing firms to get you to anchor to certain things and then ultimately get you to do what they want. So, we’ve got to be very careful. How do you know when to know when to use your fast brain or slow brain? I mean, fast brains kind of automatic, the system one.
But how do you know when to deploy this more calorie burning a little bit more effort slower brain? Well, certainly when there’s more zeros involved, I certainly slow down right. And certainly, when there’s decisions that frankly I can’t afford making a bad decision and that there’s no, you know, turning back like I can’t unwind that decision, especially in business.
Like when I make business decisions, sometimes I make fast brain decisions just because I’ve got other things to do. But if I’m making a fast brain decision, it’s not going to be like a ten-year contract. Like I’m going to make sure that, hey, I’m making a decision, but what’s the out clause in this? Oh, there’s no contract.
Okay, make the decision. Worst case, I lose 500 bucks. I’m out next month. So, there’s times where you can definitely say, okay, I’m going to let my fast brain make this decision so I could save calories in my brain for the really more important stuff. So that’s oftentimes how you do that. But also, I think it’s very important that you take time, even most important.
That’s why we do the Honest Conversations exercise. In this exercise, we take inventory of what’s most important to you. So, when decisions have to be made, we say, how are those decisions aligned with what’s most important to you? For example, I’ve had clients say, well, you know, I’m retired, and I want to get a gym membership, but it’s too expensive.
It’s like $300 a month where I want to go because whatever, let’s say it’s luxury. And I said, well, wait a minute, let me stop you real quick. Let me reference this. You said that one of your top priorities in life is taking care of your health. So, tell me how this decision is going to help or hurt what you told me was most important to you.
So, it’s having that consistency in your decision making with your money really, really helps you be sincere and use that slow brain. In that case, the client may say, Yeah, you’re right. I did need to make this decision because I did say that was my priority, being healthy and it still is. Well, good. Let’s make the decision. We’ve already recognized you have the money.
I think it’s important to you because you told me it was important to you. You told me when it was important to you, when we were rational, when we were sitting down unemotional, and we developed this on Honest Conversations. So that’s why the Honest Conversations exercise is so important. Not only that, but here’s where it’s super, super important. It gives the non-CFO spouse, somebody who generally doesn’t like numbers, a way to participate in a money conversation, to be able to say, hey, can I at least tell you, honey, what’s most important to me?
I don’t know financially how we make all this connected, but can I tell you what’s most important to me, sweetie? Because whatever decisions that we make together, I just want to make sure that you honor what’s most important to me. And so, a behavioral finance exercise allows that non-CFO spouse, the one that hates talking about money, the one that hates talking about finance, to have a voice.
So that’s part of the reason why we’re continuing to stay committed to the Honest Conversation. If you if you’re not a client, there’s an alternative to the Honest Conversations. And this is called it’s under the think, and the number two, perform, website. Think2Perform. If you go to that website, there’s a values exercise where you can go through that values exercise, it’s free and you and your spouse can do that and then use that as a way to anchor your decision making.
When your amygdala, the little, tiny second part of your brain gets hijacked and you’re having a hard time turning on that system two. It’s just not cranking. So, you say, okay, now we’re having we’re really emotional right now. Let’s go to our values. And that values exercise, Think2Perform is a good tool. So, we’ll continue to lean into behavioral finance as a key element of our financial planning experience, not because clients are out there saying, we really want this, we really want this. It’s because we really know that it’s needed. After working with thousands of people over the last two decades, we want to make sure that we help people make the most rational decisions.
What’s most important to them, not us, and align those decisions with unemotional decisions anchored in, but a process that isn’t rooted in heuristic and rules of thumb, but rather rooted in what we call today an Honest Conversation. So, I hope that today helps you kind of get a framework of how we do things. And I hope it gives you a little insight into this world of behavioral finance.
And check out Daniel Kahneman’s work I think you’ll enjoy. It’s a very thick book. So, if you don’t want to read the book, just check out CliffsNotes. There’s plenty of them online and videos on YouTube. And remember, as always, you think different when you think long term. Have a great day.
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