John Wooden, Hall of Fame basketball coach at UCLA (and considered one of the greatest coaches of all time in any sport), said, “A coach is someone who can give correction without causing resentment.”¹ That’s a critical insight as advice given, but not followed, is of little use. The best financial professionals understand this and coach throughout the cycle—modeling the good behaviors when times are good, so they don’t have to modify the irrational behaviors when emotions run high.
But, as much as we like to prepare clients for the inevitable downturn, we often find ourselves in the role of the psychologist, talking otherwise intelligent and successful clients out of acting irrationally.
Rationality versus intelligence
Keith Stanovich, professor emeritus, applied psychology and human development at the University of Toronto, has studied the link between intelligence and rationality extensively. He defines rationality as the ability “to adopt appropriate goals, take appropriate actions given one’s goals and beliefs, and hold beliefs that are commensurate with available evidence.” Few would argue with his definition, but what’s most striking about his research is the low correlation he’s found between someone’s IQ and their ability to make rational decisions. In fact, he’s advocated for replacing IQ (intelligence quotient) with RQ (rationality quotient) to test a person’s ability to make good decisions.² He’s isolated two primary gaps between them—one is a processing issue and the other is a content (data) issue. Here, we focus on the processing aspect.
Dual processing theory
As much as we like to think of ourselves as individuals, the way we process information and make decisions is actually quite common to all of us. Seymour Epstein, Ph.D., clinical psychologist at the University of Massachusetts, is considered a pioneer in the area of dual processing theory. His work suggests we have two systems for making decisions—system one and system two—each controlled by different regions of the brain. In effect, we have two distinct computer systems in our head—each programmed to process information and make decisions differently—and we can seamlessly toggle between the two systems based on the decision at hand. System one is fast and reflexive—capable of generating an immediate response in any situation but also prone to jumping to conclusions. It’s an ancient and intuitive way of thinking, and from an evolutionary perspective, it was more concerned with being safe than right—a vital trade-off for early humans who didn’t have time to evaluate whether that rustle in the grass was the wind or a stalking tiger.
System two evolved much later and is slower and more deliberate, capable of following a series of steps to arrive at an accurate answer. From that perspective, system two looks before it leaps. Researchers also believe that system two is aware of the thoughts of system one, but not vice versa. This places the burden of controlling the impulses of system one on its more logical sibling.
Why does all of this matter? Most decision errors reside in system one thinking because it relies on emotion and preferences—how we feel versus what we think. System one is also reliant on the use of heuristics (such as ballpark estimates and rules of thumb), which are prone to estimation “speeding” errors. As it relates to investing, there’s another factor to consider: Researchers have established that we process investment losses in the same area of the brain as mortal danger.³ This helps explain why normally rational investors who understand the virtues of buying low and selling high tend to do the opposite when markets are in turmoil. As a result, understanding each client’s predisposition to relying on their intuition or logic can be useful, especially in stressful situations.
Researchers have established that we process investment losses in the same area of the brain as mortal danger.
Behavioral coaching: the PAUSE framework
Coaching clients through the uncertainty
Understanding how people process information and make decisions is a critical first step to becoming an effective coach. Developing the ability to shift the investors mode of thinking to the more logical, long-term focused system two is a critically important skill that the financial professional brings to the relationship.Using PAUSE can encourage clients to think rationally about their investment decisions and in times of deep uncertainty help them see the difference between what’s plausible versus what’s probable.
1 The Naismith Memorial Basketball Hall of Fame, John R. Wooden. 2 “Rational and Irrational Thought: The Thinking That IQ Tests Miss,” Keith E. Stanovich, Scientific American, January 1, 2015. 3 "Op-Ed: Don't let coronavirus market swings hijack your brain", Stacy Frances, CNBC.
This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector, or index. The information contained here is based on sources believed to be reliable, but it is neither all inclusive nor guaranteed by John Hancock Investment Management.
This material is not intended to be, nor shall it be interpreted or construed as, a recommendation or providing advice, impartial or otherwise. John Hancock Investment Management and its representatives and affiliates may receive compensation derived from the sale of and/or from any investment made in its products and services.