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.
Behavioral coaching: the PAUSE framework
Pause begins the process by getting the client to literally pause, take a breath, and slow everything down. A simple phrase like, “Let’s talk about this for a moment, because it’s an important decision” is sufficient to get things moving along a more productive path.
Acknowledge their emotion, but not their point of view. This step is about conveying empathy, which is critical to building trust. While this may seem basic, the sequence is critical if we want to shift them from system one thinking to system two. A simple phrase such as, “I can see this is important to you and you’ve been giving this a lot of thought” helps you stay on the same side of the table as the client.
Understand their point of view. Restate their fears, but use more measured language, and ask them to confirm or clarify their response. For example: “If I’m hearing you correctly, you’re concerned that X may lead to Y and cause Z, is that correct?” Allowing them to confront their own logic without the emotions attached begins the pivot away from system one thinking to system two thinking.
Search for alternatives to their point of view. System one can make inappropriate links, assuming cause and effect relationships where none exist. This is especially relevant in the complex world of investing where there are many plausible scenarios and linkages that are, from a statistical perspective, low probability events. Making this distinction between “plausible” and “probable” can be particularly effective in making the shift to system two. Ask them to consider other potential outcomes to their scenario. For example: “Yes, it’s possible that the market could continue to fall because of X, but there are any number of other outcomes that we need to consider that are just as possible and perhaps more probable based on history.”
Evaluate the best course of action. System two is responsible for longer-term planning, something system one lacks. When evaluating a potential decision error with the client, there is often a short-term belief that is temporarily usurping a longer-term goal. Framing the discussion around how emotional decisions may negatively affect longer-term objectives can help the client complete the pivot to system two. A simple phrase like, “In my experience, there’s always someone predicting some chain reaction event as if they had a crystal ball. We’re on track to meeting your goals and that’s what matters. I just don’t see how doing Z will help us in the long run.”
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.