Fighting System 1

The human mind is not built for investing. We are far too prone to biases and a good story, and annoyingly good at convincing ourselves we're thinking rationally. What can we do about it?

I’m currently about a third of the way through Daniel Kahneman’s famous book, Thinking, Fast and Slow. It’s been an excellent read so far and, while it’s not about investing but psychology, I’d recommend any investor to read it. For the time being though, here’s a summary.

The central premise of the book is that we have two distinct systems of thinking in our brains.

System 1 is fast and automatic, with no effort and no sense of voluntary control. When you hear and immediately understand a sentence in your native tongue, when see someone’s face and immediately know what mood they’re in, or when you look at 4 or fewer of a certain object together and instantly know how many there are without counting - that’s System 1. You couldn’t avoid doing any of those things if you tried. Crucially, while System 1 can make certain broad quantitative assessments with relative ease (e.g. knowing approximately heavy a bucket of water is gonna be before you pick it up), it’s generally pretty bad at mathematical and especially statistical thinking (google the librarian vs. farmer problem).

System 2, on the other hand, is slow and deliberate, and very effortful. When you carry out a difficult computation in your head, or try to recite the alphabet or a well-known song backwards, or try to single out a voice in a crowded room, that’s System 2.

System 2 is also a lazy bugger. You’ve no doubt felt this before - it’s really quite mentally draining to think hard and deep, and after maybe 10 or 15 seconds, we are likely to seek an escape - maybe we’ll whip out our phone, or decide it’s time for lunch, or maybe we’ll just take a sip of water and stare into the distance for a few seconds. Interestingly, it’s very easy to tell when System 2 turns on and off - not only does our heart rate rise measurably, but our pupils dilate by up to 50%. The second we complete the difficult task, or give up, they shrink back to their normal size. The brain will also have used significantly more glucose during that intense processing than it otherwise would have, and our blood sugar drops accordingly. We will avoid using System 2 whenever we can.

One crucial feature of the interaction between the systems is how we narrativise things. When we learn a surprising new piece of information, it’s not processed in its raw form by System 2 - instead, System 1 looks at it and generates a number of plausible explanations, and System 2 decides which narrative to accept, based in large part on how well it fits with previously held beliefs. But this processing is effortful, and we will seek to minimise it, often settling on an answer more quickly than we should, or substituting easier questions for harder ones.

It’s clear to see which system we should ideally be using for investing. However, we’re simply not built to employ System 2 for hours at a time - System 1 will try to take the weight off. This will inevitably lead to errors in our judgement, as System 1 leaps to judgements, fits new information to those judgements, and substitutes easy questions (“do I like the product"?) for hard ones (“in which direction will the company’s profits go?”).

Match Group - An Example

I’m writing this post because I’ve just begun looking into Match Group, owners of Tinder, Hinge, Match.com and OkCupid, and I can already feel System 1’s pull. The story my System 1 has decided to construct is centered on a comparison to Meta. Like Meta, Match owns some very addictive apps, which saw excellent growth for a long time, and carry strong network effects. Like Meta, their share price peaked in 2021 at a pretty high multiple of earnings, then began declining as user growth slowed/reversed. Meta fell from $380 to just $93, despite the underlying business not changing a huge deal (there were some negative developments for sure); MTCH fell from $175 to <$30.

But we all know what happened next at Meta - user growth began tentatively improving, revenue started increasing again as the ad market picked up, and Zuckerberg began to cut back on costs. The stock has since risen to ~$500, a return of around 435% from the low (it still blows my mind that a mega-cap with an incredibly stable underlying business can be SO volatile). Match, on the other hand, has languished, and still sits at $30, just 12.4x 2023’s earnings.

The story, therefore, is that Match are just going through a temporary lull like Meta did, and the market is punishing the hell out of them for it - when they inevitably return to growth, the market will reward them like it did Meta. It isn’t a difficult story to believe - I’ve used a couple of their apps, and I’m fairly sure that if I was still single I’d still be using them, even though I certainly never got enough out of them to justify the time I spent. It fits with my personal experience that their usage would continue growing. It’s also a story which is very tempting, almost exciting to believe, given how well Meta did.

Accompanying this story, there’s a familiar feeling as I research the company - that in a way I’ve already practically made my mind up, and I’m no longer trying to inform my decision to buy so much as justify it (unless I come across something particularly bad). Even as I acknowledge this, I cannot shake this feeling, any more than one can, for example, get rid of their crush on that colleague, by telling yourself he/she would clearly not be a good partner. Deciding against buying would feel like I’ve wasted all the time spent researching, and I’m missing out on a potentially large reward. It would be psychologically rather uncomfortable.

How to Fight System 1

So, what can we actually do to fight this, and make sure System 1 isn’t making our investment decisions?

Well, I’m afraid I don’t have a silver bullet. But I do have some suggestions for things that have helped me, at least somewhat:

• Read the book! Thinking, Fast and Slow is $17 on Amazon - I’m sure it’ll save you a lot more than that. My summary doesn’t do it any justice.

• Actively monitor your thinking for biases, oversimplifications and pleasant/exciting stories. Don’t just note them mentally - say out loud “System 1 is doing the talking here, and I’m falling victim to X bias/heuristic” (the big ones are covered in detail in the book). Even better, write it down - that’s half the reason I’m making this post.

• Talk to others, find dissenting opinions. There will be people who disagree with you on whether it’s currently a good investment - that’s why the stock price is where it is. Seek them out, and make every effort to take their arguments seriously.

• Remind yourself that, while often a little too emotional, the market generally isn’t stupid. It’s reasonably efficient most of the time, and if something is quite obvious that should prompt you to look very carefully. For Match Group, for example, I am reminding myself that the market loves software companies at the moment and that Tinder is a super well-known brand - the company certainly doesn’t fly under the radar with analysts so for it to be so cheap is a bit concerning.

• Remind yourself that time spent researching an investment you don’t make is not time wasted. You’re gaining more knowledge about an industry, and about investing as a whole, and you can’t be a good investor without rejecting the vast majority of the things you look into. To quote Buffett: "I only need to make a few good decisions in my life, as long as I don’t make too many bad ones." Try to enter the research process expecting to reject it.

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And as per usual, if you have any thoughts to share on Match Group (positive or negative), drop them in the comments or send me a message. Thanks!