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Behavioral Finance and the Two Systems in Our Brian and Quick Guide to Volatility

March 23, 2020

We want to thank those of you have commented to us that you have found these helpful to get through these trying times. Know we are writing these for you. We are here to help navigate through this. These happen infrequently but when they do it can be a doozie.

As I am writing this on Thursday evening, the U.S. stock market experienced its worst day since October 1987 which was known as Black Monday. To give that perspective, on October 19, 1987, the U.S. stock market fell 22%. Today, it was a bit over 10%. What is an investor to do? Some folks are actively buying. Some folks are selling. Some folks are looking for reassurance. Some are saying, “This too shall pass and what am I going to do anyway?” Others may be saying, “If I hear one more time to keep a long-term perspective, I am going to pull my hair out.” There are a lot of responses. No matter what you are thinking, someone else somewhere is probably thinking it too.

We at Harford Financial Group really embrace what is called behavioral finance. Quite simply it is the psychology of money. News flash, we as people are irrational, biased, have blind spots, and have the ability not to see we are irrational, biased and have blind spots. The human mind is an incredible thing. We can create, emote, love, think, and do so many things. But there is no perfect system in nature and hence we have all these irrationalities. Behavioral finance combines the discipline of psychology with economics and finance. The challenge with traditional economics and finance is that its central premise is we as people make all our decisions based on rational decisions. I don’t know about you but I can get hangry, that irrational anger you get when you’re are hungry. That is just one instance. I know my friends, family, and co-workers could cite more.

The reason we tell you this is it is important to understand that times like these, we are not alone when our emotions and rational brain are in conflict with one another. Daniel Kahneman, Nobel winning psychologist who has done a lot of research on behavioral finance talks about how figuratively we have two systems in our brain. System 1 operates automatically, reflexively and it is the fight or flight part of our mind. System 2 allows advanced mental and complex thinking. One system is not better than the other. Each has pros and cons (If you want to learn more about this I highly recommend, Thinking Fast and Slow. Awesome book!).

We want you to know all this because that anxiety, stress, and fear you may be feeling is your system 1 at work. A lot of folks would just tell you to discount it and not follow it. Others may call it, trusting your gut and completely follow it. The challenge is neither method is 100% fool proof. Sometimes my gut has allowed me to make amazing decisions. Other times, it has failed me miserably. I can imagine it probably has happened that way for you too. We say listen to it and know it can be a sign but don’t just blindly follow it. It is like other parts of your health. When you are pain, understand it could be a sign that you need to do something but also do not assume the worst. This is where you want to use both your system 1 and system 2. Take a breather, do your own research, talk to people you trust and whose opinion you value based on competence and good intention. Hopefully, you feel we can provide that sounding board and guidance. Hope this helps!!

The attached guide is a Quick Guide to Volatility provided by one of our partners. You can click on the link and it will take you there. It has good detail but is not too wonky!

Click HERE for your Quick Guide to Volatility.