Rational vs. Irrational Thinking
There is a world of difference between rational and irrational thinking. If you are prone to thinking in
“all or nothing” terms (dichotomous thinking), it is easy to believe that thinking what is not rational
must be irrational. It is not true. A vast array of intuitive thinking modes lay between the extremes.
Let’s start at the rational. How do we think through a simple problem about familiar items that easily
lends itself to a mathematical solution? For example, let’s say that a bat and ball are in a package
that costs $1.10. After some research, we discover that the bat costs $1.00 more than the ball.
What should you be willing to pay for the ball alone?
If your answer is “$0.10” then you agree with the vast majority of people faced with this particular
problem. The answer is $0.05. The ball is $0.05 and the bat costs a $1.00 more or $1.05 for a total
of $1.10!
The fact that most answer $0.10 is not a reflection of poor math skills. Studies show the better
educated you are the quicker you will arrive at the wrong answer. The problem isn’t math; it is the
intuitive thinking shortcut. It was too familiar, too small and too easy to think out. Psychologists
theorize that it is not that our intuitive processes are poor at math. These shortcuts aren’t a faster
way of doing the math; they’re a way of skipping the math altogether.
Our intuition is a set of shortcuts around discipline. They play a vital role in our thinking because
we often need to make decisions based on less information than rational thought requires.
However, intuition often leads to less than optimal decisions. If we feel familiar with the problem,
intuition is usually our “default” decision process even if there is sufficient information to make a
correct decision.
People are often content to trust a plausible judgment that comes quickly to mind. It is familiar.
But, at the end of it, most are willing to pay twice the amount the ball is worth. It is no wonder
marketing people love to exploit these shortcuts.
There was a commercial for a razor blade back in the 1970’s. It challenged men to shave half their
face with a competitor’s razor and the other half with their new razor. They then would run a credit
card over their skin to feel and hear which card cut closest. While it was a successful marketing ploy,
it was a false test. It turns out that our beards are right and left handed. Your beard grows slightly
thicker on one side than the other. The results of the card test had little to do with the sharpness of
the blade. It was successful marketing because we intuitively thought it was a valid test.
We use our intuitive process most often when the task appears to be easy and comfortable.
Daniel Kahneman, in his book Thinking, Fast and Slow relates studies that test subjects with a list
of problems like the bat and ball. When the problems are on white test paper and in normal fonts,
90% of the subjects make at least 1 error. However, when the problems are in “washed out” ink
using jumbled fonts, only 30% make errors. It appears making the task slightly more difficult
improves the decision making. How counter-intuitive!
It's very important to step back and examine your decision. It's important to separate whether a
decision is done because that's how we've always done something (familiar) or whether it is the
right thing to do.
An underlying thread to all this is “Beware of the familiar.” We often unknowingly adopt outdated
assumptions as “truth”. This is especially true when investing in equities. Prices change daily as
does the companies’ competitive environment and eventually management themselves change.
Once you think you really know a company, chances are strong you don’t. The investment
processes should be predominantly re-examining what we think we already know and testing
assumptions. The world of investing is always changing.
Barton Peters
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