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Improve Money Habits With System 2 Thinking

Image with a pink heart on the right with a pink background. The left shows a blue background with maths equations written in whiteboard style.

How well are you utilising your two thinking brains?

When we make decisions, we do so by leading with efficiency and cost-effectiveness. Our brain uses up 20% of the body's energy, so this is a wise strategy. We rely on the information we already have stored in memory, the assumptions we have about the environment and allow our emotional state to guide us.

Now, it is well and good to base decisions on these factors for the sake of preserving energy, but this oftentimes leaves us with suboptimal outcomes. Making decisions this way can be described as using our System 1 brain, instead of our System 2 brain. You can read more about this in Thinking, Fast and Slow by Daniel Kahneman.

Two Thinking Systems

🧠 System 1

This term is used to describe the part of the brain you use to make quick decisions - it happens in the amygdala and the basal ganglia. These decisions are made unconsciously and automatically, relying on memories, emotions and biases to make quick and effortless decisions. You use this type of instinctive thinking when you roll out of bed and start walking on your feet, take your usual route to work or still go out on Friday night thinking you will stick to your saving plans!

⚙️ System 2

System 2 thinking, however, is the slower, more logical and effortful part of your brain, where you’ll be engaging the pre-frontal cortex. You’ll use your rational mind to solve a maths problem, find a new route home after a train breakdown, or calculate your tax return!

When you use your System 1 thinking you are basing decisions on emotions, beliefs and biases, such as feeling excited or bored, thinking a higher price means more value, or relying on familiarity.

Interesting to know: The implementation of auto-enrolment pensions was based on behavioural science insights into this type of thinking. It is based on the fact that we are more likely to go ahead with the ‘default setting’. So, as your pension contribution is set up to be ‘automatically’ paid, you will more likely leave it as is, thus contributing to a pension! Genius!

This type of thinking (System 1) can of course be problematic when it comes to our personal and business finances. System 1 thinking is responsible for:

  • Impulse spending and not staying within budget

  • Staying with the same bank you had since you were 16 years old

  • Forgetting about subscriptions and not cancelling them after the free period

  • Not updating your prices as sales are still coming in, not realising you’re making a loss

A purple background with a pink brain in the center. Text on the left reads 'System 1, fast, emotional, intuitive, automatic', text on the right reads ' System 2, slow, rational, logical, effortful'

Improve Your Decisions:

The following tips are based on using friction as an intervention. When you use friction, you are putting obstructions in place that force you to stop, before making a financial decision or stop you from making the decision altogether.

✔️ Use frameworks

Reduce impulsivity by following a pre-agreed process or checklist. Building a new habit of checking a list or framework before making a decision will force you to slow down and be less impulsive. Thinking of buying an expensive new jacket? Check whether you can buy the jacket four times over and still have enough for bills this month and the minimum emergency savings balance left over.

✔️ Make spending harder

Put blockers in place that make it hard for you to access your money. Try removing Google and Apple Pay from your phone, or delete your favourite shopping apps and put your savings into a savings account that requires a notice period before you can withdraw money.

✔️ Increase awareness

Raising awareness about how your brain works can be rather effective in debiasing your thinking. Try adding another decision maker/sounding board to your decision-making process. Having someone with a different outlook on things will help you identify blind spots and missed opportunities for optimisation.

Overriding System 1 thinking is not easy, but through practice and commitment, you can make significant changes to your decision-making and financial circumstances.

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