A heuristic is a mental shortcut to a quick decision, sometimes referred to as a "rule of thumb." And while heuristics are often helpful, they can sometimes lead investors astray when used to make important investment decisions.
In his book, Thinking Fast and Slow, author Daniel Kahneman describes two pathways in our brains that help us make decisions. The larger part of our brain, the sub-cortex or what we'll call System 1, does the "fast thinking" for us. System One operates automatically with little to no effort or control. Meanwhile, another part of our brain, the pre-frontal cortex or what we’ll call System Two, is the part of our brain we use when we concentrate and carefully consider all our available choices.
Applying this to the investment world, sometimes investors can get into trouble by making quick decisions rather than evaluating all the information at hand.
Let’s take a look at some examples of how our brains may make quick decisions vs. carefully considering all our options:
