Opinion – Grain to Grain: Find out if you are reflective or impulsive in investment decisions

When it comes to investment, we tend to think that our decisions are very well reflected. But is this really what happens?

How you approach tasks may explain your propensity to fall into investment traps. These traps occur because of the financial biases that we usually tend to follow. Complete the short quiz below and then explain what it represents.

Answer the three questions:

1- A ball and a bat together cost R$1.10. The bat costs R$1 more than the ball. How much does the ball cost?
2- In a race, if you pass second place, where are you?
3- If 5 machines take 5 minutes to produce 5 devices, how long does it take for 100 machines to produce 100 devices?

This test is known as the Cognitive Reflex Test (CRT). It sounds simple enough, but this test was used in Shane Frederick’s work entitled Cognitive reflection and decision making and published in the Journal of Economic Perspectives in 2005.

In fact, the second question is taken from the work of Maggie Toplak and others from 2011. I used this question as I found it more interesting and following the tip of Nobel Prize winner Daniel Kahneman, who was the creator of the first question.

The test sounds simple, but as Frederick describes in his article, its result in assessing the cognitive level of respondents is powerful. This test measures your tendency or ability to escape an intuitive but wrong answer, to commit to thinking carefully about the answer.

Many people when faced with financial decisions end up acting impulsively, believing that following their intuition is the best answer. However, an accurate analysis and reflection on the problem could generate a different answer and possibly better results.

Let’s look at the issues.

In the first question, intuitively, most tend to answer that the ball costs R$0.10. But in this case, the bat would cost R$1.10, as it costs R$1 more than the ball. This sum results in R$1.20 and not R$1.10 as the problem describes. The correct answer would be to say that the ball costs R$0.05, as in this case the bat would cost R$1.05 and the sum would be correct.

For the second problem, intuition leads you to answer that you would be first. However, if you pass second, now you are placed in second place.

Impulse leads us to say that it would take 100 minutes to produce the 100 devices, but realize that each machine takes 5 minutes to make one device. So, if there are 100 machines, in 5 minutes, they will produce the 100 devices.

Don’t feel bad if you didn’t get the answers right. In Frederick’s research, several students from prestigious Harvard, MIT and Princeton universities also achieved low levels of success.

The important thing is to warn if maybe you are getting carried away by easy answers when facing your decisions and thus falling into recognized behavioral biases.

It is most appropriate in investment decisions to avoid the impulse of the intuitive response and stop to think carefully about each scenario and potential biases we may be facing.

Michael Viriato is an investment advisor and founding partner of Investor’s House