The StressTest column appears every Sunday on Fool.com. Check back weekly, and follow @TMFStressTest.
Today, there are a lot of good reasons to invest in Bank of America (NYSE:BAC). There are also a lot of good reasons to not invest in Bank of America.
Those good reasons are worth knowing. But that's an article for another time. Right now, I want to talk about one really bad reason for not investing in Bank of America.
The genesis of your mistake
In his book Thinking, Fast and Slow, behavioral finance expert and Nobel laureate Daniel Kahneman explores two theoretical thinking systems that he creatively calls "System 1" and "System 2."
System 1 is your quickie system. It's the system that's behind all of the wonderful feats that Malcolm Gladwell talks about in Blink. It's very effective over a large number of day-to-day situations, like: What should you do when the traffic light turns green, but a bicyclist is racing through the intersection?
When you're working on your list of holiday card recipients next year, consider adding System 1 -- for the most part, it's a darn good friend.
But there are situations where System 1 gets it completely wrong. In those situations, we're better served by using our System 2, the slower, more plodding, deliberative system. System 2 resists the quick conclusions that System 1 thrives on and reasons out the best solution.
Unfortunately, System 2 also tends to be -- as Kahneman puts it -- lazy. Unless you mindfully override System 1 in favor of System 2, System 1 will plow ahead with the quick, and wrong, answer.
What's wrong? In a word: substitution
In his book, Kahneman details many situations where System 1 can deliver a faulty conclusion. Here's the one we care about right now:
I propose a simple account of how we generate intuitive opinions on complex matters. If a satisfactory answer to a hard question is not found quickly, System 1 will find a related question that is easier and will answer it. I call the operation of answering one question in place of another substitution.
Kahneman goes on to illustrate an experiment that shows how substitution can work. The experimenters asked a group of students how happy they were and then followed up by asking how their dating lives had been lately. They analyzed the responses and found that there was little connection between the two.
They went on to ask another group the same questions, but in the reverse order. So, they asked about the students' dating lives and then about how happy they were. This time, the results were highly correlated. Why? Here's what Kahneman writes:
"Happiness these days" is not a natural or an easy assessment. A good answer requires a fair amount of thinking. However, the students who had just been asked about their dating did not need to think hard because they already had in their mind an answer to a related question: how happy they were with their love life. They substituted the question to which they had a ready-made answer for the question they were asked.
Great, but what does this have to do with Bank of America?
Glad you asked. If the question we have in front of us is: Does Bank of America's stock make a good investment right now? One thing that we can say for sure is that we're looking at a difficult question.
To faithfully answer that question requires that the investor have a good amount of knowledge about how the business of banking works, what the current industry climate looks like, how Bank of America's operations in particular stack up versus the rest of the big banks and the industry as a whole, and so on.
All of that analysis can then inform a calculation of various probabilistic scenarios about what kind of results Bank of America will report in the years ahead. That, in turn, will inform a view into what Bank of America is worth. That can be compared to what the market currently says Bank of America is worth, and a determination can be made as to whether it looks like a good investment.
But like I said, that's a darn tough question. And it's a lot of work.
However, there's a much easier question: How do I feel about Bank of America? You don't have to be an experienced investor to answer that one. In fact, you don't have to be able to differentiate between price-to-tangible book value and quiche Lorraine to answer this question.
For many investors, the insidious substitution heuristic may be at play, sneakily replacing the meaningful question of "Does Bank of America make a good investment?" with "How do I feel about Bank of America?" Given all that's gone on since 2007, we can easily guess the answer that most people come up with to the latter question.
Another tool for the toolbox
This certainly isn't just a Bank of America issue -- though because of the strong opinions about the "feel" question it's a better example than, say, 3M. How many people have you heard actively decrying 3M?
Figuring out whether a company makes a good investment isn't an insurmountable question. But it's a challenging question and one that takes some work. So it's critical that investors make sure that when they are making a call -- be it to buy something or to avoid buying something -- that they're actually answering the question that they think they are.