Financial markets: risk, reward and thrill

The Ritcey Report

March 2, 2018

Why does bad behaviour feel good? Why do we make choices that are not in our best interests? How is this relevant to investing and making money?

Freud believed that pleasure driven behaviour was precipitated by a subconscious entity called the id. That’s where, according to Freud, our desire for food, drink and sex comes from. Same goes for money.

The id, argued Freud, was counterbalanced by the ego. To over-simplify, the ego acts according to the reality principle. It seeks to please the id’s drive for pleasure in realistic ways that will deliver long-term benefit, rather than bring grief.

The id, the ego and dopamine

Recent breakthroughs in neuroscience have helped refine our understanding of the way we behave (and why) and placed it on a more scientific basis. The id and the ego are all well and good, but what about dopamine?

According to the publication Psychology Today1, ‘dopamine is a neurotransmitter that helps control the brain’s reward and pleasure centers. Dopamine also helps regulate movement and emotional responses, and it enables us not only to see rewards, but to take action to move toward them.’

The presence of a certain kind of dopamine receptor is also associated with sensation-seeking individuals, or ‘risk takers’, Psychology Today adds. An excess of dopamine in only a few neurons, neurologists have discovered, make games of chance difficult to resist.

The reward-seeking thrill factor

Part of the fun of investing is that it has definite associations with chance taking. Accepting a degree of uncertainty and unpredictability is the price of admission we all pay to participate in the financial markets. There’s a reward-seeking thrill factor involved. It’s called risk.

Countering that – certainly if we’re prudent and don’t want to lose our shirt – are the steps we take to mitigate, and therefore neutralize risk. We call that risk management.

Balancing risk and reward is a key ingredient in a successful long-term investment strategy. I perform that function every day on behalf of my clients. It’s a central part of what I do for a living.

I’m also acutely aware (or try to be) of the psychological (and neurological) vulnerabilities to which we are all susceptible – especially when it comes to investing. The stakes are high. So it pays to know what’s motivating and driving our decisions.

Variable interval rewards

Recently, my attention was drawn to an online paper called The Thrill of Uncertainty2. It was written by an investment professional called Morgan Housel (co-founder of the New York based Collaborative Fund) and in it, he referenced the work of Harvard psychologist B.F. Skinner.

Skinner came up with the idea of variable interval rewards, which he characterized as ‘the dopamine rush of obtaining something important that you knew would eventually come but didn’t know when is what keeps you hunting for more.’ Variable interval rewards, he explains, are why we compulsively check email, or Twitter and Facebook.

Or, he might have added, why some investors obsessively check stock market news reports and other financial market indicators. It makes them feel in touch and on top of things. They think they’re being sensibly self-aware and analytical.

The truth is more prosaic.

They are – in reality – hooked on a dopamine-fueled variable interval reward, which can lead to self-destructive decision-making. A daily, or worse still, an hourly dose of stock market news is enough to get even the best of us hyped up.

Conclusion: hooked!

I observe this behaviour in my clients with considerable frequency and it’s one of my fundamental professional responsibilities as a wealth advisor to calm them down and urge restraint.

I’m not sufficiently cavalier to tell them it’s their dopamine-fueled variable interval reward mechanism setting them off again, though I’m tempted to.

It feels good to check in on the markets regularly. Just don’t do it so compulsively that you use it as a rationale for making impulsively bad decisions.

Dave Ritcey, The Ritcey Team, Scotia Wealth Management