Several years ago I read an article using research to illustrate how the brain reacts to gain and loss. It seems the amount of pleasure we receive from a gain of $1000 is not equal to the amount of sadness we feel for a loss of the same amount. Our capacity for regret seems to outpace our capacity for happiness.
In fact, it turns out that happiness is fairly transitory. Brian Christian in “The Alignment Problem” writes that one of our hormones for creating a sense of happiness - dopamine - plays games with us. While serotonin stabilizes our moods and feelings of well-being, dopamine sends a message to the brain that things are going to be great but it’s not always true. If there is a drug for hope - this is it. Dopamine creates the expectation of things being better but sometimes the hormone is writing checks that our brain can’t cash. Eventually, the predicted change doesn’t come and the equal and opposite negative prediction error is sure to follow. “It seemed like everything was going to be so great…” We can chemically fool our brain’s prediction mechanism - but not forever. However, genuine happiness comes from things actually going well and not simply the anticipation of things soon being even better than expected.
There have been a number of studies done of day traders becoming addicted to the rush of dopamine which only increases their levels of risk while decreasing their impulse control. Ironically, no matter how successful their trades, the results are never enough to meet their ever increasing unrealistic expectations. In time, the money doesn’t matter as much as the expectation of more. In one experiment, participants were asked to make bets while making and losing money. Along the way, they were asked, “How happy are you right now?.” The researchers concluded that however happy it made the participants to make a winning bet, five bets later 92% of that impact had disappeared. “Anything that happened more than ten bets ago may as well never have happened. This meant that the subjects’ happiness had virtually nothing to do with how much money they actually made.”
The article I read went on to show several applications for normal investors. Some people will hang on to a losing investment out of “loss aversion” and hope it will somehow come back to the level at which they bought it. It’s easy to think the stock remembers your purchase price and is working to get there again so you can sell. Unfortunately, equities do not have memories. Others will sell a stock too soon that has gained value because they want to feel the concrete but momentary pleasure of making a bit of money and as well avoid the risk of somehow losing their profit.
The best investors I know understand the value of limiting loss and focusing their full attention on new opportunities. Training yourself to take the loss in order to invest in something that has potential for gain seems to be going against a hard-wired bias. We have a difficult time accepting the pain of the actual loss and focusing on potential rewards of a future gain.
Staying The Course
I’ve been watching my own emotions as well as those of people around me as they react to the substantial market losses we have been experiencing over the last several weeks. Some of the significant appreciation of last year is being pared back in the first few days of January.
A few are giving in to panic.
Some are licking their chops (that may be a little overstated) thinking about buying opportunities.
Others are totally immobilized, angry or looking for someone to blame. They want to personalize the reasons for their loss so they blame the Chairman of the Federal Reserve or the President and his economic advisors for intentionally creating inflation.
Some have gone to bed “rich” and awakened to a market that has moved them suddenly to “not rich” and that’s a tough pill to swallow.
A number are wishing they had given away more while secretly thinking God might have then limited their losses as a reward.
Others are just dealing with it and trying not to let their paper losses do any more damage to their sense of values than the paper gains did to their identity. Neither gain nor loss has changed them. It’s not fatalistic or naïve. Os Guinness used to say about the Puritans, “It is as if they had swallowed a gyroscope.” That’s what I want to feel more than fleeting happiness based on unrealistic expectations or the impossible avoidance of loss. I don’t want to be writing emotional checks that bounce.
I want to stay the course.