The thrill is wrong
January 19, 2006
Jason Zweig / Money


Sometimes investing seems like a struggle for survival against mysterious and hostile forces, but our worst financial enemy is usually easy to find: We just need to look in the mirror.

We said that we'd learned our lesson from the tech debacle in 2000; then we loaded up on real estate just in time for that bubble to begin leaking. We tell ourselves that we're too smart for get-rich-quick schemes -- most of us, after all, do manage to avoid answering e-mails from exiled Nigerian princes -- yet we still chase hot mutual funds, try flipping condos or pile into whichever stock is the "next Google."

Why do so many of us make such bad investing decisions even when we know better? A new breed of scientists dubbed "neuroeconomists" are starting to come up with some answers. Blending neuroscience, economics and psychology, these researchers are delving into how our brains work when we set out to make money in the markets.

The more they learn, the clearer it becomes that we're wired to chase the big score -- over and over again. The good news is, this research also makes it clear that we can conquer our own worst impulses. (See "5 ways to outsmart your brain.")

High on anticipation

You may think your investing decisions are the result of reasoned, careful analysis, but when scientists look at what happens in the brain of someone aiming for a financial reward, they see a brain on drugs.

Obviously a lot goes on in the brain when we invest, but it's clear that a chemical called dopamine plays a major role in the process. Not that dopamine is bad. It helps you regulate movement -- Parkinson's sufferers don't have enough dopamine -- and it focuses your attention, putting you on high alert for action and priming you for excitement.

Neurons deep in your mental basement flood the emotional centers of your brain with dopamine when you anticipate basic pleasures like food and drink, drugs and sex. For better or worse, the same thing happens when you're confronted with an opportunity for an investing gain. And in the heat of the moment, you can't turn off the messages that dopamine sends out. That's why it's important to learn how your investing brain works -- and how to lay plans to avoid acting on its impulses.

It turns out that the human brain reacts to an anticipated financial gain and to an actual profit in very different ways. When you think you might make money, dopamine rushes into a region of emotional circuits toward the lower front of your brain called the nucleus accumbens. On the other hand, when you actually get the money, your emotional circuits quiet down and your prefrontal cortex, an area in the upper part of the brain involved in long-term planning and evaluating alternatives, takes over.

I learned this firsthand when I participated in an experiment run by neuroeconomist Brian Knutson at Stanford University. When I was presented with a chance at a big gain, a dopamine rush helped set my body atingle. Actually earning the money that I had hoped to make, however, activated the more analytical upper part of my brain, yielding a kind of drowsy satisfaction.

Anticipating an investment score feels "hot," while pocketing it creates a kind of neural letdown.

Think about the power that this cycle of hot and cold exerts over the process of making investing decisions. The thrill of thinking we're going to make big money pushes us to take wild risks -- and win or lose today, to try again tomorrow.

Gotta get it back

In Knutson's experiment, my brain's emotional centers quieted down when I actually received a gain that I had expected to get. Other experiments have shown, though, that an unexpectedly large gain -- you strike it rich, in other words -- can also trigger a dopamine surge.

And the more uncertain or surprising your investing gain, the bigger the rush inside your brain. The result: If you score big, you are unlikely to forget the feeling -- and you're likely to try pretty much anything to get that feeling back. A single stunning profit may affect your brain much like an addictive drug -- creating an insatiable craving for more of the same. (Why do you think they call it dopamine?)

That makes it hard to learn quickly from your mistakes. According to Nobel prize-winning economist Vernon Smith, people who earn big gains as stocks become overvalued -- and then suffer big losses when prices come crashing down -- will go right back and do it all over again.

Smith's research shows that the adage "Once bitten, twice shy" is wrong for most people. Because the thrill of making money is so strong, even if the gain evaporates, it generally takes getting burned at least twice for investors to learn not to touch an overheated market.

I'm in charge here

It turns out that something else fires up the emotional centers of your brain: making money as a result of your own actions rather than just earning it passively. "It's not just receiving money that fires up these areas, but how you receive it," explains Caroline Zink, a neuroscientist at the National Institutes of Health. "There seems to be a separate pleasure or arousal from feeling you did something to get it."

Zink need look no further for evidence than her little sister Laurie, who won $100,000 on a reality TV show in 2001. The joy of that windfall has been branded on Laurie's brain ever since. "Winning was so exciting -- just a thrilling, thrilling moment," Laurie says, "almost like getting a new life." Laurie had never gambled before that, but now she plays Lotto --not all the time, but whenever the prize gets "really big."

"Rationally, I know I'm not going to win," says Laurie. "But I also know how good it feels if it does happen." Caroline explains that her sister's windfall triggered that kind of rush because Laurie competed so hard to win the money. Lottery winners feel a similar high when they pick their own numbers, even though they were just very lucky.

And you feel it whenever a stock or mutual fund you picked goes through the roof. There's little harm in Laurie's attempt to recapture that high with the occasional small wager. Your attempt to pick the next killer investment is another matter entirely, as any tech stock investor circa 1999 or drug stock investor circa 2004 can tell you.

One of the problems with continually seeking a big score is that you stop paying attention to how big a risk you're taking. That's because the parts of your brain that anticipate a reward are much more sensitive to the amount of the potential gain than to the probability of actually earning it, according to research by Stanford's Knutson.

Your anticipation circuits are wired to ask, "How big is it?" but not "How likely is it?"

That helps explain why investors love long shots like initial public offerings, penny stocks, hot mutual funds or stocks in trendy industries -- even though there's massive evidence that high-risk investments like these provide disappointing returns over the long run.

And there is nothing thrilling about coming up short of your financial goals. That's why the most successful investors learn the value of second-guessing themselves and planning ahead instead of just shooting from the hip.

(source: Money Magazine, February, 2006, Vol. 35, pp. 74-77;