A reader asks:
Is it ok to take 5 (or 10) percent of my portfolio and go crazy? I.e. Trade biotech stocks, one stock, options, or pork bellies, or SPX futures to satisfy my activity addiction.
Before I give my thoughts on this subject, I think it makes sense to dig into the psychology behind the reasons why most people have this activity addiction in the first place. There’s an old book written in the 1930s called Watch Your Margin: An Insider Looks at Wall Street by W.B. Woodward. In it he details a conversation he had with a more seasoned investor who explains to him why people speculate in stocks :
“Do you know why people go into stock speculation?” asked J.H.B
“To make money,” answered Woodward.
“Not at all,” said J.H.B. “They go in for the pleasure of getting something for nothing…What they want is a thrill. That is why we drink bootleg whisky, and kiss the girls, and take new jobs. We want thrills. It’s perfectly human, but Wall Street is a poor place to look for thrills, for the simple reason that thrills in Wall Street are very expensive.”
Trying to get something for nothing is one of the biggest reasons people run into troubles in the markets. We’re constantly looking for that elusive shortcut to easily solve our problems.
But why do we crave these thrills? It’s actually something that’s ingrained in our brains. Jason Zweig’s book, Your Money & Your Brain, does a great job explaining why this is the case, with some help from an expert in the field of neuroeconomics:
An unexpected gain fires up the brain. By studying the brains of monkeys earning “income” like sips of juice or morsels of fruit, Schultz confirmed that when a reward comes as a surprise, the dopamine neurons fire longer and stronger than they do in response to a reward that was signaled ahead of time. In a flash, the neurons go from firing 3 times a second to as often as 40 times per second. The faster the neurons fire, the more urgent the signal of reward they send.
“The dopamine signal is more interested in novel stimuli than familiar ones,” explains Schultz. If you earn an unlikely financial gain — let’s say you made a killing on one stock in a risky new biotechnology company, or strike it rich by “flipping” residential real estate — then your dopamine neurons will bombard the rest of your brain with a jolt of motivation. “This kind of positive reinforcement creates a special kind of attention dedicated to rewards,” says Schultz. “Rewards are what keep you coming back for more.”
The release of dopamine after an unexpected rewards makes us willing to take risks in the first place. After all, taking chances is scary; if winning big on long shots didn’t feel good, we would never be willing to gamble on anything but the safest (and least rewarding) bets.
The fact that we are so hard wired for thrill-seeking is one of the reasons it’s so difficult to do nothing at times as an investor and simply follow a predetermined plan. Following your plan rarely provides that dopamine hit. Successful long-term investing is often boring, which is the exact opposite of what your brain craves in terms of rewards.
As far as allocating 5-10% of your portfolio to speculate, that’s really up to the individual. Some investors look at speculation as a four letter word. The assumption is that every investor should be able to exercise extreme discipline at all times. While it would be nice if everyone had the ability to utilize patience, rationality and emotional control over every investment decision, for many that’s just not possible.
Some people need to add a substantial allocation to high quality bonds in order to decrease volatility in both their portfolio and emotions. Then there are those investors, like this reader, who need to go crazy with a portion of their portfolio to satisfy their thrill gene. Others need a tactical component to their portfolio. Still others need to give up control of their portfolio to a professional to take themselves out of the equation. It really comes down to knowing yourself more than anything.
I say people have to do what they need to do to ensure that they follow-through with their plan. Some people can set-it-and-forget it and rarely worry about their investments. Others need to watch every tick in the markets to feel safe. Many investors need that illusion of control to know that they’re doing something, anything, when things go wrong.
There are many different ways to make money in the markets. But I think that there are a few universal ways to lose money — mistakes that investors repeat over and over again. Anything you can do to reduce those mistakes is a win in my book. There comes a point where finding a release valve can be the best decision for your sanity.