Satisfying Your Activity Addiction

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 (emphasis mine):

“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.

Sources:
Watch Your Margin: An Insider’s Look at Wall Street
Your Money & Your Brain

Further Reading:
8 Things I Learned From Your Money & Your Brain
Doing Nothing is a Decision

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What's been said:

Discussions found on the web
  1. Ken Faulkenberry commented on Oct 25

    IMHO taking a percentage of your portfolio to speculate with is a bad idea. We are creatures of habit and practicing good habits makes you a better investor. MIxing the two strategies is difficult for most of us. If you need to gamble, go to Vegas with a fixed amount of entertainment money. Keep your investment money growing with one sound long term strategy.

    • mikedariano commented on Oct 26

      But I can mix habits in regards to food. What makes money different? Or isn’t it?

      • Kate Stalter commented on Oct 26

        Because money is more emotional. Food is, too, but in a different way. It feels good to eat “comfort foods” at certain times and health food at others. There are feelings associated with it, but for most people, it’s fairly easy to see how eating salad results in a smaller waistline, while eating Oreos does just the opposite.

        Money, however, is more complicated, IMO. People bring a whole lot of cognitive biases to the process, which muddies the waters the issue tremendously. For example, a highly speculative portfolio will have quarters – even years- when it beats a globally allocated portfolio. This leads to the emotion of, “I can do better than my advisor” or even “I should take more risk, since I did well this time.”

        Unfortunately, those habits of stock-picking and performance-chasing can spiral out of control, in many cases.

        For people who view their trading account as “play money,” it can work out well. Sadly, the mainstream media has convinced many investors that they need to be shuffling around their holdings in reaction to the day’s news events.

        • mikedariano commented on Oct 26

          It seems that the Oreo/Salad dichotomy is just as clear in finance. People recognize what they should do, index/salad, but also want to appease their biologic cravings for speculation/oreos.

          How often do people spiral out of control? (I’m unaware of this, but I’m relatively ignorant here).

          I agree with a lot of what you’re saying, especially as it relates to mainstream media (and doubly so for commercials).

          Here’s the question: so what? If you had to give a suggestion for some kind of speculation, what would you say?

    • Ben commented on Oct 26

      My sense is this type of fun portfolio would be something that makes more sense for more novice investors. The more experience you have the more comfortable you become with a long-term process.

      • Kate Stalter commented on Oct 26

        Unfortunately, a lot of people who subscribe to stock-trading services *believe* they are seasoned investors. The truth is quite different, as one glance at their portfolios will show.

        • Here to Learn commented on Oct 26

          This is largely due to the fact that the field of investing is one where experience doesn’t necessarily translate into expertise.

  2. ishkurti commented on Oct 26

    I am with Ken. One’s financial portfolio is no place for hobbies. In a previous life, I was part of an outfit where people subscribed for trading ideas and would ask substantially the same question as the reader in the blog, about sizing a position. Each time I’g get the question, I would ask the person to imagine that position going to zero and whether that made him loose sleep at night. We’d repeat the exercise with different sizes until we reached a size where the utility of the trade to the client exceeded the cost to his comfort. Often, that size would end up at zero. I don’t mind saying I lost some clients but gained some friends through that exercise.

    • Ben commented on Oct 26

      My favorite description of investing is that it’s an exercise in regret minimization. Sounds like what you’re describing here.

    • Kate Stalter commented on Oct 26

      Sounds like you and I had similar “previous lives.”

      To this day, people ask me what I learned from the years I spent teaching technical stock trading for national newspaper (that should narrow it down)! I hate to break it to them, but almost everything I learned there is either irrelevant to investing, or downright dangerous.

  3. Mark Massey commented on Oct 26

    As one loses that 5 to 10%, the pie grows smaller and next thing you know, you have lost that 5 to 10% several times and your portfolio is 70% of what it could have and should have been. So no, do not gamble with any of your investable funds.

  4. John Richards commented on Oct 26

    I will offer Devil’s advocate to the crowd. I like to overweight asset classes at times. I can’t prove anything and won’t waste space with anecdotes, estimates, or assertions, other than to say my results appear modestly favorable.

    I follow my 10% rule (Monthly adjustments limited to 10% or less of my portfolio.)

    I almost always limit overweights to classes that appears to be significantly undervalued. I base this on a lot of reading, blogs and articles written by smart people, smarter than I am. Many fine people offer good information for free, not making forecasts, just offering solid observations. I try to use that effectively.

    I hope to take advantage of the same dynamic that rebalancing does, simple reversion to the mean, with the admitted disadvantage of uncertain timing. This approach is about as close as I can get to a ‘margin of safety’ w/r/t asset class investing.

    • Ben commented on Oct 28

      That’s the whole point — have something that works for you. I like the constraints on your rule.

  5. Scott England commented on Oct 27

    I would argue that taking 5-10% of one’s portfolio to “go crazy” is perfectly acceptable within a portfolio that follows the barbell strategy of investing. In fact, you could make a strong argument that investing 5-10% in things that are ultra aggressive and 90-95% in things that are ultra conservative is a safer way to invest. Too many people think they have a “conservative, diversified” portfolio and don’t realize that there is far more risk in their portfolios. Just look back to 2008 and how these portfolios performed for a reminder. Here is an article from Futures Magazine that expounds on this strategy: http://www.covenantcap.com/custpage.cfm/frm/178029/sec_id/178029/news_id/33316/High%20vs.%20Low%20Volatility%20Strategies%3A%20A%20Different%20View%20of%20Risk

    • Ben commented on Oct 28

      Makes sense. I agree that mixing different strategies together can actually work out better than most people assume.