Blame it on dopamine.
But perhaps instead of visiting the casino, you would have been better disposed to an insurance offer…. Loss avoidance is the second fundamental motivation, rooted in our primitive “fight or flight” response. Insurance products are mechanisms for avoiding pain by shifting risks—from policy holders to the insurance company. When we’re inclined to buy a policy, it’s in part owing to activation of a neurotransmitter different from dopamine: norepinephrine. Norepinephrine is a chemical that causes an increase in our awareness, heightened alertness, and focused attention. Anxiety and fear of disappointment cause a release of norepinephrine. It’s our neurochemically-governed nature that makes us want to shift cost or blame when we anticipate loss, pain, and regret.
Interesting science, for sure…but how can knowing natural, biological factors intersect with angel investing? One way is to help us more intelligently respond to the inevitable cycles of emotion that accompany investing. As the following illustration from Barclays shows, investor emotions follow a well-observed pattern, starting with reluctance-turned-to-optimism, then excitement, and finally exuberance as dopamine reinforces sensations of “winning” when a rewarding investment opportunity appears to be present.
Notice that excitement and exuberance can turn quickly to fear, desperation, and panic once the dopamine “high” subsides and worry over loss takes over. Norepinephrine takes control in the brain; our feelings toward investing go from despondency to apathy and indifference before the whiff of a new reward opportunity once again triggers the next dopamine kick. In short, dopamine helps fuel investors’ enthusiasm; norepinephrine throws a proverbial “wet blanket” on the emotional fire.
If you are someone who loves to gamble, you probably have a more active dopamine reaction; if you are mainly looking to hedge and shift risk, norepinephrine is working on your brain. Either way, it’s beneficial for investors to know their own dispositions, and in groups, to know the prevalent reactions of their fellow angels.
We can’t prevent the effects of neurotransmitter chemicals, but rational investors can recognize extreme emotions and make efforts to keep their enthusiasm or pessimism in check. Professionally-minded investors rely on method rather than on emotion to make financial decisions. In fact, if you’ve heard the derogatory expression “dumb money” tossed about by financial service pros, it was likely as a reference to individual investors who traded based on fear and greed rather than on any investment system. As emotions about investing run in cycles, Angel Capital Group recommends investors adopt techniques for dampening those cycles. The prescription is for angels to takes seriously their due diligence before making any investment decision. 20-40 hours spent performing both descriptive and some form of evidence-based predictive analysis ought to be required before angels elect to invest money in any deal.
One necessary technique is to allow one or more members of a group’s due diligence or executive committee to play “devil’s advocate.” In assuming the role of antagonist to a deal, the designated member is merely acting in accordance with the scientific method: Rather than allowing enthusiasts for a deal to stack up reasons to support an investment hypothesis, those following the scientific method would actively seek to reject a deal, based on factual reasoning and evidence. If evidence for rejection was not forthcoming or was insufficient, the “devil’s advocate” would lose their case, and the deal could be brought forward for a yes or no investment decision. In this way, investors could have confidence that emotional thinking had been overcome (at least in some degree) by logic.
There’s more that can be inferred from the study of behavioral finance: how neurotransmitter chemicals play a role in the way investment presentations are perceived; how positive and negative information regarding investments can be manipulated to increase or minimize psychological effects; and how biology may predispose some investors to types of investments while other investors will be naturally biased in an opposite manner. One thing is proven from the science: when we don’t enjoy outcomes we achieve as investors, if we haven’t substituted technique for feelings, it never farfetched to blame the bad decision-making on nature.
This is published under the Appalachian Regional Commission POWER Grant, PW-1835-M.
Copyright Appalachian Investors Alliance, Inc. 2018
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- Richard Peterson, “Neurofinance,” in Investor Behavior, ed. H. Kent Baker and Victor Ricciardi (Hoboken, NJ: Wiley, 2014) 381-392. ↩