Your favorite stock unexpectedly goes up and your risk tolerance suddenly rises, your spouse loves to go shopping after a bad day at work and every Friday your brother blows half of his paycheck on cheap beer and scratch-off lottery tickets. Have you ever wondered what causes these irrational, financially destructive behaviors? Scientists are finding that they are all related to a neurotransmitter called dopamine. Read on to learn more about what dopamine is and how you can keep it from creeping into your finances.
What is Dopamine?
Dopamine is a chemical that is naturally produced in your body. Among other functions, it plays a crucial role in your brain's reward system which provides you with feelings of pleasure and motivation. Dopamine is important to your survival because it gives you the "natural high" that motivates you to act on critical opportunities like eating, making money and reproducing. In the book "Satisfaction: The Science of Finding True Fulfillment," neuroscientist Dr. Gregory Berns states that, "Without dopamine, you would be unable to obtain any of the things you consider rewarding."
Recent scientific studies have shown that everyone's dopamine system is different depending on their biological makeup and age. This helps to explain why some of your friends or relatives may have extremely addictive or risk taking personalities related to gambling, shopping, sports or drugs. It is also worth noting that dopamine agonists are used to treat debilitating neurological disorders like Parkinson's disease.
How Can Dopamine Affect You Financially?
By the time you are an adult, your brain has been conditioned to understand that making money is a rewarding experience. For this reason, investment decisions can affect your dopamine system. Neuroscientists like Dr. Brian Knutson, a professor at Stanford University, have found that your dopamine levels become elevated when you anticipate a large, uncertain financial gain. Scientific studies have also shown that the more surprised you are by a financial gain the bigger your dopamine rush.
Like a primitive hunter looking for food or a drug addict looking for a fix, this emotional high reinforces your risk-taking behavior, which can cause you to make irrational financial decisions. This explains why some people love to gamble, even if the odds of winning are next to none. It also helps explain why investors experience behavioral biases, like positive feedback loops and are willing to take more investment risk towards the end of a bull market.
Financial gain is not the only thing that affects your dopamine system. The "thrill of the hunt" involved with shopping at the mall and experiencing novel products, sights and sounds increases your dopamine levels which can cause you to make impulsive, irrational purchases. Savvy marketers know this. That is why they do things like hire attractive sales people, play eclectic music, keep show rooms bright and create infomercials that encourage you to "act now" - while you are still influenced by dopamine.
Understanding this phenomenon can help you take steps to keep dopamine from hijacking your finances.
How Can You Minimize The Effects?
- Have a method to your madness.
Write down your rules for both buying and selling investments and honor them. Make a shopping list and stick to it. Having a plan will help you avoid making impulsive financial decisions when your dopamine levels are elevated. (For more about creating a trading plan read, Ten Steps to Building a Winning Trading Plan.)
- Be wary of too much stimuli.
Fast flowing news feeds and "high-tech trading tools" may light up your computer screen, but they also light up your emotions and can encourage unnecessary trading. Keep in mind that online trading companies want you to trade, and entertaining financial news channels are designed to sell advertisements, not necessarily to help you make sound financial decisions.
If you like shopping at the mall, carry only the money that you plan to spend and leave your credit card in the car. Remember, you are probably longing for the shopping experience itself, not necessarily the products on the shelves. (For more tips about how to avoid over spending, read Sneaky Strategies That Fuel Overspending.)
- Use mental accounting to your advantage and delegate.
Some people just like to trade. This is not the worst way to get your dopamine kicks! If you are one of these people, designate a small account with limited funds for speculating. That will allow you to get your daily dope, but not by risking your nest egg. If you have expressed compulsive risk-taking behavior in the past, hire a professional money manger to manage the bulk of your investments. (For related reading see, Use A Money Manager Or Go It Alone?)
- Sleep on it.
Unexpected investment gains and purchasing products when they are on sale are both good things. But, try to allow yourself some time to cool off and think. Especially if you have just experienced a large gain on an investment or you are thinking about purchasing a big ticket item, like a car or a boat.
The Brain and the Bank
The study of dopamine and how it affects you when making financial decisions is the product of a new science called "neuroeconomics". Neuroeconomics combines behavioral economics and neuroscience to study how people make economic decisions.
Long before economists were interested in neurotransmitters, value investor Benjamin Graham said, "The investor's chief problem - and even his worst enemy - is likely to be himself." The more we learn about our brain's decision-making process, the better we will understand the "why?" surrounding our sometimes irrational economic behavior. As a consumer and investor, having this knowledge will help you avoid making bad financial decisions. It could also teach you ways to profit from other investor's irrational biases. In the end, it may finally make you best friends with your "worst enemy". (For related reading see, This Is Your Brain On Stocks or Market Problems? Blame Investors.)