Casinos, Investors & Variable Rewards

I was recently in Las Vegas for a few meetings and witnessed something that intrigued me – a slot machine that was experiencing a lot of wins, even though the player was actually losing. In other words, this machine was framing the losses as gains.

The Wizard of Oz

I don’t gamble and generally don’t like casinos, except for the shows and buffets. But you have to walk through the casino to get anywhere. Whenever I walk through a casino I try to be observant, both of the people and the games. There is a lot of marketing, psychology, and emotion in play at the same time. I don’t loiter, but last week as I was walking through a casino, the Wizard of Oz slot machine grabbed my attention. It was physically large and beautiful, dominated in bright colors of green – my favorite color. I stopped to admire the look and view all the bells and whistles that made this so attractive to my eyes. And then someone sat down and began playing the game. So I watched for a minute.

As she started playing I noticed she got a lot of wins right off the bat. It wasn’t hard to see when she won, the machine makes it very clear. But I noticed something strange. Despite her winning, the number of credits kept going down with each spin. And then I realized what was happening. Every play deducted $5 from her, and then when she won, she would only win a small payout such as $1. So the player lost $4, but the machine framed it as a win. Very deceptive. Despite having several wins, she was down 50% within two minutes, said something about the machine not being lucky to her friend, and cashed out.

Irrational Deductions

Of all the casino games, I wonder why slots are so popular. They have one of the worst odds and payoffs for players and are very lucrative for casinos. Perhaps it is because no thought is required. Unlike poker and blackjack that require decision-making and incorporate some elements of skill, slot machines only require pressing a button (no longer requiring the physical stamina to pull a lever). Slot machines have various themes and are generally very attractive (like the Wizard of Oz). But perhaps the greatest reason they are popular is because of the potential for a huge payoff.

The brain likes rewards, and it really loves unexpected and variable rewards. In fact, it can get addicted to them. The suspense and thrill of not knowing what is coming on the next spin, and the possibility it could be something big, activates our dopamine receptors. And dopamine release doesn’t just happen when we make money, it happens when we simply imagine hitting the big win.

What’s This Got to Do With Investing?

When it comes to the brain’s love for variable rewards, the stock market is like a casino. Every day we don’t know if the market will go up or down, and how much in each direction. When you go granular, and talk about individual stocks, we see individual securities that performed the best and worst that day – some moving 20% or more in a given day. Then we think…

“Imagine if I owned a stock that went up 20% or more in a day. Or maybe it goes up 300% this year. I could hit my financial goals early. But to do that I have to buy an individual stock, and one that has the potential to move fast.”

Cue the dopamine!

The media, when referring to the act of investing, will use statements such as, “investors bet the markets will be higher” or “how to play the inflation situation.” They use verbs that refer more to speculating and gambling than long-term and thoughtful investing. Couple that with our innate and unconscious love for variable rewards, and it is no wonder that many investors unknowingly treat capital markets like a casino.

So how do we help investors not get sucked into treating the markets and their portfolio like a casino? It comes down to one simple activity. One activity will nullify the gambling urge. It is to stop looking. Stop watching the markets and tuning into the financial media (whose only job is to get you to tune in). It really is that simple. Incredibly difficult to do, but quite simple in execution.


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