When you hear the term “risk-taking” your mind probably first goes to things like jumping motorcycles, gambling, and skydiving. While those are indeed risky behaviors, most of the risks we take are much smaller and much more everyday. Among those everyday risks is investing, a practice that when done right can ensure a secure retirement and money to spare, but when it goes awry, can sometimes mean serious financial distress. Investing may not give us the rush that jumping out of a plane might, but it still has a serious effect on our minds, causing big changes in how we think, feel, and act, and not always for the better. While there are still many unanswered questions about why we take risks and what parts of our brains push us toward risky behavior, there’s a fair amount of research out there on the subject that can give you a better picture of just what your investments are doing to your brain, often without you even knowing it’s happening.
The Anatomy of Risk Taking
In recent years, studies have pointed to specific regions of the brain and chemicals in our bodies that play a role in how risk-averse or risk-favorable we may be, showing much more clearly what happens to our brains, physically, when we take risks like making investments. In fact, it’s just as important to know how our brains affect risk-taking as it is to understand how risk-taking affects our brains. Read up on the latest research here.
- Risk-taking may be in your genes.A study from Northwestern University found that there are variants of two genes that can impact your desire, or lack of, to take risks. Those genes regulate dopamine and serotonin neurotransmission, and in previous studies were linked to emotional behavior, anxiety, and addiction. As it turns out, these genes also affect risk-taking with regard to investment decisions, with those carrying the risk-averse gene taking 28% fewer risks than those carrying the alternate variation of the gene.
- Hormones play a big role in risk-taking. Varying levels of certain hormones in your body can play a big role in determining how likely you are to take risks, with investments or anything else. Studies done in Denmark and Japan found that those with more dopamine in their brains were more likely to seek out stimulation in the form of risk due to a lower sensitivity to the hormone, results that have been replicated in the U.S. as well. It’s not just dopamine that affects your risk-taking, however. Some studies have also shown that higher levels of testosterone, a male sex hormone (though it’s also found in women), can trigger higher levels of aggression, competition, and risk-taking behavior.
- Men and women are equally likely to take risks.While testosterone may increase risk-taking, studies have shown that when it comes to engaging in risky behavior, men and women exhibit little difference. While women are more likely to see situations as being risky, recent research found no difference in actual risk-taking behavior. Yet this gender equivalence isn’t the same in all places around the world. Places where women have greater equality and less strictly defined gender roles show the greatest equivalence in levels of risk-taking.
- Certain parts of the brain play a larger part in risk-taking than others. Researchers at the California Institute of Technology think they may have pinpointed some of the regions of the brain that are responsible for motivating individuals to take risks. Unsurprisingly, these parts of the brain are those influenced by the neurotransmitter dopamine. Researchers found that when perceived risks increased, these areas of the brain lit up with activity. More critically, however, they found that the participants’ brains focused on rewards before risk, demonstrating why so many risky behaviors are so addictive.
- Brain damage can create superior investment results. Oddly enough, some kinds of brain damage could make you a better investor. How? By changing your perception of fear. Those who’ve suffered damage to the amygdala or the insula regions of the brain were found to make better investment decisions with higher returns than those with normal, healthy brains. The amygdala and the insula play a critical role in our perception of risk, and those with damage to those areas can much more easily approach investment opportunities without any inhibition from prior investment losses. Without fear in their way, the subjects of the study were able to make smarter choices and were more willing to take investment risks that had big payoffs, showing that sometimes, your brain may actually be holding you back from being a successful investor.
- Age plays a role in investment success.We like to think that it’s the young who are prone to taking risks and making bad investments, but research is pointing to the opposite actually being true. Stanford researchers found that older people are more likely to make investment mistakes than younger people, a phenomenon that’s entirely unrelated to memory loss, senility, or cognitive decline. The culprit? An inability to estimate value. Brain scans revealed that older adults had more “noise” in the subcortical parts of their brains, short-circuiting their evaluation processes and making it harder to make smart stock choices.
- Some people are simply more willing to take risks than others. Increasingly, research is showing that some of us are simply more likely to take risks than others. In short, a propensity for risk-taking is simply hard-wired into certain individuals’ brains. There are two major personality traits, which appear readily in the brain when monitored through scanning technology, that govern our inborn risk-tolerance. The first is ambiguity tolerance, meaning an individual can deal with a certain amount of uncertainty when making a decision, and the second is reward-sensitivity, with the person being more focused on the reward than a fear of loss. Those who exhibit these traits (and the corresponding brain activity) are much more likely to take risks than those who don’t.
The Psychology of Risk
It’s not just anatomy that influences how and why we take risks, our experiences and beliefs also play a role. Read on to learn more.
- Those who’ve faced combat are more risk-averse. Sometimes, our experiences can color how our brains approach risk. That’s proven to be especially true with veterans who’ve faced combat. Those returning from a combat experience are 14-18% less likely than other veterans to invest in risky assets like mutual funds and stocks. Experiencing a trauma or shock (even when unrelated to finances) can trump factors like education, wealth, or the economy in a person’s investment behavior, leading many to make safer, less risky investments.
- Surprises, both good and bad, make us more risk-averse, too.While it isn’t surprising that a traumatic experience like being engaged in active combat can change your attitudes toward risk, what is surprising is that minor shocks, even good ones, can impact future risk taking. Psych researchers found that people weren’t just risk-averse after an unexpected loss; they also were less likely to take risks after an unexpected win. The lesson? It’s not whether outcomes are wins or losses, but whether they’re expected, that makes the difference.
- Many of us think we’ll take risks, but chicken out. When it comes to doing risky things, from skydiving to making an investment, many of us plan to take risks but opt out at the last minute. It’s a phenomenon researchers call the “illusion of courage” and it’s actually quite common. It’s caused by an empathy gap, whereby the individual can’t imagine how they will feel in future emotional situations. When risks seem far off, you don’t feel the strong emotions that are associated with them and don’t make decisions that are accurately based on your personal willingness to do those actions. In order to get a better sense of whether or not you’re really ready to take on a risk, researchers advise doing things that will put you in a similar state of mind right now, which will give you a more accurate estimate of your interests, fears, and desires.
- Beliefs are more important than preferences in investing. While fear of loss certainly plays a role in why investors sell off certain stocks, it’s not the only motivating factor, at least according to new research from Ohio State University. When it comes to deciding which stocks to keep and which to toss, it turns out the beliefs about a stock’s future are the most important factor, much more heavily influencing behavior than preferences toward losses and gains. Of course, this doesn’t make these decisions any more rational, as beliefs that a stock has a bright future or a dim one can be based on a wide range of sometimes illogical reasons.
- We don’t always react rationally to risky situations.Risk, and the fear that goes with it, can sometimes cause us to act in some pretty stupid ways, including when it comes to investments. Researcher and former trader John Coates found that irrationality is at its peak during times of boom and bust, due in large part to emotional and sometimes visceral reactions to good and bad news. This creates markets that can be volatile and hard to control, and riskier for everyone taking part in them.
- Humans subconsciously weigh the risks and benefits of any choice or course of action. How big a risk feels depends on the potential benefits it has to offer. If if taking a particular action affords little or no benefit, the risk automatically feels bigger. Much of this process of analyzing a risk takes place subconsciously, but the results of it can have big implications for our conscious lives.
- Emotion outweighs logic.Our brain is an emotional organ and our emotional systems often exert much greater control over what we choose to do, especially with regard to risk, than our cognitive systems, even if we often like to think that the opposite is true. It’s one of the ways we’re hardwired to survive, but it doesn’t universally play to our advantage.
- Those who are more willing to take on risky investments often take risks in other ways. It should come as no surprise that those who are willing to make bold, assertive moves in investing are more likely to carry over that comfortable attitude towards risk in other aspects of their lives. A recent study by the University of Oregon and the University of Notre Dame found that CEOs who enjoy the adrenaline rush of activities like flying an airplane are more likely to be bold managers and investors.
How Risk is Processed by the Brain
What happens when you take a risk like making an investment? As you’ll learn a number of different parts of your brain play a role. Here’s a play-by-play of how your brain handles a risky situation.
- Your brain takes in the situation. The first thing that happens when you’re faced with a risk is that your brain takes a minute to soak it all in. At this time, the thalamus, the news reporter of the brain, figures out the basics of the situation, including the who, what, when, why, and how. From there, the information makes its way into the amygdala.
- Then you have a gut reaction.As we’ve talked about previously, emotion is a key part of your brain’s reaction to risk, and you can thank the amygdala for that. The amygdala is responsible for emotional responses, and produces emotions that we sometimes refer to as intuition or gut reactions. The first reaction you’ll have to a risky situation is an emotional one, with the information only traveling to the cognitive parts of the brain after hitting up the amygdala.
- Finally you start reasoning.It takes a full 22 milliseconds for news of a risky situation to reach your cerebral cortex, the part of the brain responsible for decision making and reasoning. Once the cortex gets hold of the information it begins to try to figure out the best approach, breaking things down and sending signals to other regions of the brain.
- Other areas of the brain may be lighting up as well.Risky situations don’t just limit themselves to using the parts of the brain that we’ve discussed so far. In fact, two other regions play a pretty big role, too. First, there’s the ventral striatum, an area involved with emotional responses. People who have greater activity in this region of the brain, tend to be more willing to take risks. Second, there’s the insula (also called the insular cortex), which is tasked with cognitive reasoning. Those who have more activity in this area tend to be much less willing to take risks, making conservative decisions.