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Most academic studies in psychology are pretty boring, at least how they're done.
The surveys, the tests that they run to try to figure out how people think.
Maybe the results are interesting if you like reading that kind of stuff, but most of the tests themselves are kind of boring.
But once in a while, you come across a test where you're like, oh, that is so well designed.
That was so genius.
That is so fascinating.
And one of my favorites, my favorite studies that I've come across showing this.
It's actually pretty well known.
This is not that much of a secret.
Came from a Harvard psychologist named B.F.
Skinner.
BF Skinner did most of his work at Harvard about 100 years ago and his famous study that made his career and I think was so interesting is a study that he did on pigeons.
And B.F.
Skinner wanted to figure out the science, the psychology of incentives.
What gets people to seek out a reward?
What's the best incentive structure?
And so what he did is he took a ton of pigeons and he put them in a cage and he basically trained them to say if you want a reward in this case it was food you need to tap this lever.
So, in a very basic experiment, you put it in and it's like okay, Mr Pigeon, if you want a piece of food, tap this lever.
Out comes a little seed, whatever it was, and that's your reward.
So that was one incentive.
But then he figured out that there would be different kinds of incentives, different structures of incentives that you could do in this situation.
So, for example, one of the things he could do was what he called a changing reward, which was maybe today the pigeon taps the lever and gets a piece of food, but tomorrow it has to tap the lever twice.
The next day it has to tap the lever three times and then maybe six times.
It's going to change every day.
That was even more of an incentive for the pigeon to hunt, because they figured out that every day there was a new structure they had to learn.
There was a new pattern that they had to learn.
And that would just flood them with dopamine and be like Okay, today what's the new pattern to get our food?
We got to figure it out.
Let's keep tapping to figure out how this works.
That was one of them.
But the most interesting incentive structure that B.F.
Skinner came up with is what he called the variable interval reward.
And basically what that was was for these pigeons.
Maybe you tap the lever and you will get food on average every hour, But that might mean five seeds, five rewards in the next hour and then nothing for the next five hours after that.
So in these situations the pigeon would get the same amount of food, the same amount of reward that they would in any other day, where they're just tapping the lever once and getting one seed.
They're getting the same amount of reward, but they did not know when it was going to come.
They have to keep hitting the lever and sometimes a ton of seeds are going to fall out.
Other times they sit there hitting the lever for hours and nothing comes out.
And this drove the pigeons absolutely mad.
They lost their minds.
It was like they would just sit there, for sometimes he would document.
The pigeons would sit there for 15 hours straight just frantically, maniacally smashing the lever, waiting for food to come.
And they knew it would come, but they didn't know when.
And that drove them nuts.
It's like it turned them into addicts.
And I think there are so many analogies that you can draw to this that are so appropriate in investing.
Because I think we want to as investors.
It's intuitive, it's appealing to think of investing like it's a fixed reward.
Tap the lever once and get your reward.
Or in this case, buy stocks and every month or every year you get your reward.
That's how we want to think of it.
That's how it should be.
That's how it should work.
And of course, if you have any experience in investing, you know it is not.
It is so much closer to this world that the pigeon's faced with the variable rate award where, if you are an investor in the stock market for a long period of time, you can state with pretty high confidence that over the next 20 or 30 years you're going to make a lot of money.
Like if you're diversified, that's a pretty good bet.
Not 100%, but a good bet.
But you have no idea when those rewards are going to come.
You might get all of that return next year and then have 15 or 20 years of flatline.
You might get nothing for the next 10 years and then have a bonanza in year 11.
It might be trickled out, boom and bust here and there.
You have no clue when it's going to come.
And just like the pigeons that can give your brain so much dopamine, so much stimulation, drive you so crazy that investors start to lose their minds.
And in fact, B.F.
Skinner himself pointed this out.
In his studies, he wrote, quote, You can move from the pigeon to the human in this case.
A variable interval reward is at the heart of all gambling devices.
It has the same effect.
A pigeon can become a pathological gambler just as a person can.
It's the same thing, of course, with gamblers.
You know, or at least you hope, there's going to be a winning, but you don't know when it's going to come.
So what do you do with the slot machine?
You sit there for hours on end, pecking at the buttons.
And I bring this up, this idea because, of course, if you had not noticed, there's a lot of stock market volatility lately.
And what's interesting to me about stock market volatility is that You know it's going to come.
You know it's going to happen.
This is how the stock market works.
But every time it does happen, it is so common for people to say, this is wrong.
This doesn't feel right.
This feels broken.
What happened?
And of course, they end up in the situation by saying, I want out.
One thing that's important in the stock market.
This is so simple, it's so basic, but in my view, this is probably the most important logic to wrap your head around in the stock market.
That volatility, dealing with it, is not a fine, it's a fee.
What I mean by that is a fine means you did something wrong.
A fine is like a speeding ticket.
You get pulled over by the cop.
You did something wrong.
You're in trouble.
Here's your fine.
Don't do it again.
A fee is something very different.
A fee is like you go to Disneyland and it costs something to get in to the admission price and you pay the admission price and you get something great in return.
You're not in trouble.
You did nothing wrong.
And maybe the Disneyland ticket costs the same amount as the speeding ticket, but they're very different.
One is just to get something in return.
The other is an indication that you did something wrong.
Volatility in the stock market is, by and large, almost always a fee.
It's a cost of admission for doing well in the long run that you have to be willing to pay, that you have to be willing to put up with and endure.
And yes, there are investments out there that are much closer to the fixed reward idea, where the pigeon hits the lever once and gets a piece of food every time.
That is bonds and cash and whatnot.
And the returns you're going to get from those are meager, and that's what you deserve.
If you want to earn higher returns, there is, of course, a cost.
Nothing that is great comes free in life, and the cost of admission in the stock market is putting up with and enduring a never-ending chain of uncertainty and the idea that you can be confident that you're going to earn a good return on your money over the next 20 30, 40 years, but you have no clue when.
You have no idea when it's going to come.
And there's so many extreme examples of this.
The Japanese stock market very famously effectively had no returns from around 1990 to around I think it was about 2015.
It was like 35 years of no returns, 0%.
Of course, a lot of ups and downs in there, but over that period, 0%.
Very interestingly though, if you look at a longer-term view of history, in the 1960s and 1970s and 1980s, the Japanese stock market went straight up like an absolute rocket ship.
And so over a very long period of time.
We're getting into unreasonably long periods of time here 60, 70 years.
Whatever it was the Japanese stock market actually did great.
It actually did fine.
An average annual return, I think, was about 6% or 7%.
It's just that you got all of that return in this very compressed period in the 1970s and 80s, when Japan was having this miracle boom coming out of World War II and the reconstruction that it had taking over the world at the time.
And so that's a very extreme example, but you see this in markets all over the world.
The 1990s were just an extraordinary time in the stock market.
The early 2000s, the first decade of 2000s were terrible.
So over a 20-year period, you got all of your reward up front.
And the cost of that, the cost of admission, for that was dealing with another period where you didn't do that well.
Always the case.
But again, this can drive people nuts.
When you know you're going to get a reward, you just don't know when it's going to come.
And I think the central skill of all great investors professional amateur, doesn't matter is putting up with and enduring and dealing with that uncertainty.
And so right now today, the US stock market is down I don't know 10 from its previous high, something like that close to that.
And of course, it's not enjoyable.
I don't necessarily enjoy it.
You probably don't enjoy it.
But I think the right mindset to have whenever this happens is, rather than saying this is wrong, something is broken, somebody made a mistake.
Even if that might be true, I think the better way to look at it is.
This is the cost of admission that I must be willing to pay and put up with and endure in order to do very well over the next 20 or 30 years.
And just like the pigeons, a lot of people do not want to put up with that.
They will do the equivalent of sitting there all day smashing the lever, waiting for the next reward which, in investing in the stock market, comes from people trading in and out, in and out, in and out.
And the results from that 99 times out of 100 are horrendous.
It's much better if, rather than thinking that you can outsmart and outwit the game, that you just understand the rules of the game and say look, this is the cost of admission that I need to be willing to put up with and endure.
And if you can do that and view volatility as a fee instead of a fine, That is the simplest but, I think, most powerful idea that any investor can wrap their head around and put up with during times like these.
B.F.
Skinner once wrote, quote science is a willingness to accept facts even when they are opposed to wishes.
Isn't that so true in investing as well?
I wish the stock market just went up 1% every month, month after month after month.
That would be great, wouldn't it?
Not how it works whatsoever.
It's a variable interval reward.
And we know historically the rewards can be extraordinary.
And I think they will be in the future as well.
But how they are distributed, whether you get all your reward at once...
You get it tomorrow.
You get it five years from now.
Whenever it's going to come, you don't know.
I don't know.
Nobody knows.
And putting up with that is the single most important part of investing.
That's it for this week.
Thanks again for listening and we'll see you next time.
