Pavlov's New Dog

Exploring the "conditioning" of today's investors and the changing rules of the game.

By Stephen Weitzel, CFP®

Foreword: I began writing this white paper nearly 4 years ago, but it was somehow, some way, lost to time. Perhaps that initial draft is still saved on my hard drive, nested closely to some bitcoin I had unknowingly mined. Thank you to my friend, Jason Perz, for his continued prodding for me to complete this writing.

In one of the most iconic studies in behavioral psychology, Ivan Pavlov showed that behavior could be shaped through association. By repeatedly ringing a bell before feeding dogs red meat, Pavlov found that over time the dogs began to salivate at the sound of the bell alone, even when no food was present. This experiment introduced the concept of conditioned responses, a principle that applies not just to animals, but to humans as well.

Take children, for example. Many dread visiting the doctor because they associate it with painful shots. Parents often counter this with promises of a reward – perhaps a visit to the toy store, or an ice cream shop. This is another form of conditioning: pairing discomfort with a future benefit to shape behavior.

Many investors have been conditioned to favor what has rewarded them in the past, and to avoid what has caused them financial pain. While this might seem logical and is, in fact, consistent with Harry Markowitz’s Modern Portfolio Theory, the real world doesn’t operate inside an academic vacuum. Inside the classroom, Dr. Markowitz could mute the human condition and ensure that investors be capable of rational decision making. For those of us living outside of those scholarly walls, we share a different lived experience. What might start out as rational behavior with the best of intentions can very quickly turn into a situation of unforeseen consequences.

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