Research Highlight: Temporal Discounting

We’re going to throw around some terms today that will impress your friends at dinner parties. Get out your notepad. Today’s topic is intertemporal choice and temporal discounting. Intertemporal Choice is a term used when a choice involves making a decision at a certain time that will impact the outcomes at a different time. For example, remember the Marshmallow Study? It is an intertemporal choice to choose between taking one marshmallow now or waiting for the second marshmallow. Temporal Discounting simply means that we value the second marshmallow less than we value the one sitting in front of us because the one sitting on the table is here NOW and the other one is LATER. If I told you I would give you a dollar now or you could wait a week and get the same dollar, why would you wait a week? The dollar now is worth more. You could spend it on your way home (don’t. even though the dollar is fake). In one of the most obvious financial examples, it’s hard for people to save for retirement because they value the money now more than the money later.

Temporal discounting is a highly studied topic because it’s important for people to understand how much an individual will discount that future dollar (or marshmallow, or whatever) for the one today. (Would you trade a dollar today for FIVE dollars next week?) It’s also important to understand what factors into that discounting. (Do you trust me? Have you been raised on a family saying of “Take the money and run?”)  This is one of my favorite topics (I reserve the right to share more research in this field at a later date… but because of temporal discounting, THIS post NOW is definitely worth more… I know. I’m hilarious.)

So what does the research say, and how can we learn from it?

  • Wait to choose. Taking some time to make the choice increases the likelihood of people choosing the larger-later rewards. If you really stop to think things over, your future self will thank you. This is why waiting a day is recommended for purchases and big decisions. Our less impulsive sides are much more prudent. If you give them time, they will emerge.
  • Stop thinking about it. It’s so hard to save money when you think about all the things you could buy now. It’s impossible to diet (so I’m told) when you think about food all the time. “Task unrelated thinking” (as the study called it) or simply thinking about something else helped people wait longer for rewards. The marshmallow study showed similar results. Kids that were able to distract themselves waited longer for that second marshmallow.
  • Picture the future physically close. Intertemporal decision making is impacted by interspatial perception. In a series of studies, people were given maps showing the distance between things. If things were farther away on the map, an associated time seemed farther away. If retirement is at the end of that road in the common stock image that never ends, we’re less likely to save for it. Instead, picture retirement now. Make it physically close in your mind and you’ll make better choices.
  • Educate yourself. Another study demonstrated that after being educated on the benefits of choosing larger-later rewards, people were more likely to choose those rewards. This same study showed that peer-generated advice in this direction also has a big impact. Keep reading all those personal finance blogs! We’ll all help each other make the best decisions!
  • Understand that stress levels and emotions impact your choices more than you think. When you’re stressed, you make poor choices. Study participants had to prepare a public speech. If the speech was soon, they were less likely to choose larger-later rewards because they were stressed out. Maybe you’re not stressed out, but you’re scared. That will change things as well. In one study, literally making a fearful face helped people choose larger-later rewards versus making a happy face. Making the fearful face activated different areas of the brain (as seen on an MRI) than making the happy face. Try that next time you make financial decisions. “Honey… why do you look so scared? We’re just depositing a check.” (This study had a small sample size of only 22 people, but it’s still interesting.)
  • Get over your past! Your past and upbringing impact your decisions. Your age, life experiencessubstance abuse level, even your religious upbringing and “intrinsic religiousness” can impact your financial temporal discounting rate! If your identity is robbing your future self, be aware, and go against those poor choice instincts when making financial choices.
  • Picture yourself rich! When study participants had to pretend their annual income was cut in half, they were more likely to take the money now. But when they were to pretend their income was doubled, they were way more likely to take the larger-later rewards.
  • Remember that your kids are watching. The temporal discount rate for mothers (especially for short-term intertemporal choices) translates to the ability of their preschool children to wait for a bigger reward. This means that if I’m able to stop spending money today and save it for the future, my children will be more likely to do the same (or at least be able to wait for a second marshmallow since the study is only about preschool-aged kids and edible rewards).

Again, there is so much research out there in this field. But for now, these few tips should help you make better choices for the future you! Good luck!

Temporal

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2 Comments

  1. I found this one by flipping through your old posts. Very cool, I’m an economist by training; These behavioral biases are really fascinating. A lot of the bad and irrational financial decisions in life can be tracked right back to one of those. And it’s not like anybody is immune. I’m financially savvy, but I have to constantly remind myself not to fall for those. Knowing about the biases is the first step to avoid them!

    • MaggieBanks

      So true! I love to connect with economists! I feel like behavioral economics explains so much about how we screw ourselves over. If only we learned!

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