What makes us human? I feel that the key differentiating factor between us and the rest of the animal kingdom is our understanding of the concept of time. Specifically, we can project our thoughts to the future and relate to the future version of ourselves. Animals, however, are programmed to live in the present. The concept of the future does not exist for them, at least not in the sense we are able to connect our future selves to our present.
How does this behaviour play into the field of personal finance? It’s through a simple concept of delayed gratification, and has been the subject of a very interesting study by professors at Stanford university.
The setup is as follows: Four year old children are led into a room one by one and given a small reward, in this case a marshmallow. They are then offered two choices: They can eat the marshmallow right then, or if they decide to wait for 15 minutes, they will be rewarded an additional marshmallow. Roughly two out of three children would eat the marshmallow and forego the additional marshmallow. One of the three children managed to last the whole 15 minutes and were rewarded for their wait with the second marshmallow. The children that lasted through the wait did so by distracting themselves (singing songs, falling asleep, licking the marshmallow, playing with their clothing, etc.). In follow-up studies of the same population of children, it was found that the children that were able to delay gratification had better SAT scores, lived healthier lives and were more successful than the children that could not.
Subsequent studies have analysed variants and concluded that the children’s response also depended on their upbringing at home – The poor children tended not to wait because were not sure the promise of two marshmallows will be honoured based on their experiences at home. Inadvertently, this may explain why people in financial crises may not be able to think beyond the immediate future and keep taking decisions that act against their own self interest and keep them poor.
Thus, the ability to exert self-control is key to success. Mapping this to the field of finance, the ability to forego instant gratification and wait out for the delayed (and bigger) reward is a determinant for a secure financial future. If you can resist the urge to buy the latest iPhone the day it comes out and invest the amount into assets that appreciate in value, you will be able to reward your future self with a present that travelled through time. This is all the more important in today’s age of a YOLO (You Only Live Once) philosophy, egged by the constant temptation of advertisements and marketing all around you, and enabled by credit solutions of Zero-interest EMIs and one-click buy solutions that encourage you to spend money you have not earned yet.
PS: There are plenty of entertaining videos of the experiment online, I’m linking a few below: