Hyperbolic Discounting: why we make dreadful life choices

24 Oct 2018

Have you ever had one of those days when work is overflowing, deadlines are nearing, and you know you need to get things finished, but for some reason you cannot bring yourself to do it? Instead, you put on your cosy slippers, switch on Netflix and have a cup of tea while thinking how proactive you will be tomorrow.


We call this hyperbolic discounting, driven by temporal myopia which causes people to choose the smaller immediate rewards over the possibly larger rewards they can earn later on. Many of the most serious and pervasive problems we face as individuals, and as a society, reflect the fact we are temporal myopic creatures who are inherently inept at long-term planning.  


Researchers ran an experiment that illustrates this. 


A group of subjects were asked individually “Which of the following two options would you choose: 100€ now or 120€ in one month from now?”


As financial advisors, we would argue that the rational decision is to take the 120€ in one month from now, because 20€ for a month’s patience is a very good yield. However, the study showed that given this type of “intertemporal” choice, where people must make decisions that affect their future opportunities and profits,  the majority of people chose the immediate 100€. 


The second question put to the subjects was “Would you rather 100€ in 12 months, or 120€ in 13 months?” 


In both sets of choices you gain 20€ more by waiting a month, so logically you would presume that the majority of people chose the first choice as they did in the first case. Yet the study showed that many people reverse their strategy waiting the extra month for the additional 20€ in the second scenario. 


People want immediate rewards if it is on the table but when the rewards are placed in the future they behave more rationally. Our thirst for gratification can cloud our judgement - to put it bluntly, it is inherently more exciting to learn that you will be given 100€ right now rather than in a month. 


This can be linked to a theory that our more primitive parts of the brain are strongly attractive to immediate gratification. In contrast, activity in areas associated with more recent human brain evolution (frontal cortex) tends to better reflect a more rational evaluation of reward. 


Unfortunately, the choices you have to make in everyday life are not as easily comparable; we are continuously making real-life decisions that require balancing short term and long term decisions. So it’s like the choice between the cheaper gas fuelled car, or the more expensive hybrid, which, in the long run, will be better for the environment and would allow me to save money on fuel. 


For our Homoerectus ancestors, life was governed by: the unpredictability of weather, availability of food, and disease. They had no need to plan long term. Today, however, the modern world is the complete opposite. Our biggest threats arise from a lack of long-term planning. As a consequence of our evolutionary inherited present bias, we tend to make temporarily myopic decisions that influence our health and finance among other things. 


Long-term planning is a skill best accomplished by copious awareness of how the disproportionate sway of short-term gratification affects our allegedly rational decisions; additionally long-term planning benefits.    
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