Did you know that most of the decisions you make in life have already been made well ahead of time? That split second judgement about selling your shares, your choice of food at a restaurant when dining out and even your decision to quit a bad habit were actually made well before you indicated you choice to anyone, including yourself.
In this post I’m going to cover the concept of hyperbolic discounting and show why you make the decisions you do about all kinds of things that effect your life, especially your finances.
What is Hyperbolic Discounting
Do you often wonder why you have trouble following through on an action when the time comes, even though you always intended to do so? The cause of this is the diminishing value you place on achieving your goal as time draws closer. This change in value over time is called hyperbolic discounting.
Maybe you promised yourself a coffee on the way to work if you went to the gym before hand. The night before this seemed like a very achievable goal and the reward of the coffee would more than compensate your effort of waking up early and doing the hard work.
When your alarm goes off the next morning to wake you for the gym, you hit the snooze button, roll over and go back to sleep – maybe you could just go to the gym after work instead?[/box]
Hyperbolic discounting describes the inconsistency in your choices about the same thing at different points in time, this is also referred to as dynamic inconsistency. These choices require you to evaluate the costs and benefits of a goal or reward and may relate to any number of things, including saving money, exercising, your diet, the amount of work you do and even your relationships.
Enjoy it now and worry about it later
Up to a certain point most people will choose a lesser reward if they can have it today rather than waiting, but if the reward isn’t available for an extended period most people will gladly hold out a little longer in order to receive a greater reward instead.
Hyperbolic Discounting and Your Money
People use hyperbolic discounting to make decisions about money all the time. They make choices today that their future self would prefer not to make, despite using the same reasoning.
For example, if you offer someone a choice between $100 now and $150 a year from now, many people will choose to take the reward that arrives sooner. If you use the same figures and delay between rewards, but extend the waiting time before you can have it, something funny happens. The people that took the lesser reward initially will likely wait for the greater if they are given the choice of $100 in ten years or $150 in eleven years because the extended waiting period changes their perceived value.
You may not think that hyperbolic discounting effects anything you do, but you might be surprised.
when you bid on eBay for example, you start out with a fixed price in mind for a specific item. As you get closer to the finish time and more people start bidding, your perceived value of the item changes and you decide you could perhaps increase your price in order to win the sale. The same is true for anything that you might pay more or less for at different times because of the perceived value rather than the true value.
Hyperbolic Discounting and Your Health
We have already seen how hyperbolic discounting can influence the decisions you make about your health. By discounting the value of your future health, you may make choices that satisfy your immediate needs, but may also have long term side-effects.
For many of us, the most common example is our diet (or lack thereof). We eat the things that look good, taste good and make us feel good at the time, but don’t really think about the impact of these decisions on bodies in the future (or even how we might feel about those choices later either).
Strangely enough, we can also apply a similar approach to relationships. Often we have an exaggerated value of “now” so we make decisions (for good or bad) accordingly. By understanding the effect of hyperbolic discounting we can attempt to put some space between our immediate feelings and those we might have in the future, or even in the past and make a decision that is far more rational.
In both cases asking yourself “how will I feel about this later” is often a good start, but the biased effect of your perceived value may be difficult to combat.
Hyperbolic Discounting and Your Habits
Knowing the degree to which you discount is very important in understanding your habits and influencing your choices, especially in the discounting of rewards associated with money. Most of us have a tendency to favour things which are pleasant in the short term, rather than those which are seen as valuable in the long term. So in order to improve our habits, we need to understand and control our desires.
Because you are already working against a preference for one option over another, you need to find a mechanism that enables you to tip the balance. If that coffee wasn’t enough to get you out of bed, then perhaps you need to try something that isn’t as easy to discount. What about a bigger, more desirable reward if you make every gym class for a week?
The level of discounting varies for each of us, so get to know your triggers and find a suitable mechanism to help you achieve the desired result.
Can you think of any examples where you have used hyperbolic discounting to make a choice that seemed perfectly reasonable to you at the time, but that you questioned later?
Image by InaFrenzy