[P]eople rely on a limited number of heuristic principles which reduce the complex tasks of assessing probabilities and predicting values to simpler judgmental operations.
Daniel Kahneman & Amos Tversky
We don’t decide about life; we’re captured by life.
David Brooks
You do not need good numbers skills to be a smart and successful captain of your money boat. They help – but they are not necessary. What you do need is to be in control of the boat.
How well are we doing that?
In a 2015 paper published by the National Bureau of Economic Research, Gopi Shah Goda of Stanford University et al argues that two key attributes are required for the successful money captain. Two attributes are needed for successful financial planning for retirement.
The first attribute is the ability to delay gratification, that is, the capacity to envisage the future and avoiding biasing decisions to the present. Other economists call this avoiding the hyper-discounting of the future.
To save for tomorrow, you need to be able to delay today’s gratification.
By placing a high value on your future life, you are able to set aside some money from today’s spending and save it for the day when you have few other sources of income. Some people see the future as such a distant place that they focus only on the present and discount the importance of their future lives. Their approach is “I see it, I buy it” Without thinking of their future needs. Those who can balance the present and the future are able to make choices in their own long-term best interest.
Professor Goda took the multi-year longitudinal data from the American Life Panel conducted by the Los Angeles-based think-tank, the RAND Corporation, and combined it with the Understanding America Study at the University of Southern California. Using this information, Professor Goda estimated that just under half (45 percent) of American adults have the necessary ability to delay immediate gratification of their needs. Most of us suffer from “present-bias”.
One survey shows only 45% of American adults can delay gratification of today’s desires.
Other researchers are not so sanguine. In 1960, Walter Mischel and Ebbe B. Ebbesen also at Stanford University conducted a ground-breaking experiment. They took a group of three and five-year olds, put each in a separate room and then placed a white marshmallow on plate in front of each child. Then the lab attendant explained to each child that they had a choice. They could either eat the marshmallow now (immediate gratification) or they could wait until the attendant returned and then be permitted to eat two marshmallows (delayed gratification.)
The length of the wait was generally 15 or 20 minutes. The videos of these young children trying valiantly to wait for the return of the attendant are fascinating. In total, about 25 percent of the children succeeded in waiting for the second marshmallow. But three out of four kids succumbed to the temptation of the immediate reward. What was interesting were the techniques used by the successful hold-outs.
The Marshmallow experiment found that only 25% of five-year-olds could wait for their second marshmallow.
The children who were able to delay gratification used a number of mental tricks to achieve their success. You can see the original video in the following link presented by Igniter Media . The successful kids took measures to distract themselves from the tempting marshmallow in front of them. They sat on their hands. They stared at the ceiling. They focused on the plate rather than the marshmallow itself. They walked around the room.
Even more interesting was the follow-up study some two decades later. The researchers tracked down almost 100 of the 500 children in the original study and looked at their lives. Across the board, the children who were able to wait for the second marshmallow had better life outcomes. They were more successful in completing their formal education, they had been in control of their weight, they had better success in managing their finances. Read strategies to help you wait for the second marshmallow.
Keep reading for Part 2 of the backstory — and the second attribute needed for financial planning.