If you find it hard to save you can blame hyperbolic discounting. This economic theory explains why humans are hard-wired to seek instant gratification. Here’s the science behind why your bank account feels like a sieve!
What is hyperbolic discounting?
Hyperbolic discounting refers to the tendency for people to increasingly choose a smaller-sooner reward over a larger-later reward as the delay occurs sooner rather than later in time.
Confused? Here’s an example:
If offered $100 now or $110 tomorrow, most people would opt for the $100 today.
However, those same people offered $100 in 30 days or $110 in 31 days would opt to wait an extra day and receive the extra $10.
People are prepared to wait a day for the extra money in the future but not now. This is inconsistent and means they make choices today that their future self would prefer not to have made. When faced with the exact same choice people act impulsively in the short term but exhibit greater patience in the long term.
Why is hyperbolic discounting a bad thing?
If we consistently make decisions to take immediate rewards now this can have a negative impact on our future financial wellbeing particularly, although not exclusively, in retirement.
Your need for instant gratification is not your fault. It’s a hangover from caveman days when food was scarce and an enormous effort was required to acquire it. Our ancestors, understandably, seized the possibility to eat whenever it arose.
The trouble is that those hard-wired behavioural responses are mismatched to the actual risks we face in the 21st century. While a starving Neanderthal could be forgiven for gorging on a whole mammoth leg when the opportunity presented itself, you really can resist the urge to splurge on an iPhone which is moderately better than the one you already have!
How could hyperbolic discounting affect your retirement?
Our need for instant gratification means that we often prioritise spending over saving and start saving too late even though any financial planner will tell you that you should be saving as much as possible, as early as possible.
When we are young we discount the importance of having enough money for retirement because it simply feels so far away. Going back to the example above, we choose to take the $100 now. Then suddenly, we get to our 40s and retirement doesn’t seem so far away after all. Cue: panic.
Saving, and financial planning in general, goes against our natural predispositions, which explains why certain people find it incredibly difficult. But that doesn’t mean that we should follow our instincts and neglect to plan for the future. In fact, it is absolutely vital that we take time to consider our future financial requirements and how we are going to secure a comfortable life once we stop working.
Overcome your natural instincts and plan for retirement
This need to fight our natural instincts is yet another reason to work with a financial adviser. Their guidance and encouragement will help you beat the drive to spend spend spend and instead coach you to save save save. They can also advise on how to invest wisely to build your wealth over the long term.
You might have a justifiable reason for finding it hard to save and plan for your financial future but you definitely shouldn’t use that as an excuse not to do it. Start now to ensure that you enjoy a fruitful and happy career followed by a long and secure retirement. Contact me at firstname.lastname@example.org if you’d like help and support with putting together a watertight financial plan or if you’d like the free resource for tracking and reducing impulse purchases I put together for clients, called “Do I really need this?”.
I work as a Financial Planner with expat clients to meet their financial planning needs and goals, with a focus on adequately protecting expats & their families, and helping people to grow their savings over the long term. I strongly believe in building meaningful and lasting relationships with clients to ensure the best client outcomes are achieved.