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The One Discount That Won’t Save You Money
Have you ever told yourself you’d go to the gym after just one episode of a TV show, only to end up watching five episodes and then skipping the gym altogether? If so, you’d be exhibiting a type of behavior that economists label “discounting.”
Discounting refers to the fact that we’re wired to highly value the present and care less about what happens in the future. We “discount” the future by placing less emphasis on it. We know that going to the gym will bring benefits, but those don’t come until much later, and after much effort.
Evolutionarily, discounting makes sense. The future was never guaranteed to our ancient ancestors, who lived in a much more dangerous environment. Their survival largely depended on thinking in the now.
But people in today’s advanced societies live, on average, into their late 70s. Given that, discounting can cause us to behave in ways that make our future selves quite upset over the laziness of our past selves.
Why Discounting Is a Problem
Discounting represents one of many cognitive biases that induce us to make poor choices with our money. It’s an especially pernicious bias because it is so prevalent. It rears its head whenever we’re faced with situations that require discipline, planning, and delayed gratification.
I got a chance to speak with Jeff Naecker, an economics professor at Wesleyan University, about the effects of discounting and how we can structure our lives to mitigate its negative consequences. Naecker called discounting “one of the most important applications of behavioral economics in our day to day life.”
To see its effects in action, consider an example from the research literature. One experiment on discounting involved asking subjects a version of the following question: Would you rather have $100 today, or $120 in a week? The majority of people chose the immediate $100.
To most people, a week feels like a long time. Who knows what could happen? They want that cash in hand as soon as possible, even though waiting just a bit longer would net them 20% more money – a return any investor would envy.
The mindset of wanting the $100 immediately is analogous to the example laid out at the start of this article. At the moment you finish watching that first TV show, you really value watching the next one. After all, that episode will provide an enjoyable hit of dopamine right away. So, you keep watching, foregoing whatever future benefits you might have gained from going to the gym.
Now that we know the problem, what can we do to stop it?
Commit to Something
I’ve found that the best way to hack this cognitive bias is by making myself pre-commit to stopping points when I engage in activities that I know can be all consuming. In essence, I make rules and stick to them. If I want to watch less TV, I will make a rule that I can only watch one episode per night, no ifs, ands, or buts.
Hard and fast stopping points are so helpful because we are always going to be untrustworthy in the future. That sounds harsh, but it’s the truth. Discounting ensures that you are going to really want to watch that next episode, play that next level, or take your whole paycheck instead of putting aside a set percentage into your 401(k).
Naecker noted that while discipline on its own is commendable, it’s not going to work well unless you take it a step further. “Commitment must have a well defined incentive,” he said. “Money works well for most people, but you want to use whatever is valuable to you as the incentive, whether that’s money, losing access to resources, or losing out on a prize.”
Money is very motivating to me, so it’s clear that my efforts at self discipline would be improved if I imposed a fine on myself every time I watched too much TV. Or, if you’re addicted to your phone, you might want to use access to your phone as an incentive. You could promise to give up your phone for a week if you don’t meet your goals.
Another compelling bit of research out of Harvard and MIT shows how effective commitment can be in changing discounting behavior, specifically in a financial setting. The researchers offered 700 clients of a bank the chance to use a product that would purposely restrict access to their savings accounts. Only 202 accepted, which is understandable, because who wants a bunch of New England nerds meddling with their money?
Well, the group that agreed to be restricted apparently understood the power of a commitment contract. After 12 months, those who used the restrictive technology had 81% more money in their savings accounts than the group that could raid their accounts at will.
Use Your Imagination
I first learned about the power of imagining the future as a way to curb bad habits while reading the neuroscience book “The Hungry Brain.” It shows that if we take some time before eating to visualize how we will feel when we’re done with the meal, we tend to eat healthier than we normally would. An honest visualization will reveal that our future self will feel better after eating broccoli as opposed to Cheetos, for instance.
Visualization has been shown to help us be better long-term planners, and not just with our diets. The same idea applies to financial matters. There’s a reason it’s so effective to ask yourself a series of questions before making any purchase. Two of the most important questions are, “Do I need it?” and, “Will this improve my life enough to be worth the cost?”
Both of those questions force you to slow down and actually imagine yourself in the future. Sure, your current self really wants that shiny new iPad, but you might want it less once you take the time to imagine yourself struggling with bills the next month, having put yourself further into debt just to buy a really big version of your phone.
Through imagination, you can know yourself better, and through that knowing you can improve your ability to counteract your innate preference to discount the future.
When battling the effects of discounting, it will help to have defined incentives, a visualization practice, and a commitment. Those tools can help tie us to the masts when the siren calls of procrastination get strong.
In order to keep yourself focused on discounting the future as little as possible, you might want to make use of an online habit-building tool that utilizes commitment contracts. Your future self will thank you.