How Hyperbolic Discounting in Behavioral Economics Explains Your Irrational Money Choices

by Emily Guy Birken · 4 comments

Would you prefer a nice crisp $50 dollar in your hot little hands today, or would you prefer to receive $55 in 10 months? Chances are, you chose the instant money, despite the fact that waiting would give you 10% more — a rate you’d kill for from your bank’s savings account.

That preference for instant gratification is human nature, but it’s also the reason why we have so much trouble saving for retirement, losing weight, and quitting unhealthy habits. Our brains are wired to prefer the instant, the immediate and the now over the future. Behavioral economists refer to this psychological quirk as hyperbolic discounting.

Hyperbolic Discounting and Decisions

Put simply, we “discount” things that will happen far in the future as being less important than those things occurring right now. Yes, I’d love to fit back into my size 6 dress for my class reunion in April, but the chocolate cake is in front of me right now! We have all fallen victim to those decisions that we have later come to regret. Sometimes we even know that we will regret those decisions while we make them, but the instant gratification exerts such a pull that we chow down on the cake while we think “I’m going to hate myself for this in April!”

The hyperbolic discount ceases to have an effect when you place the decision past a certain time threshold. In the money example above, would your decision be any different if I asked you whether you’d like $50 on February 4, 2013, or $55 on December 4, 2013? Since you are waiting for the money anyway, it is easier to decide to wait the additional week for the extra money.

Borrowing From Future Selves

Jerry Seinfeld has a very funny bit about Night Guy vs. Morning Guy. When Jerry’s having a great time at night, he stays up late, continuing the fun. He’s Night Guy, and he doesn’t worry about getting up early in the morning. That’s Morning Guy’s problem, and boy does Morning Guy hate Night Guy.

That in a nutshell is what is happening with hyperbolic discounting. We push today’s consequences onto our future selves without worrying about how it will affect that future self. We’re basically saying that it’s not our problem, even though it will be when the time comes.

Credit cards build their business on this borrowing from a future self. Since credit is so readily available, it’s very difficult to save up money now to buy something later, when in our heads later sucks! It’s easy to fall for the instant gratification now and convince ourselves that later can take care of itself.

Combating Hyperbolic Discounting

This is not an easy effect to buck, as focusing on the immediate and the now served our ancestors very well. In a world where death was around every corner, it made sense to grab for all the instant gratification you could get. But now that we live in a time when planning for the future is not only possible but imperative, we need to find ways to rationally deal with our preference for instant gratification.

When it comes to saving money, the important thing is to take the decision out of your hands. Have your contributions taken out automatically before you even touch your paycheck. Without a choice, there is no temptation.

For credit cards, there is something to the old advice about freezing your cards in a block of ice. It forces you to take a moment (or an hour of defrosting) to think about the purchase you want to make and decide if it’s really something that will make your future self happy you whipped out the plastic.

Making decisions with your future happiness in mind can help to fight hyperbolic discounting, even though it can be difficult to determine what will make you happy in the future. But if you know your version of Morning Guy will want to strangle you for what you’re about to do, step back and do what you know Morning Guy would prefer. Make those kinds of decisions often enough, and it will become second nature to think about the consequences of your actions before you jump in.

This is part of a series on Behavioral Economics. We are done, covering other topics such as Availability Heuristics, Loss Aversion and Anchoring.

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{ 4 comments… read them below or add one }

JP A November 4, 2011 at 7:47 am

Thanks for the post Emily. A few ideas on how to fight hyperbolic discounting in addition to what you already provided:

- Measure – track in google docs or on a notepad things you want to change. Just knowing the data behind your current habits is a great way to understand what needs to be adjusted.

- Automate Short Term Decisions – pre cook all of your food for a week to control how healthy you eat, set up automatic reminders on your phone to spend time calling extended family members

- Pick One Life Goal – pick one Long term goal. Change your habits just around just that. Screw the rest until you line up that one.

- Schedule Time – schedule time to deal with long term decisions. Take a couple hours a week or a day a month. Box it and nock it down. Avoid the apprehension of thinking about it all the time.

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Emily November 4, 2011 at 2:14 pm

Wonder if this comes from an ancient survival instinct, if you see a buffalo now, kills and eat or it might not be there tomorrow?

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Alex November 5, 2011 at 10:25 am

I have studied this topic (I personally would choose $55 in 10 months hands down assuming there is no risk of not receiving the pay), and I have heard people just term the idea “impatience.” I don’t think it is hyperbolic discounting per se, but the assign a variable discounting all future events which does not appear in today. People discount everything in the future by a fixed amount equally and immediate events aren’t discounted so people have this conflict of now vs. not now. All of my friends would rather have the $50 now but something interesting may be to compare $50 in a year vs $55 in a year and 10 months in order to eliminate this impatience discount factor.

One way to combat this is to try to contract with yourself in the future to not procrastinate further. I like your example of freezing your credit card as a way to contract your future self to prevent him or her from making the same mistakes. Of course, there are other ways to force yourself to think about the future but none come to mind off the top of my head right now.

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Kolton November 7, 2011 at 7:11 pm

I have never heard of hyperbolic discounting before and it’s something that can really put things into perspective. It seems to me today in America tobacco is one thing that people have a hard time avoiding hyperbolic discounting. It gives you instant buzz while costing you valuable money saving dollars.

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