Temporal Discounting

Temporal Discounting
plants on piles of euro coinsTemporal Discounting

Are you saving enough money for retirement? You probably ask yourself this question before.

The case for retirement savings

Depending on how close you are to your planned retirement date might ask yourself this question almost every day and if you are already retired you surely consider whether your current income in your lifetime savings are enough to maintain your desired lifestyle. Now if you are like most working age adults you’ll express cautious optimism about your retirement. Perhaps you haven’t save as much as you would’ve liked, but you know that you are partially covered by Social Security income.

You plan to save more and more as your retirement date nears and, besides, you don’t think that you’ll need all that much in retirement. Your normal monthly expenses will go down you just want enough for the occasional vacation or dinner with friends. Unfortunately that cautious optimism is often unwarranted. Based on comprehensive national surveys approximately half of all American households are projected to fall 10% or more below the income needed to maintain their lifestyle.

Most current retirees report that they haven’t saved enough, about half of all households report essentially no savings aside from home equity meaning that Social Security provides the primary source of retirement support and the people who are most likely to have significant expenses during retirement, those with ongoing health challenges, report the least savings.

Why don’t people save enough

In some cases personal circumstances prevent the accumulation of significant wealth: chronic health conditions care for disabled children or other lifetime financial demands can make saving difficult or impossible, but problems with retirement savings are pervasive in our society. Even among people who have a relatively high household income and have remained healthy a substantial minority still haven’t saved enough to maintain their standard of living.

To understand why people fail to save for retirement even when they know they should will require stepping back from this specific problem. The decision to save her once retirement is a prototypical example of what we call intertemporal choice in that we sacrifice the ability to spend a small amount of money now under the idea that her money will grow and thus we can spend a large amount of money later.

In today’s article will talk about why decisions involving time are so challenging and how we can make better decisions about our future. I’ll begin by introducing the idea temporal discounting. To an economist the term discounting means a reduction in value so temporal discounting means a reduction in value because of the anticipated passage of time.

Temporal discounting

Let’s suppose you walk into a behavioral economics laboratory to do an experiment on temporal discounting for money. The experimenter gives you a choice between two options that differ in the reward value and timing and you just report what you prefer
So which would you rather have? $100 today or hundred and $10 in six months? In laboratory experiments most people prefer receiving $100 today that’s a smaller sooner reward.

This implies that the value of money diminishes over time, we’d rather have less now than more later. So let’s change the question. Which would you rather have? $20 today or $200 in one month? Most people choose $200 in one month. They picked the larger later reward. In the laboratory we can ask people a series of these questions systematically varying the reward values and timing and then estimate a mathematical function called the temporal discounting function.

That describes how time influences the subjective value of money. So when we get if we measure people’s temporal discounting the laboratory? The most obvious result is that people vary tremendously in their patience. Some people discount money very slowly such a they have equal value for $48 now and $50 in six months. Others discount very very rapidly, they have equal value for about $20 now and $50 in one month.

Temporal discounting experiments

Temporal discounting isn’t restricted to money or even the humans. A very wide variety of animal show temporal discounting of one form or another: rodents like squirrels and birds like scrub jays exhibit caching behavior. They put aside food and hidden caches during time of plenty and they return to those caches when times are lean, often days weeks or even months later.

In effect those animals are engaging in a form of temporal discounting, they spend effort to acquire food now so they’ll have sustenance later. Caching behavior represents a relatively extreme case and most of the time animals don’t show this level of patience
researchers have tested many animals temporal discounted rates using laboratory procedures analogous to those for humans.

For example, a researcher might give a rat a choice between a small squirt of juice now and a large squirt of juice later. By varying the juice amounts and timing that researcher could map out the rats temporal discounting function for juice just like was done with humans for money. When tested in procedures like this nonhuman animals show very fast discounting for rewards like food or juice.

Different brains different temporal discounting

Pigeons and rats discount such rewards falling only a few seconds, while monkeys and apes discount over tens of seconds to minutes. Such differences make sense based on what we know about the brains of these different animals. The brain of a chimpanzee for example is considerably more developed than that of a pigeon and thus it isn’t surprising that the chimpanzee can remain patient for a minute or two while the pigeon is only patient for a few seconds.

Let’s think for a moment about just how long people show discount. When did you first start saving for retirement? For many people the answer that question is in my 20s
assuming a plan to retire around age 65 or later that implies that people often delay monetary rewards for 40 years or more or something like 20 million minutes compared to two or three minutes for a chimpanzee.

This difference probably reflects a special nature of money more than anything special about us humans. You see we can test humans using procedures similar to those for monkeys and chimps using nonmonetary rewards like squirts of juice or viewing photographs of attractive faces. When we test humans for those sorts of rewards, then there are discount rates turn out to be pretty similar to those of our primate relatives.

People aren’t willing to wait more than some seconds to view an attractive image or to get a larger squirt of juice. So there seems to be something special about money and were not even consist of inner attitudes toward money itself.

By successdotinc

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