The Present Value of Your Future: Finding Your Point of Indifference
If you could choose between being gifted $50 today or in a year, you would undoubtedly pick today. This is the framework for the financial concept of the time value of money. The money has greater value to you if you have it now. You could earn interest if you had the money today, whereas you’d gain nothing by waiting a year. What’s hard to calculate is the tangible value you gain from starting something today instead of next week. The advantage of starting earlier is not just getting into a healthy habit, but also the ability to utilize compound interest. The great thing about compound interest is that your returns are calculated based on your initial investment plus your previous interest earned. But what if the choice was between $50 today and $100 in a week? With such a short time-horizon and a bigger pay off, you’d likely be willing to wait.
With clear examples and short timelines, it’s easier to pick the best deal. Our brains automatically want to discount the scenario — or in other words — we want to know what value an option has for us today. While financial professionals use discounting to compare investments, it can also apply to how motivated we are to invest in the first place. The interesting part of discounting is that our brains, unbeknownst to us, work off a point of indifference.
Psychologist George Ainslie came to the conclusion that, at a certain point, it becomes hard to adequately connect the present value of a future reward. In his studies, he offered participants $50 today or $100 in a year. When they chose $50 today, he then asked them to choose between $50 in five years or $100 in six years. In the first case, people wouldn’t wait a year if they could have $50 today. However, once he pushed the pay-off to the future, they chose to wait six years to receive $100. His findings showed that participants felt differently about waiting a year today than waiting a year in the future. This is because it was past their point of indifference.
One of the reasons it’s hard to start saving for retirement is because the benefit of present value is challenging to feel when the reward is past our point of indifference. Like a New Year’s resolution, it’s simple to name a goal, but harder to follow through with it. This is partially due to restraint bias. This prejudice is just another method in which we all tend to overestimate our abilities. We imagine that tomorrow or next year we will be better at controlling our impulses and more motivated to pursue our goals.
In an effort to control your cognitive biases, try to identify your point of indifference. For most people, it’s not enough that future-you will be pleased with today’s accomplishments. Instead, try to find the present value in your future success. You may realize that your point of indifference is within a couple months. As opposed to rewarding yourself only with your end goals, write down an incentive you’ll grant yourself if you stay on track. This could be peace of mind and the satisfaction that comes from security, or you may need to take it a step further and tangibly reward yourself for staying on track.
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10765 Double R Blvd. Suite 200
Reno, NV 89521
Phone: (775) 850-5620
Fax: (775) 850-5639
Email: [email protected]
Where you want to go in life is up to you. How to help you get there is up to us.
Contact us today to start your journey…
Contact
Schultz Financial Group Inc.
10765 Double R Blvd. Suite 200
Reno, NV 89521
Phone: (775) 850-5620
Fax: (775) 850-5639
Email: [email protected]
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Copyright © 2018 Schultz Financial Group Inc.