Temporal Discounting

Temporal discounting can negatively affect individuals' financial and emotional well-being. Therefore, it’s crucial to develop strategies to avoid impulsive behavior:

• Having an Accountability Partner: A person can hire or consider someone wise who can guide them in making rational financial decisions.
• Setting Long-Term Goals: Individuals should fix future goals with a definite period to ensure that they don't get attracted to instant rewards.
• Delaying Immediate Rewards: One way is to take time in decision-making to postpone immediate gratification to improve one's patience level.
• Practicing Mindfulness: People should engage in breathing exercises and other mindful practices that keep them stress-free and improve their self-awareness.
• Visualizing Future Financial Position: It is often better to frame a picture of the future financial status, which can be achieved by waiting for a greater reward in the long term.
• Automating Financial Decisions: To avoid impulsive behavior, individuals can set automatic deductions of periodic contributions towards mutual funds, retirement plans, or other long-term financial commitments.

Temporal discounting is a cognitive bias studied in behavioural economics. It highlights how people tend to prioritize immediate rewards over future gratification, particularly in financial decision-making. However, these impulsive decisions are often considered irrational as they can lead to negative financial and emotional consequences in the long term.

In everyday life, we encounter various situations where we must choose between immediate gains and future benefits. Some examples include:

• Personal Finance: Individuals may prioritize short-term pleasures, like vacations or dining out, over long-term financial goals such as saving for a house or retirement.
• Investments: Stock market investors may opt for risky short-term trades instead of holding long-term positions that offer potentially higher returns with less risk.
• Health: People may indulge in short-term pleasures, like sweets or skipping exercise, which conflict with their long-term health goals, such as maintaining a diet or fitness routine.
• Addiction: Those battling addiction often struggle with immediate cravings for substances, which can hinder their long-term recovery efforts.
• Consumption: The "buy now, pay later" mentality can lead to impulsive spending, negatively impacting long-term financial stability.

The different causes of temporal discounting can be categorized as follows:

Contextual Factors: These are the conditions that can trigger temporal discounting. It includes:

1. Past Experience: When people get exhausted and long for future rewards, they give up on their decisions and aim for short-term gains.
2. Social Influence: The group in which the individuals socialize or belong significantly influences their decisions to choose immediate gratifications.

Psychological Factors: These are the individual psychological traits and behavior that shape the people's decisions:

1. Emotional State: Individuals' emotional thinking and well-being, such as greed, satisfaction, happiness, or stress, can impact their choices.
2. Impulsive Behavior: The degree of patience that an individual has determines their impulsivity in decision-making.
3. Cognitive Abilities: A person's inner ability to discover, think, respond, and learn about things is the key factor behind their decision-making.
4. Risk Aversion: People who don't like to take more risk often settle for less immediate gratification.

Now that we have understood the temporal discounting theory let us go through some examples for a more comprehensive overview:

Example #1

Suppose Mr. Alex has $5,000 in hand. He has two choices to make: he can put this money into the inventory, which is expected to be sold within a week, yielding him a 5% profit, i.e., $5,250. Or, he can invest this amount in a long-term investment opportunity, which would reap him $10,000 after 3 years, I.e., a 100% return. Mr. Alex is an impulsive decision-maker and decides to buy inventory from this amount to gain $250 in just a week rather than making $5,000 after waiting for 3 years. Thus, his decision is a classic example of temporal discounting psychology.

Example #2

One recent study examined the relationship between temporal discounting and procrastination in real life through a research participation task. In this experiment, the participants completed the tasks throughout a semester, and their procrastination was measured using various metrics. The outcomes indicated a significant association between higher temporal discounting and surged procrastination when examined using the Mean Unit Completion Day (MUCD) metric. However, no significant relationship was found between the two on the day of the final task completion.

Further, the study analyzed the association between risk attitudes and procrastination using the risky-choice task and a risk-taking questionnaire but couldn't establish any such dependency. Thus, it was concluded that procrastination is related to an individual's perception of future rewards rather than their risk tolerance level. Also, it was found that the strategies to reduce procrastination can emphasize adjusting incentive structures or lowering discount rates with the help of practices like mindfulness or episodic future thinking.

This research was based on 194 students from a 2021 Introduction to Psychology course at NYU. Out of these, the final samples included 84 participants for the delay discounting task and 91 for the risky choice task. Moreover, this study was approved by the NYU Institutional Review Board and was pre-registered on the Open Science Framework. Nevertheless, the limitations, including a small sample size comprising NYU undergraduates and the use of a non-academic task, couldn't be overlooked, indicating the chances of getting different results when the experiment is performed over a diverse population and different tasks.

Source - https://www.nature.com/articles/s41598-024-65110-4

Temporal discounting is a cognitive behavior that can significantly influence an individual's future decisions. The real-life significances are:

• Gauging Decision-Making Behavior: It helps in understanding why individuals make choices driven by immediate gratification rather than waiting for a more substantial future reward.
• Financial Aspect: It shows individuals' financial behavior in terms of personal finance management, budgeting, savings, investments, and future financial planning.
• Facilitates Strategic Planning: It is a key factor in the government's strategic planning, such that people make decisions that demonstrate a higher level of patience for deriving greater future benefits.
• Enables Policy Making: It helps the government and other regulatory bodies to make policy decisions that encourage people to make rational choices with future returns.
• Understanding Social Hazards: It is crucial for identifying the socially important aspects where people develop hyperactivity disorder, not being attentive towards social hazards like eating disorders, drug abuse, etc.
• Health Impact: It explains why people struggle to achieve long-term health goals like regular exercise or sticking to a diet.
• Product Design: Companies use insights from temporal discounting to design products that encourage rational decision-making.