Stories | January 30, 2013

Why trust is important for marshmallows – and investments

Personal finance experts often advise people to think about the long term, delay consumption and save for the future.

Planning for the future can mean forgoing the instant gratification of some meals out at a restaurant or buying fancy electronics now. This type of thinking is generally very sound but there are some occasions when it may be more reasonable to consume right now. The surprising findings of a variation of the classic “marshmallow” test of self-control help explain why.

The savings challenge
We all know that saving for the future can be difficult in the face of so many temptations from the likes of travel agents, shopkeepers and clever restaurateurs. Even if we want to put money aside regularly for a deposit on a home or to pay for early retirement, self-control (or more correctly, a lack of it) might get the better of us and challenge our ability to resist immediate buying opportunities.

In these cases, commitment devices  – self-imposed arrangements that encourage us to stick to our goals – can help us stay on track. Another reason we don’t save when we should is that we have a hard time planning for the future. Amazingly, seeing an image of ourselves altered to look older may help us in this endeavour – perhaps making our future as an elderly person more real to us now. But another reason that we might not save right now is that life is uncertain, and decision making under uncertain conditions can be very difficult.

A classic test of self-control
Like other things that provide immediate gratification, a decision to buy a pair of shoes now rather than saving that money for later might not actually be an indication of low self-control or lack of forethought after all, new research shows. Instead, what looks like impulsivity or poor self-control might be a reasonable response to uncertain, unstable, or unreliable environments.

In this new research, Celeste Kidd and her colleagues at the University of Rochester ran a variation of the now famous “marshmallow experiment” run by Walter Mischel back in the 1960s.

The original study (and several replications since) sits a pre-schooler in front of a plate with a marshmallow on it. The experimenter offers the child a choice: he can eat that one marshmallow, or, if he refrains from eating it and waits, the experimenter will return with two marshmallows. The experimenter leaves the room and observes the child’s behaviour. Whether a child eats the one marshmallow now or waits for two marshmallows later has been interpreted as measuring the extent of the child’s self-control.

We’ll wait longer if we believe the reward will come
In Kidd’s variation of the study, she and her colleagues show that self-control is not the only determinant of whether a person opts for the smaller short-term reward over the larger long-term reward. Prior to conducting the marshmallow experiment as previously described, the researchers manufactured the setting to be either “reliable” or “unreliable”.

They did this by first setting the child a task, such as to decorate a piece of paper. In the room were some mostly-broken crayons. An experimenter then told the child to wait while she went to get a new, bigger set of art supplies. In the “reliable” treatment, the experimenter did indeed return with a better set of supplies; in the “unreliable” treatment, she returned empty-handed, apologised for being mistaken, and prompted the child to go ahead with decorating using the original mediocre set.

After this task, they conducted the marshmallow study. The results were striking: children in the “reliable” treatment waited for roughly 12 minutes on average before eating the marshmallow, whereas those subjected to the “unreliable” treatment waited for only three minutes. Kidd’s findings illustrate that the decision to eat the marshmallow is not solely down to a lack of self-control or insufficient forethought, but rather, it becomes a reasonable strategy in the absence of trust that the opportunity will exist in the future.

In other words, it may be rational to consume now rather than later if you are not confident that the future promise will materialise.

How investments are like marshmallows
The experiment may have been run on preschoolers eating marshmallows, but it’s not hard to see how the concepts it demonstrates apply to adults spending some money now, or putting it aside to accrue interest (or employer contribution and tax relief in the case of saving in a pension) for a larger sum later.

Our environment and experience – as well as how well we cope with taking on risk – will probably play a role in decision making, whether we consciously know it or not. A similar idea is detailed in economist Chris Dillow’s blogpost  for eZonomics when he writes that new research is emerging which suggests that our appetite for risk is shaped by experiences.

When considering financial decisions that are likely to have long term effects, factors such as risk appetite, interest rates and compound interest calculators showing how much to save each month to meet a long term goal are important. However, it is also important to consider the reliability of your environment and how much trust you have in those you deal with. Working with people and businesses you trust is important as it increases the confidence that your long term expectations will be met.

Nathalie Spencer
Nathalie Spencer

Behavioural scientist at ING

SpendingInvestingPersonal finance

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