Marshmallows, part II

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  By Guest Blogger Doug Rowat

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Consider this:

Would you rather receive 1) $100 today or 2) $110 in a week?

According to the American Economic Association, 60% of us pick option 1), indicating that most of us prefer instant gratification. It’s human nature, it seems, to prefer happiness today versus happiness in the future.

Put another way, most of us lack willpower.

A few years ago, I highlighted the famous 1970s Stanford University marshmallow experiment, which showed that a remarkably high percentage of children will devour a single marshmallow left in front of them rather than wait to receive TWO marshmallows a short time later.

All of the above relates to ‘present bias’, our tendency to settle for the smaller reward rather than wait for the larger one.

How might this relate to our investment decisions?

There are a myriad of implications. We may, for instance, delay saving because the upfront costs (effectively, the removal of an immediate reward) outweigh the future benefits. We may become more prone to FOMO as the media attention given to certain high-flying investments creates the impression of a quick reward and we may therefore forgo more sensible, longer-term investments.

But another good example of present bias, and the first time I wrote about marshmallows, was the sudden demand we were seeing for GICs back in mid-2022. Here’s what I reported here at the time:

Flash forward to June of [2022] and our client requests for GIC purchases suddenly increased. GICs, with their steadily more attractive interest rates, effectively became a tempting marshmallow. And even though I cautioned clients that they were ignoring the potential upside of a bond- and equity-market recovery that would likely feature returns many multiples of what GICs were offering—effectively, the chance for TWO marshmallows—many simply couldn’t resist the immediacy of the GIC yields.

A 2-year GIC purchased at the time might have provided investors with a 3% annualized yield, certainly an attractive return based on their history, but here, for instance, was the opportunity cost over the past two years of impulsively jumping on those GIC yields and shunning equities:

US equity (white line) and global equity (red line) returns since my August 2022 ‘marshmallow’ blog post

Source: Bloomberg. S&P and MSCI World returns from August 19, 2022 to September 10, 2024.

Now let’s consider discount rates. Essentially, this is the extent to which we value a reward based on how far into the future we’ll receive it. If we’ll get the reward soon, we tend to value it highly (apply a high discount rate) and are more likely to forgo a greater reward down the road.

Sad to say, but our individual discount rates likely determine whether we’ll be winners or losers not only in investing but also in life. Author, law professor and former Morgan Stanley investment banker Frank Partnoy describes it this way:

Over and over, studies have shown that high discount rates correspond to bad behavior. People with high discount rates are generally less happy and less successful. They are fatter, have more debt and less savings, drink more alcohol, smoke more, exercise less, have lower-paying jobs, don’t stay in jobs as long, and are more likely to be divorced.

So, the next time you’re presented with the opportunity of receiving something now or receiving even more later, you know what your answer should be.

Always target the second marshmallow.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd.