What’s Your Reward Preference: Smaller-Sooner Or Larger-Later?

Would you prefer a $100 bill today or $110 tomorrow?

What about a $100 in 60 days or $110 in 61?

Are these choices different? Which one would you prefer?

We face a variety of such choices often in our career, investments, lifestyle or even relationships. The rewards may be different but the decision principle is same. The more rational ones among us might calculate a Net-Present-Value (NPV) of both the options by discounting the future reward by an ‘appropriate’ time value of money (read discount rate) and then choose the one which gives a higher return.

In the scenario presented at the beginning, people tend to prefer a smaller-sooner reward than a larger-later reward. Behavioral scientists have given a fancy name to this bias: Hyperbolic Discounting.

Under the classical view, we discount a future reward by a factor of 1/(1+i)^t where, i is the discount rate, t is the delay in time. The discount rate doesn’t change with the delay in time. This view has a fancy name too: Exponential Discounting.  However, under the Hyperbolic Discounting paradigm, we would discount a future reward more if the reward is distant than if the reward is closer in time. The factor of discount would be 1/(1+i*t)^b/a, where b, a >0. It simply means that the rate of discounting decreases as the delay increases although the discount rate is higher if the delay in reward is longer.

But pause, in all these technicalities, are we missing a larger point here?

The more fundamental question here is whether we are okay in delaying gratification. Do we want to focus on what is ‘right’ for us to do and wait for the return or we want a quick-fix?

Some sample situations where we find such a bias:

  1. In a corporate environment if the CEO focuses only on immediate quarterly results rather than longer-term good of the company and its shareholders
  2. In personal finance, having a large credit card debt at a much higher interest than a large amount in savings account at a lower interest rate
  3. In personal health, choosing that tasty high-calorie burger over a more healthy greek salad
  4. In our effort to lose weight, relying on a magic weight-loss-pill over hitting the gym four times a week for six months in a row

Let’s face it. As an evolved species, we understand logic well but we are rarely logical although what we want ourselves to believe in ‘reality’ is a completely different story. I don’t know whether behavioral experts have a fancy name for this bias as well.

avijit@nonlinear.in

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