The human brain is pretty decent about making decisions right now about what's going on right now. Everyone is pretty good at that.
The number one just makes sense to the human brain. Two too. Many brains just naturally get three, but not all. After that even counting is an abstract concept that at least takes some work. Thankfully most of us have enough fingers to get to ten.
Now let's talk about the effects of the impact bias, temporal discounting, and arithmetic. Things your brain doesn't naturally understand.
Now then. I'm not going to teach you about psychology or arithmetic I'm just going demonstrate why these things are important to know and give you enough information that you may educate yourself if you choose to.
The impact bias is the tendency for people to overestimate the length or the intensity of future feeling states. When we think about how something that we choose, or have inflicted on us, we tend to believe it will be more intense with a longer duration than it turns out is the case. How would you feel if you were paralyzed tomorrow? Take a moment. How would that change your life? How would you feel about that? Compare that to how your life would change and how you would feel after winning the Lotto.
Spoiler alert: paralytics are happier than Lotto winners. It's true on average in all other cases, but I'm sure you're the one person who would be happier winning the lottery. It's not just that you think you would be. Your brain couldn't possibly get this wrong. Not you.
Temporal discounting is the tendency to give greater value to rewards available "now" and less value as they are more distant in time, either to the future or the past. A nicotine addict assigns a high value to a cigarette within the next 6 hours, but essentially zero value to cigarette availability in 6 months. Or if I offer you $100 today or $1000 next month and you choose the $100 today.
Arithmetic is taking numbers and logically applying the concept of numbers to numbers to generate consistent results of numbers. Like:
5x5=? 25
12x12-12= ? 132
Sally buys a bag of 4 apples for $1, she dips each of them in caramel for 10 cents each. At the start of the fair, she can sell them for 8 times as much as each caramel apple cost her but after an hour must reduce her price by 10%. In order to keep selling apples, she must continue to reduce her price by 10% each hour. Sally doesn't like pennies and drops them from all of her prices. She arrives an hour late to the fair and sells one apple per hour, how much money does she have by the end of a 6 hour fair?
1/4=.25 +.1=.35 *8=$2.80
Hourly breakdown: $2.80, $2.50, $2.25, $2, $1.80
Sally makes $8.55 selling apples for 4 hours after missing the first hour of the fair.
Now then. I got my first job collating papers. I made $3 per completed binder. Let's pretend I completed 12 binders a week and got paid monthly. Here are 3 savings accounts I could've set up in 2000.
The black line is a checking account where my earnings are stored, after 17 years my total savings would be $29,952.00
The Green line is added to a savings account where 1 year CDs are purchased in series, totaling $32,808.26
The Red line is a basic account where Shares of the ETF SPY are purchased whenever the account has sufficient funds finishing at $67,808.75
The choice to invest in CDs in this arbitrary scenario represents a 9.54% gain over the initial investment.
Purchasing SPY instead during this time would have yielded a 126.39% gain.
In October 2002, the SPY account returned -27.2% compared to the Checking account while the CDs had returned 3.9%, the very time when the brain would be inclined to believe this was a failed venture is the most important time to continue with it. To reach the 226% total value, you must invest every month especially when the account is losing value.
The chart looks fundamentally the same no matter the size of the regular investment, it's just arithmetic.
The number one just makes sense to the human brain. Two too. Many brains just naturally get three, but not all. After that even counting is an abstract concept that at least takes some work. Thankfully most of us have enough fingers to get to ten.
Now let's talk about the effects of the impact bias, temporal discounting, and arithmetic. Things your brain doesn't naturally understand.
Now then. I'm not going to teach you about psychology or arithmetic I'm just going demonstrate why these things are important to know and give you enough information that you may educate yourself if you choose to.
The impact bias is the tendency for people to overestimate the length or the intensity of future feeling states. When we think about how something that we choose, or have inflicted on us, we tend to believe it will be more intense with a longer duration than it turns out is the case. How would you feel if you were paralyzed tomorrow? Take a moment. How would that change your life? How would you feel about that? Compare that to how your life would change and how you would feel after winning the Lotto.
Spoiler alert: paralytics are happier than Lotto winners. It's true on average in all other cases, but I'm sure you're the one person who would be happier winning the lottery. It's not just that you think you would be. Your brain couldn't possibly get this wrong. Not you.
Temporal discounting is the tendency to give greater value to rewards available "now" and less value as they are more distant in time, either to the future or the past. A nicotine addict assigns a high value to a cigarette within the next 6 hours, but essentially zero value to cigarette availability in 6 months. Or if I offer you $100 today or $1000 next month and you choose the $100 today.
Arithmetic is taking numbers and logically applying the concept of numbers to numbers to generate consistent results of numbers. Like:
5x5=? 25
12x12-12= ? 132
Sally buys a bag of 4 apples for $1, she dips each of them in caramel for 10 cents each. At the start of the fair, she can sell them for 8 times as much as each caramel apple cost her but after an hour must reduce her price by 10%. In order to keep selling apples, she must continue to reduce her price by 10% each hour. Sally doesn't like pennies and drops them from all of her prices. She arrives an hour late to the fair and sells one apple per hour, how much money does she have by the end of a 6 hour fair?
1/4=.25 +.1=.35 *8=$2.80
Hourly breakdown: $2.80, $2.50, $2.25, $2, $1.80
Sally makes $8.55 selling apples for 4 hours after missing the first hour of the fair.
Now then. I got my first job collating papers. I made $3 per completed binder. Let's pretend I completed 12 binders a week and got paid monthly. Here are 3 savings accounts I could've set up in 2000.
The black line is a checking account where my earnings are stored, after 17 years my total savings would be $29,952.00
The Green line is added to a savings account where 1 year CDs are purchased in series, totaling $32,808.26
The Red line is a basic account where Shares of the ETF SPY are purchased whenever the account has sufficient funds finishing at $67,808.75
The choice to invest in CDs in this arbitrary scenario represents a 9.54% gain over the initial investment.
Purchasing SPY instead during this time would have yielded a 126.39% gain.
In October 2002, the SPY account returned -27.2% compared to the Checking account while the CDs had returned 3.9%, the very time when the brain would be inclined to believe this was a failed venture is the most important time to continue with it. To reach the 226% total value, you must invest every month especially when the account is losing value.
The chart looks fundamentally the same no matter the size of the regular investment, it's just arithmetic.
Here it is for $250 a month:
Here it is for $500 a month:
For $1000 a month:
And $1:
Our knee-jerk reactions cannot be trusted.
Our knee-jerk reactions cannot be trusted.