Most humans suffer from the present bias where immediate rewards valued more strongly than equivalent rewards in the future. How do financial advisers ensure their clients balance their short term wants with their long-term needs?
Decisions that involve a trade-off between a more immediate, but smaller reward, and a larger, but more delayed reward, are typically subject to temporal discounting i.e. gains and losses in the future mean less to us than gains and losses now. This tendency to place greater value on an immediate rewards means that people are present-oriented – there is a strong tendency to choose options offering immediate relatively small rewards rather than options offering much larger delayed rewards.
However, give people the choice between a smaller, sooner reward, and a larger, delayed reward, albeit both delayed to the future, and people are more likely to choose the more delayed reward. People thus discount the immediate future to a much larger extent than more distant future, leading to dynamic inconsistency e.g. on the one hand, a person may prefer to have £200 in 12 months over £100 in nine months, but on the other hand they may prefer £100 in one month as opposed to £200 in four months. Thus, whilst the amount of delayed time is the same, people tend to prefer to smaller reward when it is near, than when it is far.
This tendency to trade-off short term and long-term outcomes is called the hyperbolic discount rate. The greater the hyperbolic discount rate the more likely there is a struggle in choosing between what they should do e.g. save for retirement (delayed reward), and what they would want to do e.g. buy a new car (immediate reward).
This has direct implications for investment e.g. people with higher discount rates are likely to prefer shorter-term investments with smaller returns, as opposed to longer-term investments with greater returns.
Bambooing is here to help…
Bambooing provides key information about present bias characteristics of consumers. High levels of present bias indicate that a person is strongly present minded seeking short term gains at the expense of longer term gains and well-being. On the other hand low levels of discounting suggest that a person is less driven by the need for immediate gratification and better able to take account of longer-term goals and aspirations. Knowing whether a particular individual is a low, medium or high in relation to present bias is useful. For example we may need to ensure that information and advice to high discounters places more emphasis on the need to take account of the long-term outcomes of financial activity rather than just focusing on the short term. High discounters might also be encouraged to focus on an objective approach to their financial decisions, a simple manner of which is to consider how one might advise a friend or relative facing the same decision.