Author: Paul Heys

The Marshmallow Metaphor

In a well-known experiment conducted in the late 1960s, Stanford psychologist Walter Mischel studied the behavior of children faced with a choice between immediate and delayed gratification.

Given the choice between a small treat now or two small treats if they waited 15 minutes, the children behaved in different ways. Some ate one marshmallow immediately while others waited—with effort—for the promised two marshmallows. The subject’s age often affected the results.

Some have argued whether or not Mischel’s experiment correlates with later success or failure in life, or whether some people are better at delayed gratification than others. But the bigger point is that we can easily identify with the kids in the test, especially (in my case) when writing about this example right before dinner.

Taking the first marshmallow right now is a great metaphor for spending on immediate consumption. It’s at the heart of the “spilling” phenomenon described in my book. It’s also a very normal aspect of human nature—even when we know it will limit our future consumption.

Waiting 15 minutes for two marshmallows is also a metaphor—for spending towards long-term growth. Like the children in the marshmallow experiment, we need to develop habits that reinforce our reasoning and increase the likelihood of spending behavior that leads to future, spendable wealth.

An Unlikely Scenario

A sample from the upcoming book…

Imagine living in a house or condominium that you own—either outright or with the help of a mortgage. Despite its imperfections, it is home. It satisfies many basic needs and, in all probability, will appreciate in value over time.

Now imagine a stranger coming to your door, offering you money for the house or condo right now. If his price is ridiculously low, you will probably close the door—and perhaps call the police (or suggest counseling). If it is ridiculously high, you might accept it as a windfall—if he is not actually mad. But if the price is anywhere in between, you will almost certainly just say no. You were not considering selling and are satisfied with your home and the likelihood of its increased value in the future. It has value worth more to you than any price he is likely to offer. Price is wholly irrelevant, and you would consider anyone offering to buy suspicious.

Now, relate that unlikely scenario to investments. If a stock or fund has value in the long term, and you have no immediate need to sell it, then almost no price will be acceptable. However, with investments is there is a “stranger at the door” quoting a different price every day. Whether it’s a mobile investment app, a too-frequent portfolio review, or a cocktail party conversation, the price message is persistent, and almost always unrelated to a portfolio’s long-term value.

The secret is to treat the “stranger at the door” with the same suspicion when it comes to the price of stocks as you would with an uninvited offer to buy your house. The stranger may not be deranged, but his message is almost always moot. If you have no immediate need to sell something of value, then almost no price is worthwhile.

A Must-Read Letter

Not so long ago, I was privileged to work with University of Washington professor Dr. Ronald Smith in the Investorship Training seminar series we co-developed.  As I was working on my book, Spending Your Way to Wealth, I was thrilled to receive a letter from my long time colleague and friend. His enthusiastic support has resonated with that of many others in educational and financial circles, so I wanted to share the entire letter with you.

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Why Do We Spend?

We spend for only one reason: to satisfy a need or a want. That’s all, folks. There’s no other reason. Think about that while reflecting on the definition of spending…

Spending: The act of exchanging one thing of value for another. It is not limited to money; spending also includes one’s time, energy, or reputation. It can be beneficial or detrimental. It may be characterized as either worthy & meritorious or unnecessary & frivolous, depending on the outcome. Spending is something everyone does, naturally and frequently.

Given this definition, it is easy to understand why spending is one of the most frequent activities and behaviors that we all engage in. For most of us, hundreds of times a day. We do it knowingly and willingly. And, for the most part, we enjoy doing it. We enjoy it so much, in fact, that we are inclined to engage in it frequently, excessively, and without giving it the thought it deserves. Done properly, spending is not only a worthy activity, it can be a noble one. Think “spending our time” for education, “spending our energy” on a community or charitable project, and yes, spending our money on our loved-one’s (self included) financial security.

Because we spend so often and so easily, we almost always fail to consider the fact, that every spending decision has both a short-term and a long-term financial consequence to it. Since the subject of this and future articles by your author is “spending your way to wealth”, let’s pause and consider what the long-term financial consequence are of the kind of easy and frequent purchase decision we all tend to make.

Consider the person who love lattes; and indulges in two a day.

Let’s assume the person is 27 years old, and that they feel they need (or deserve) a couple of lattes a day. At a cost of $2.95/latte, their daily expenditure amounts to $5.90/day Very seldom does the person stop to consider that a latte expenditure of $5.90/day for the remainder of their working years will amount to over $162,000 (adjusted for 3%/year inflation). By framing the latte’s cost as a daily expense of only $5.90 the amount seems rather small. However, if the amount spent is framed as an aggregate expenditure over time, the amount becomes significant. In fact, that expense amount adjusted for inflation amounts to a whopping $162,000. Worst of all, that money is gone, vanished, forfeited: Never to be available to the spender again: EVER. However, all is not lost. Its possible to have your latte and future wealth as well.

If the consumption of lattes were reduced to one per day instead of two, and if the money spent on the second latte ($2.95) were re-allocated to a no-load, low fee stock mutual fund (S&P 500 Index Fund), its likely value (assuming the average return of the fund over the past 60+ years) at that person’s retirement age will be in the neighborhood of $710,000.

Moral: Spend after thinking: thinking about the long term consequences of even the smallest expenditure, and you’re well on your way to spending your way to wealth.