Updated: October 21, 2021

What is hyperbolic discounting, and how is it related to investing?

Before I answer that, let me first give you a thought experiment.

Below are three scenarios that I want you to consider. Carefully read the question, and answer immediately which among the two given choices you prefer.

Scenario A
I’m giving you money. Which one would you prefer?

Scenario B
Let’s say that I changed my mind and instead, I’m choosing to give you money in the future. This time, which one would you prefer?

• Receive P10,000 five years from now; or
• Receive P20,000 six years from now.

Again, finalize your answer before proceeding below. If you’ve made the choice, then consider this last scenario.

Scenario C
Imagine that it’s five years later, and I’m now giving you a chance to change your original answer in Scenario B, which one would you now choose?

### What is Hyperbolic Discounting?

Without being too scientific about it, hyperbolic discounting is the tendency of an individual to prefer things that arrive sooner rather than later.

This is the reason why most people would choose to receive P10,000 now rather than the P20,000 a year after for Scenario A.

However, when presented with Scenario B, more people will choose to wait six years to receive P20,000 rather than getting the P10,000 five years after.

Lastly, take note that Scenario C is just like Scenario A, but only set in the future.

If you choose to receive P10,000 now in Scenario A, then you’ll most likely want to receive P10,000 also in Scenario C, even if your choice was to get P20,000 in Scenario B.

Indeed, most people will choose to get the money now, instead of waiting for the better reward in the future; but are willing to delay gratification to get the higher amount if both choices require waiting.

Each person is different, and there would be those who will still choose to get the P10,000 in Scenario B.

If you’re one of them, then ask yourself: would you still choose P10,000 in that scenario if the delay was 15 years, instead of 5 years? Or are you going to choose the second option (wait 16 years) and get the P20,000?

Logically, it’s best to choose P20,000 in all scenarios. But people will “discount” or fail to realize this because they fear the uncertainty that comes with waiting.

If you still remember what a hyperbola looks like, that’s the shape that forms when you plot the number of people who are willing to wait longer for the better reward against the waiting time.

That is, more and more people will be willing to delay gratification and receive the higher amount if you increase the waiting time to receive the lesser amount.

### The Investor Mindset

Those who chose to receive P10,000 in both Scenario A and C can be described as “present-biased”; and it requires an investor mindset to logically choose the better recourse of getting P20,000 a year later.

If you’re financially aware enough, you’ll know that it’s rare to find an investment today that can double your money passively within a year – and that’s why the second option is such a great deal.

Unfortunately, not a lot of people will have that knowledge, nor will they have the kind of mindset that is willing to take the risk. So they’ll choose what’s “sure” and settle for the lower reward.

And this is the reason why most people don’t invest.

Remember that life is uncertain, and having that fear is normal.

However, with proper financial education, you’ll know better which financial risks are logically and practically – worth choosing.

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Photo credit: vanf

1. Gosh! Wala akong malay dun Fitz ha, atleast my investor mindset have been developed already, I was unaware and unconscious of what I chose, then reading until the bottom the explanation I could say that over the years nawala na yung impulse attitude ko and have developed a long term thinking mind and actions. I enjoyed this article.

2. kori1111 says:

Wow… I just chose the three 20,000 options, I think I’m learning more and more about my money matters now compared before.. Thanks sir fitz, your articles are helping me a lot understand my personal finances… Now, I’m starting to diversify my source of income which I learned from your advice sir fitz, salute to you..

3. but cant you take the lesser reward and invest to a better performing portfolio ?:)

and of course considering inflation rate future value of 20k will be lesser 🙂

4. Rose says:

I chose A in all three questions. Yes, it’s rare to have an investment that can double my money in a year, but I’d still prefer that even if I know for sure that there is only 1% chance on doubling my money in a year. It’s not about immediate gratification, it’s about taking logical chances or risk (if you’d rather call it) and keeping the inflation rate in mind. BUT, if the difference between the two is P100k and above, I’d probably have second thoughts before choosing one of the two.

Thank you for another thought provoking post!

5. “Unfortunately, not a lot of people will have that knowledge, nor will they have the kind of mindset that is willing to take the risk. So they’ll choose what’s “sureâ€ and settle for the lower reward.”

I’m an OFW at marami sa paligid ko, pag investment na ang topic, ayaw! Sasabihin lang sayo, saka na yan, e reward ko muna ang sarili ko dahil pagod sa pagtatrabaho.

Anyway, one day, lalapit din sila sa atin at magtatanong… paano mag invest? Saka natin tulungan.

Thank you for this Hyperbolic Discounting idea sir Fitz! Cheers!

6. Erudite says:

Most minds are also asymptotic, especially when it comes to investing.

7. Jack says:

I have been at the investing game for many years and I think and hope I have developed at least a little patience. It is good to give a new position time to work and that is exactly what was needed in the examples in this article. Your patience paid off over time. Now, I also face the exact opposite situation frequently in my option selling. There are times when we have sold short put options and within a day or two there will be a huge move in the underlying that renders the put options almost worthless. This recently happened to puts I sold short on the ETF USO when crude oil spiked the day of the drone attack on Saudi oil fields. All most every time a stock or ETF moves that far and that fast, there will soon be a retracement or reversion to the mean. Those are the time you must make a snap decision to maximise profits. We quickly buy to close the put options knowing that the vast majority of the time, we will be able to sell a new position to open when the underlying pulls back. You earn two profits in the time you would have earned one! I believe consistency of time is what you want to aim for.