What does hyperbolic discounting mean?

Yesterday on the way home from work I was listening to talk radio and ran across an interesting phrase: hyperbolic discounting. In the context of the call the phrase did not refer to money, but after looking up the definition of hyperbolic discounting, I thought the term could be applied to living the frugal lifestyle.

Hyperbolic discounting, in behavioral economic terms, refers to the fact that people tend to prefer sooner payoffs to later payoffs, even if the later payoff is much larger. In English, people are willing to hock their future for today’s wants.

This phenomenon explains why people are willing to trade a decent retirement for a $500 a month car payment. Hyperbolic discounting explains why people are unwilling to give up the famous $4 daily latte for a $50,000 college fund ($20 a week at 10% growth for 18 years).

In the book, Your Money or Your Life, author Joe Dominguez touches on phenomenon of hyperbolic discounting while explaining the roots of consumerism. He explains that as Americans, it has been ingrained into our culture to work hard so we can afford to consume the latest hot product delivered to us by a wave of advertising. It is almost as if it is our predetermined destiny to buy all we can now, and wind up broke later.

Going about our day-to-day activities with a frugal mindset helps us think long-term, financially. Being frugal means sacrificing a little bit of fun or extravagance today and investing that sacrifice for a reward to come many years later. Dave Ramsey, the popular financial talk show host, sums it nicely with, “Live like no one else, so later you can live like no one else.”

In other words, make the sacrifices now when no one else is willing to make them, and later you can live at a standard no one else can afford because they didn’t make the same trade-offs.

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