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What do Marshmallows have to do with Investing?
No prizes for guessing that the kids who were subjected to more reliable environments prior to the experiment, displayed the higher ability to wait it out for the second marshmallow.
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Admittedly, marshmallows – soft and delectable as they are, were famous long before Walter Mischel’s landmark behavioral psychology experiment in the 1960’s and 70’s. However, Mischel’s work probably created the now well documented association between marshmallows and self-control, or more aptly; the ability to delay gratification.
For those who are unaware, Mischel, then a professor at Stanford University, experimented with a group of 5-year-old children. The test was fairly simple. The child in question was made a ‘deal’ by Mischel – one marshmallow now, or two after fifteen minutes. Having offered the first one, Mischel left the room – leaving some kids squirming, some resolutely waiting it out for the ‘higher’ reward, and some succumbing instantaneously to the delicious treat that lay in front of them.
In an effort that I am sure was a test of delayed gratification in itself, the researchers then tracked these kids for the next forty years. The outcome was clear – the kids who could delay gratification for fifteen minutes and wait for the second marshmallow fared better in life overall. Better marriages, lower BMI, better exam scores, more money – you get the gist.
And thus, what we subconsciously knew all along was empirically proven – that one of the most critical elements of long term success is the ability to wait for lengthy periods of time for future rewards. Over time, this theory was extended to the investment world, and it was decisively proven that the ability to resist the allurement of short term temptation (speculative investments, short term trading, liquidating your goal based investments to buy a new TV, etc) was indeed the most typical hallmark of successful long-term wealth creation through investing. But a critical question yet remained unanswered: that is, what are the factors that influence this personality trait? Is it genetic and uncontrollable, or derived from specific sources and cultivatable?
Fortunately, a very interesting follow up experiment was conducted by researchers as Rochester University in 2012 – the marshmallow experiment, but with a twist. In this experiment, the kids were subjected to the same conditions, but after a precursory experience; either reliable, or unreliable. For instance, one group of kids were promised a box of crayons, but given none. The other group of kids were given whatever promised. How do you think this affected the succeeding experiment? No prizes for guessing that the kids who were subjected to more reliable environments prior to the experiment, displayed the higher ability to wait it out for the second marshmallow.
From a behavioral investment standpoint, this experiment leads to an interesting corollary. That is, investors who operate in volatile, unreliable environments and have been previously stung by losses, will probably display a lower proclivity towards investing their moneys with a long-term view. Unfortunately, that is the case for most securities markets.
This also creates an interesting paradox. What the above described phenomenon essentially means is that Investors who commit their moneys mainly to stable, fixed return investments will display a higher propensity to holding their investments for the long term (in effect, delaying gratification) whereas investors who select more volatile instruments such as equities will be more prone, from a behavioral standpoint, to seeking out short term rewards over long term ones.
To overcome the above tendency, investors need to consciously invest with a high degree of emotional intelligence. The world-renowned psychologist Daniel Goleman had broken down emotional intelligence into two critical aspects: self-awareness and self-regulation. Beginning with a clear awareness of our behavioral tendencies, we can then proceed to regulate our investment habits by regulating our actions in the face of turbulent market forces. Learning to wait for the second marshmallow can turn out to be extremely financially rewarding!