How To Retire On 2 Marshmallows

After having read The Marshmallow Test: Mastering Self-Control by Walter Mischel, I was wondering how this book has been perceived by the Unique Finance community. To my surprise, I found this book has hardly gotten any mentions here.

The most common obstacle to success in investing is the person behind the wheel: the investor. If you have ever figured out that your portfolio turnover is surprisingly high and your trading activity a drag on performance, you know what I am talking about. When a leading psychologist promises to help people master self-control, investors should pay attention.

The Test

You have probably heard about the marshmallow test. In the original set-up, an experimenter presented to a child one plus two candies of the child’s choice, for example marshmallows. It was explained to the child he could either have one marshmallow as an immediate reward or he could wait alone until the experimenter returned “on her own” (which could take up to 20 minutes) in order to be rewarded with two marshmallows. Should the child call for the experimenter to return or start eating a marshmallow, though, he would have to suffice with only one.

Much to Mischel’s surprise, this simplistic test proved to be predictive for the children’s ability to cope throughout his life: Children that had managed to delay gratification did not only have higher self-esteem as grown-ups, they were also more likely to accomplish their goals (e.g. scoring higher on the SAT) and were more resistant to disappointments as well as stress (e.g. lower body mass index) than their peers.

Had Mischel stopped at this point, his findings would have been not very helpful. A child can belong either to the group that possesses or the one that lacks the ability to hold out. Either the child is lucky or not. Mischel has important messages for both groups, though:

• The idea of a biological lottery that would determine a child’s odds in life is misleading. Even if the child fails in the marshmallow test, there are ways to catch up with those who passed.
• The ‘can do’ mentality shown by those children passing the test is beneficial in many situations. However, it makes them particularly vulnerable to certain substantial risks.

Getting Started as Investor

Obviously, the postponement of consumption in return for a bigger future reward is the core principle of investing. It is essential for being able to maintain one’s current lifestyle even after retirement. As Mischel points out, most Americans will fail to reach that goal. He suggests that for many of us, our future selves are too abstract and distant to be considered today. People who do not relate to their future self put less effort on building a nest egg. His advice for those who are in their working life is twofold:

• Visualize your future self. Think about who you aim to become and build a consistent story of your life including past, present and future.
• Save as much for retirement as you reasonably can and make sure to automate your regular savings.

The Hot System and the Cool System

Since you are reading this on Unique Finance, chances are that you are an investor already. In that case, The Marshmallow Test provides a number of tools that can help you mitigate behavioral risks on the way to retirement. Like Daniel Kahneman, Mischel speaks of two systems controlling our actions: the intuitive, quick, emotional “hot” system as well as the rational, slower, conscious “cool” system. During the marshmallow test, the cool system needs to find ways of holding in check the hot system that seeks instant gratification.

By definition, investors are out for future returns. As we all know this does unfortunately not mean that investors have their hot system under control. Mischel distinguishes between the decision for the greater reward and the execution. Many investors fail with the latter and it is this aspect where Mischel’s work offers a lot of inspiration.

The children passing the marshmallow test used different strategies. A common concept was distraction such as singing. If you want more marshmallows, think less of marshmallows.

While it is common among investors to aim to beat an index, some studies suggest that most investors would fail to keep up with the broad market due to poor decision-making, a phenomenon known as behavior gap. Finding distraction from investing while making regular automated investments in a broad index fund would ensure that investors do capture the full upside offered by “the market.” Investors can then end up better off and enjoy a rich life outside the investing world at the same time. (Why not take singing lessons?)

Market-Noise Canceling

Similar to the children trying to resist grabbing for the marshmallow, investors are exposed to constant temptations through market noise that can quickly lead them astray: “Sell AB,” “buy CD instead,” “EF likely to cut dividend,” “GH in merger talks with IJ.” It takes considerable mental efforts to stay the course while absorbing the endless news on portfolio stocks. The Marshmallow Test describes a couple of approaches investors can transfer to the investing world in order to cope.

It is not too much of a guess that market noise is aiming at our hot system. The pieces of information that our cool system really needs to pursue and accomplish our long-term financial goals are simply far too few to compete with the news tickers day in, day out. We cannot change the world around us, but we can:

• Tweak the view on our investment activities
• Work on our reaction to market noise.

The former approach would aim at our cool system taking on responsibility for our savings instead of the hot system. This may be accomplished by thinking of investing as a more abstract, psychologically distant concept rather than a vehicle for making a quick buck.

Since you have already established close bonds with your future self now, you may want to think of yourself as someone who is managing the portfolio on behalf of that guy from the future. This guy is not looking for anything fancy, but he will be very disappointed if you fail to capture the upside of the overall stock market for him.

With regard to the latter, one can take inspiration from what Mischel calls “if-then” situation-behavior relations. When you know beforehand that certain situations will trigger a reaction by your hot system (like a profit warning leading to knee-jerk selling), you can condition yourself to trigger a different reaction prepared by the cool system instead (like assessing if the long-term investment thesis is still intact). The more you practice, the more automated the cool reaction should become.

The Risk From Passing the Test

The Marshmallow Test is very much about the mindset that is necessary to set out, pursue and accomplish goals. It is obvious that people with this mindset are more satisfied people since they find it entirely within their power to live the life they desire. While this may sound enviable, Mischel points out that there is an important downside to this ‘can do’-mentality. The downside becomes relevant when the person in question sets out to reach goals that are either beyond a single person’s control or unethical or illegal to accomplish.

There are numerous examples of investors suffering from this kind of hubris. And clearly, the potential risks are substantial – think doubling down on a losing bet. The takeaway is that confidence and self-control need to be in balance with reality. A healthy dose of humility will not harm either.

Ethics

On a final note, I found Mischel’s thoughts on the ethical aspects of investing particularly interesting. Mischel suggests that investors who find it easy to relate to their future selves are less likely to make investments that are questionable from an ethical perspective. In that sense it may be fair to conclude that socially responsible investors are more likely to be on track with their retirement savings as well. (Disclosure: I do consider myself a socially responsible investor.)

Summary

The Marshmallow Test is no investing book, but I do consider it highly relevant for investors. Walter Mischel’s findings may be most interesting for individual investors who are managing their retirement savings. All others who want to improve self-control should take a look as well.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Unique Finance). I have no business relationship with any company whose stock is mentioned in this article.