Tuesday, February 17, 2015

Multiplying Marshmallows

Would you wait for the Marshmallow? In the 1960s and 70s, psychologist Walter Mischel did a series of experiments studying delayed gratification. Children were offered one Marshmallow immediately or two Marshmallow's if they could wait 15 minutes.

Growing up, there were a couple of examples marshmallowy tests in my family. The first was when it came to Easter. My strategy with the chocolate hoard was to hold on to it as long as possible and only start any significant eating once my brothers were done with theirs. This cunning plan didn't lead me to more chocolate. There was a large and predictable risk of the big brother seigniorage, meaning I would likely get less chocolate rather than more as a reward. What it did mean though was that I wouldn't run the risk of running out.... while others still had chocolate. That was my biggest fear.

The second marshmallow test was that we had a deal with Mom and Dad. If we could set a goal and save half of the money required from our pocket money, they would chip in the balance. The second marshmallow. I became rather good at extracting these second marshmallows from my parents.

Bill Gates and Warren Buffett are two of the most generous philanthropists to have ever lived. They introduce an interesting question though. When should you eat your marshmallow if you are good at making more? If Bill Gates had focussed on direct philanthropy straight out of university, he wouldn't have had the firepower to do the work he is doing now. Warren Buffett believed that his core skill was making money. He is famously frugal. One of the reasons he gives for this is that he multiplies the prices he sees on things by several factors. If he spends $1, he will not have the opportunity to turn it into $10. Seeing your pile of marshmallows grow can be quite addictive. The irony is that many very wealthy people won't seem rich. Enjoying growing their marshmallow pile will mean they will live very simple lives because they are so conscious of the opportunity cost of putting the marshmallow in their mouths. It is the ones that indulge in conspicuous spending that really irritate people. While they may also be wealthy, big spenders are likely either rapidly eating through their wealth or living hand to mouth. Buffett has now committed the majority of his fortune to the Gates Foundation.

If you are able to earn 5% real return on your money and you invest half of what you earn for 15 years, you could stop working after 15 years and your money would carry on earning what you were spending in the beginning. Forever. 50% at 5% for 15 years = Freedom.

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