Original Cin

There’s an interesting post on Marginal Revolution regarding personal discount rates. I’ve actually been thinking about this for a while. A lot of what I’ve read on personal finance just doesn’t include the concept.

I tried looking around Wikipedia for an overview of the philosophy of discount rates, but couldn’t find one. The closest thing there is the article on time preference:

In economics, time preference (or “discounting”) pertains to how large a premium a consumer will place on enjoyment nearer in time over more remote enjoyment.

There is no absolute distinction that separates “high” and “low” time preference, only comparisons with others either individually or in aggregate. Someone with a high time preference is focussed substantially on their well-being in the present and the immediate future compared to the average, while someone with low time preference places more emphasis than average on their well-being in the further future.

This is a bit difficult to digest, to put it mildly. The basic idea is simply that $1.00 today is worth more than $1.00 a year from now. Because you have to pass “a year from now” in order to get to “fifty years from now,” $1.00 at the end of fifty years is worth even less than $1.00 at the end of a year.

Having a discount rate of 0 has some unusual and bizarre consequences (I vaugely remember some of the funnier examples from college). Suppose you knew that you were going to live for exactly another 40 years, had a consistent personal discount rate of 0, and were completely unconcerned with the state of the world after your death. If someone were to offer you $0.01 of interest to borrow all of your money for 39 years, 364 days, you should accept this offer, because you’d have more money at a greater (present) value than if you didn’t! Likewise, if helping a friend had any value to you at all, then you should be okay with lending $1000 interest-free to them for the same period of time, since it would still be worth $1000 to you in the future! Who wants to live like that? Even in an environment free from physical risk, a discount rate of 0 makes no sense.

Yet, a lot of personal financial advice seems to assume a discount rate of 0. Consider various examples (see About.com, the SEC) extolling people to cut back on their daily cup of coffee because of the amount that money could grow into. Yes, if you can cut “just” $1.00 a day in your expenses, and place the money at the end of the year into stocks getting a return of 10% for 40 years, you’ll have approx $16,519. But, take into consideration a discount rate of 3% and the $16,519 in forty years is worth just $5,064!

Now, turning $365 into $5,064 is still impressive. Very impressive. But it’s a far cry from turning $365 into $16,519 (a 1287% return versus a 4425% return). And don’t forget that you have foregone something that presumably had a present value of at least $365 to begin with! 3% is probably too low a discount rate, IMHO.

It’s very easy to turn down the mental abstraction of a cup of coffee. What’s more difficult to grasp in discussions like this is what that actually means on a day to day basis — how a cup of coffee may be part of a routine that involves talking with friends, or sitting around and thinking about life. Even more disturbing is how such examples miss the forest for the trees — some financial writers have pointed out that starting with bigger expenses in your budget just makes more sense! If you can cut $100 a month by living in a smaller home, then the $30 a month from a daily coffee is no longer so impressive, or so important. If spending $5 dollars a day sends a signal to others that boosts your productivity and/or earnings by a greater amount, then do it. I believe in living frugally, but I also believe in having fun in the here and now.

This got a chuckle out of me:

…by meeting a huge(!) danger with a playful attitude it became a moment of fun instead of violence.

I think this can work often in life. It’s not the way you meet an oncoming, jackknifed tanker truck – they don’t respond well to a playful attitude.

-Alexander Kjerulf, Chief Happiness Officer, “Playing with Danger“

So true, so true.

I was going through my bookmarks, and found this via Collision Detection, an article which has had quite an impact on my thinking on some matters:

While yielding to temptation can certainly be harmful, this article argues that overcontrol and excessive farsightedness (hyperopia) can also have negative long-term consequences. In particular, we propose that, with the passage of time, choices of virtue over vice (e.g., work over pleasure) evoke increasing regret.

- “Repenting Hyperopia“, Ran Kivetz and Anat Keinan

I probably would not have gone to ACEN 2007 if I hadn’t read this. On the other hand, there are some things in the past that I wish I had worked harder at, as well as past tasks that I wish I had just completely neglected (case in point: I spent a lot of time, money, and effort deciding which college to attend. My friend Scott picked UIC mostly on the basis of its location, and partly at random. I think he made a better choice by far; I also probably would have gotten more out of the experience if I had done less homework and gone to some parties from time to time).

Seen on iGoogle, from Quotations Page:

An economist is a surgeon with an excellent scalpel and a rough-edged lancet, who operates beautifully on the dead and tortures the living. – Nicholas Chamfort

In other news, the dismal science is apparently somewhat unusual in that it’s an academic field with a nickname.

I recently put $500.00 into Prosper. I can’t believe the rates that I’m getting — they’re quite spectacular compared to my money would be making in a savings account or even in stocks. Of course, there’s no such thing as a free lunch — we’ll see just how risky things are, but the average default rates do not look too terrible.

What really strikes me about Prosper is how it’s — I’ll admit it — fun. It’s neat to see the things that people need money for:

• House and rental property remodeling
• Recovering from identity theft
• Financing a documentary
• Throwing a wedding
• Opening a cat shelter

Fun. Here’s an affiliate link.

Grander in scope and more humble in its implication than Keynes’ famous quote about defunct economists, seen on the homepage of the economics department at Loyola:

 “Economics is the study of mankind in the ordinary business of life.” - Alfred Marshall

I’m quite pleased at how my latest programming project is going. Here’s the output of this little application. I’m learning the ins and outs of Java (I have no formal training in it, much as when I started working with PHP), but I’m as happy as a clam about how things are going. Despite the appearance, it actually does something quite useful.

Cat Bread Java Output

I’ve been reading the Hyperreality article at Wikipedia:

 Most aspects of hyperreality can be thought of as “reality by proxy.” For example, a viewer watching pornography begins to live in the non-existent world of the pornography, and even though pornography is not an accurate depiction of sex, for the viewer, the reality of “sex” becomes something non-existent. Some examples are simpler: the McDonald’s “M” arches create a world with the promise of endless amounts of identical food, when in “reality” the “M” represents nothing, and the food produced is neither identical nor infinite.

I’m reminded a bit of some Eliezer Yudkowsky’s recent posts on Overcoming Bias on phlogiston: “Hyperreality” seems more like a politically-minded observation-sounding stop than anything… um… real. It seems nebulously defined at best. Nonetheless, based on the examples given, I’m puzzled by why clothing is not considered a hyperreality.

It isn’t natural by means. Most clothing is arbitrarily symbolic to a greater or lesser degree. It’s ubiquitous. So, isn’t a general argument against hyperreality an argument for nudism?