Readers may be familiar with what has come to be known as the “Marshmallow Experiment”–a test run by Stanford professor Walter Mischel in the 1960s. The experiment has implications for determining what traits can produce success in individuals, and it also holds useful insights around strategies for investing.
The experiment involved Mischel testing hundreds of children by sitting them in a room on their own, and placing a marshmallow in front of them. The children –most of which were around four to five years old –where then given the following deal: the researcher would exit the room, and if they refrained from eating the marshmallow in front of them, they would be rewarded with a second marshmallow. However, if the child chose to eat the marshmallow on the table, they would forfeit the second marshmallow. Put simply, the option was for one marshmallow now, or two later.
As expected, the results of the experiment were mixed, with some children almost immediately reaching for the marshmallow upon the researcher leaving the room, whilst others were able to abstain. This is interesting, but the more profound insights lie in what happened to the children years later.
The researchers intermittently tracked the children as they grew up. In the follow-up studies, the children who were able to resist eating the marshmallow had higher SAT scores, lower body mass index readings, as well as reports of better social skills by parents. Despite there being later criticisms about the skewed sample used in the experiment (the children were those of Stanford professors and graduates at the Bing Nursery –an elite subset of American society), the results suggest a great importance around the ability of an individual to delay gratification.
With this experiment in mind, there are takeaways for investing and wealth creation, given that at its very core, investing is simply delaying gratification. The marshmallow test and investing share something: they are likely to offer a higher reward the longer you wait.
Wealth creation depends on the investment returns, the amount invested, and the time spent in the market. We all have a propensity to overweight the importance of investment returns. Whilst they are undoubtably very important, they are but one part of the full story. The amount invested and the amount of time this capital is invested for are also critical factors that drive the wealth creation equation, mostly due to the effects of compounding (see this recent article written on the topic).
Charlie Munger framed the issue perfectly: “The first rule of compounding: Never interrupt it unnecessarily”. Compound interest can only work effectively if it is given enough time, and as the years pass, the initial base of capital invested will obviously play a role in the ultimate nest egg.
For many it is difficult to delay gratification by tucking money away for investment and leaving it invested–it may be the case that an individual simply lacks income above their everyday living expenses, or that they make the choice to live in the present, with any additional income spent on holidays or material possessions. Regardless, successfully building wealth in the stock market or otherwise comes down to a choice: spend now and live in the present; or defer the enjoyment to a later date in anticipation of a greater reward.
George Hadjia is a Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.