Your Mental Time Horizon, And Why It Matters
Earlier this month I attended a presentation by Dr. Sarah Newcomb, a behavioral economist with Morningstar. Dr. Newcomb presented compelling evidence from her research which showed the single greatest predictor of financial health and net worth was something she called mental time horizon. Not, as you may have guessed, age, sex, income, education or race. What is "mental time horizon," you ask? It's the answer to the question, "When you think about your finances, how far into the future do you tend to think and plan?" It turns out some of us can't think more than a few days ahead while others are considering our grandchildren. And while most of the population can think a few years out, that's still a problem if we're 30 years old and need to retire at age 65 some day. Indeed, if you're not even thinking about it, what motivation do you have to prepare?
Dr. Newcomb's work found that people who can think at least 10 years out tend to have significantly higher savings than those who are thinking only a few years out (or less). This same study also found similar results when it came to financial health. Mental time horizon had, by far, the strongest impact on how financially healthy you felt. Indeed, short-term thinking is often associated with more impulsive, risk-taking behavior. This means that those with a shorter mental time horizon are more likely to make choices that exacerbate their financial insecurity, creating a negative feedback-loop. More stability means you are able to think further ahead which leads to decisions that create more stability.
So what to do? If you find yourself feeling financially unstable or unhealthy, the easiest place to start is not by trying to earn more income or go back to college to get more educated. Rather, it's the simple act of thinking about the future. Dr. Newcomb suggests imagining how your kids might benefit from your sound financial management. Or, if that's still a time horizon too far, start with imagining what you might want your savings account size to be next month or by year-end. Check in on the goal at the end of each week - reminders and repetitions will be key. Another idea - add a picture to your goal. Try using one of those new apps that can make you look tan (if you'd like to go to Hawaii next year) or old (if you want to imagine yourself retired). As your ability to save improves, continue to fill in details. Will you go to a luau in Hawaii? Have a camper in retirement? The more details you can add, the clearer the picture will be. And, as you get better at thinking more about the future, you'll naturally get better at saving, investing & planning for the future.