Tying It Together
The central issue we’ve addressed in this chapter is how to make good choices when you face an up-front cost and future benefits. We’ve developed a powerful framework that you can use to evaluate whether an investment is worthwhile. While we’ve focused on the macroeconomic implications of this—analyzing whether a business will invest in productive capital—the same framework applies to a much broader notion of investment. Indeed, it applies anytime you have to decide whether to incur some up-front cost in return for a benefit you’ll enjoy in the future.
This means that you’ll find these ideas to be useful in broad swathes of your life. While you’re in college, you’re investing in your human capital, incurring the up-front costs of studying hard, paying tuition, and getting by without an income, so that you’ll enjoy the future benefit of a more rewarding career. When you exercise, you’re investing in your health capital, incurring the up-front costs of working out (lifting weights is hard!), so that you’ll benefit from better health in the future. Or perhaps you’ve just started life at a new college, and you’re going to more freshman mixers than you really want to. You’re investing in your friendship capital, incurring the up-front cost of feeling awkward at social events where you don’t know many people, so that you’ll enjoy the future benefit of finding a lifelong friend.
They are making an investment in their health capital.
In each case, the Rational Rule for Investors gives useful advice: It’s worth investing if the present value of the benefits exceeds the present value of the costs. But in reality, people often have trouble following this advice. I’m sure that you’ve been in a situation like this: You’ve got a big test coming up and need to study. Studying is an investment—an up-front cost, with even larger future benefits. Yet instead of following the Rational Rule for Investors, you procrastinate. You say you’ll study tomorrow, but then tomorrow comes, and you put it off again. As a result, you underinvest in studying.
It’s a pattern that people repeat in many aspects of their lives. You know you should work out to keep healthy, but going to the gym involves an up-front cost and future benefits. So you put it off. Your pile of dirty clothes is practically begging you to invest in the up-front cost of doing a load of laundry, so that you get the benefit of clean clothes next week. But you tell yourself you’ll do it tomorrow. You know you should start applying for summer internships, but the up-front cost of working on your resume sounds daunting. So you procrastinate.
This tendency to procrastinate can also play havoc in your financial life. You know you should invest in a car, in furniture for your apartment, or eventually, in making a down payment on a house. But it’s more fun to spend your money on other things today and think about the future tomorrow. If you keep putting it off until tomorrow, one day you’ll wake up to discover that you’ve been working for years but have nothing to show for it. This is an extraordinarily common mistake that I’ve seen hundreds of people make.
Psychologists tell us that the problem is that delayed gratification is hard. We’re too quick to enjoy today’s benefit, rather than investing in something with even larger long-run payoffs. All of the advice in this chapter comes to naught if you won’t follow through.
So how can you do better?
Reward yourself: The cost-benefit principle says that if you want to do more of something, you should increase the benefits, or decrease the costs. So reward yourself for studying with a bowl of ice cream. Or make it costly not to study: Make a plan with a friend to study together, and make sure it’s a friend you wouldn’t want to let down.
Break it up: A large task can be daunting, leading you to procrastinate. But the marginal principle reminds you that any big task can be broken up into a series of smaller, simpler steps. Don’t try to write that 3,000-word essay tonight; plan on writing the introduction today, each of the three main arguments on each of the three next nights, and the conclusion at the end of the week. On any given night, there’ll be less reason to procrastinate.
Constrain yourself: The opportunity cost principle reminds you that the real cost of something is your next best alternative. So constrain your future choices by making that next best alternative less appealing. Cancel Netflix during exams, lend your Xbox to a friend, or head to the library to study and leave your phone at home so you won’t have any distractions.
Plan ahead: Temptation often bites you hardest “in the moment,” and if your friends ask you to go out when you should be studying, too often you’ll make the wrong choice. Add a little distance, and you’ll probably make a better choice. It’s the interdependence principle in action: Your choices depend upon the temptations that surround you, so make those choices in the best possible circumstances. Plan ahead which nights are for socializing or studying, so that you’re making decisions when temptation exerts less of an influence.
Now that you’ve paid the up-front cost of reading this chapter, it’s time to enjoy the future benefits of making better investment decisions for the rest of your life!