Your Decision Making is Determined by Your Time Horizon
Everyone is rational. Well, actually that idea is highly debated in economics. It became a hot topic with the introduction of behavioral economics. This new field of study claims that people don’t make the most rational decisions but instead that their decisions are affected by behavior. Which would lead to an irrational choice. But just because behavior can affect your decision does not mean that it is now an irrational one. All the introduction of behavioral economics has done is change the way we perceive what a rational decision is.
Time Horizon
Everyone is rational and does a cost-benefit analysis of every decision they make. The only difference is your time horizon. Or how much time you consider in your cost-benefit analysis. Are you considering costs and benefits for the next minute? 5 minutes? A day? A month? A year? 10 years? A lifetime? Thousands of years?
The shorter your time horizon the lower the cost and more immediate the benefits. This is why people who make seemingly irrational decisions are still rational. They still, maybe unconsciously, go through a cost-benefit analysis. But it is such a simplified version of it that makes it looks very irrational.
Let’s say someone is overweight and has a goal to lose weight. So maybe they want to go on a diet and work out more. And for the sake of this example, they are given the option to eat a piece of cake. A short time horizon (5 minutes) cost-benefit analysis of choosing to eat this cake would look like this:
Short Time Horizon
Cost: N/A
Benefit: Get to eat a delicious piece of cake
There are no costs because when the time horizon is short enough none of the costs show their face. The benefit of course is being able to eat the cake. Therefore this overweight person eats the cake. It looks like an irrational decision to eat the cake when their goal is to lose weight and presumably be healthier. But if your time horizon, like it is in this example, the benefits out weight the costs. This means this would be a rational decision for the decision-maker. But people who have longer time horizons see that decision as irrational.
A long time horizon (5 years) cost-benefit analysis would look like this for the same example:
Long Time Horizon
Cost: Don’t lose weight, possibly gain weight, formation of a negative habit, increased health problems, sluggish/tired
Benefit: Get to eat a delicious piece of cake
The benefits are the same as the short time horizon, but that isn’t always the case, there are plenty of situations where there are more benefits over time. In this case, there are a lot more costs this time around. That is because you are looking at a longer time frame, 5 years. We can now see the full picture of how eating the cake affects your goal of losing weight.
Chess Engine
Similar to a low-depth chess engine. It will try to figure out the best move. But if it is programmed only to see one move ahead it will end up hanging pieces. This is because the low depth is a short time horizon for the computer. It can’t the future so it doesn’t know any better than the move it is about to make is an irrational one. It is still rational a rational move though, it still computes cost-benefit analysis. But the short time horizon, or low depth, makes the computer appear irrational.
Beliefs
People who have similar time horizons will agree with your beliefs and don’t challenge your choices. People with different time horizons will more likely disagree with your decisions. The reason for this is that people who share similar time horizons also share similar cost-benefit analyses.
Using credit cards to pay for vacations and then carrying that debt for years is a very short time horizon idea. Other people who also have short time horizons probably do a very similar thing and agree with your decision on the payment method for vacation. This is probably one of the reasons the United States has nearly $1 trillion in credit card debt.
Someone who has a longer time horizon sees that decision as irrational and irresponsible. They see the costs of paying for a vacation on a credit card as a lot greater. That you will be paying significantly more for the vacation because of the high-interest rates. But also that it will affect your credit score and can affect your home and car purchases in the future.
Both decisions are rational. But the time horizon is the difference. It changes the costs and benefits. In turn, this changes the outcome of their decision. Although the outcome of their decision changes the rational or irrational label on the decision remains the same. And that it is always a rational decision.
It is important to realize that the time horizon you base decisions on is not chosen before you make the decision. In fact, it is a decision that is made first which then determines your time horizon. Although you can practice making your decisions based on different time frames. Which could help artificially switch the order of the decision and time horizon.
Elon Musk is famous for this kind of thinking. It has been documented that every decision he makes for each one of his companies is based on one indicator. That is “what decision gets me closer to civilization on Mars?”. His decision comes first and then that determines the time horizon. But he critically thinks about each decision under the time horizon of civilization on Mars. Not just a man on Mars or civilization on other planets, but specifically a civilization on mars. In the end, his decisions should closely reflect that goal in mind.
Appropriate Amount of Time
The better you understand cost-benefit analysis the more appropriate your time horizon becomes. You’ll understand short and long-run costs and benefits. Figure out a time horizon that fits the situation. And determine the best cost-benefit analysis so your rational decisions alway looks rational.
The most important thing is to find the appropriate time horizon for the situation. This is because the longer your time horizon the more there is to consider in your cost-benefit analysis. Some decisions don’t need that long of a time horizon. Like what show to watch on Netflix tonight. There isn’t much to consider, the costs aren’t that great in the short or long run, and it is easy to change your decision. While something like choosing an apart to rent for the next year would require a much longer time horizon consideration. Even longer than just the year you will be living in it for, because of the possibility of living there for longer than a year.
Scams – Something to Watch Out For
This is exactly why scams have a sense of urgency to them. They take advantage of your time horizon to trick you into the scam. Everyone has interacted with those scam emails or ads that tell you to quickly claims your prize. Or quickly take advantage of this limited-time deal. Or a notification that a virus has been detected so download this anti-virus quickly before it’s too late.
They have a sense of urgency because it forces you to decrease your time horizon. With a shorter time horizon, your cost-benefit analysis has less depth to it. With a lower-depth analysis, your decision might look irrational in the long run. In this case, falling for the scam by downloading the malware or buying a fake product. At the time the decision is rational. This is because the scam tricked you into reducing your time horizon and the benefits of claiming your free prize or removing the “virus” outweighed the small short-term costs.
In the end, your Time Horizon and decision-making go hand in hand. Being conscious about what your time horizon is when making your decision can help improve your life choices.