The Marshmallow Experiment and Wealth Building

marshmallowexperiment

Although many self made millionaires possess very high intelligence, it’s also common to find wealthy individuals that are not exactly brilliant. If smarts are not essential, what then explains the difference between rich and not so rich individuals? And how are marshmallows related to all this?

Starting in the late 1960, a Stanford University researcher Walter Mischel conducted an interesting and often cited long-term study. Mischel arranged individual marshmallows in front of hungry 4-year-old children. He subsequently informed them they could have 1 marshmallow immediately, or if they wait several minutes, they could have 2. Some children quickly took the single marshmallow and ate it up. Other children waited.

Being a longitudinal study, Mischel surveyed the group 14 years later and found out that the children who eagerly consumed the first marshmallow were more vulnerable as compared to the children who had paced themselves for 2 marshmallows. For instance, years later, the “impatients” exhibited low self-esteem, while parents and teachers viewed them as stubborn, prone to jealousy and easily frustrated. on the other hand, the “patient” children possessed better coping skills, were more socially aware, optimistic, assertive, reliable, and scored nearly 210 points higher on their SATs.

This study is still referenced today as one way to explain the key difference in wealth disparities as not arising strictly form hard work or superior intelligence, but the ability to delay gratification.

What can the marshmallow experiment teach all of us about making money?

1. Minimize looking at marshmallows when you’re stomach is empty – In the experiment, some patient children covered their eyes so they couldn’t see the tempting goodies. Others turned their backs to the marshmallow, sang songs or talked to themselves. One child even licked the table area around the marshmallow while waiting for the researcher to return. The financial analogy here is that although it is reasonable to have financial goals and desires, it’s important to avoid constantly being in an environment that will likely tempt a person to spend money beyond their means. People who practice delayed gratification use their  imagination to get close to their financial goal without actually jumping in before the time is right. 

2. Skip  a marshmallow today and you’ll feast tomorrow – The children who waited for the second marshmallow were paid back with a 100% return on their first marshmallow. Another way of describing the power of compounding investments over time.

3. Watch your marshmallow, place it in the fire, and remove it when crisp, but before it bursts into flames – Some patient children watched over their marshmallow to prevent others from grabbing it and did not ask for additional treats beyond what they had received. The financial take home message here is for you to invest in whichever assets are suitable in your case, monitor these investments carefully and cash in when your profit goal is reached, not when its part of bursting bubble.

In the study, the children were guaranteed 2 marshmallows if they waited. However, in life there are few financial guarantees. As a result, it is important to patiently consider the probability of profiting from each investment strategy, as it is based on such factors as current market conditions and your individual risk tolerance. It is also important to not deprive yourself while your wealth is growing. Enjoy a percentage of your marshmallows as they accumulate, which would keep you motivated to follow your financial goals to completion.

Children can learn how to delay gratification, by having a role model that they can follow. However, if we apply the experiment to grownup “impatient” investors, it can be difficult for such individuals to find the balance between immediate and delayed gratification and, therefore, could negatively impact their potential for reaching a high net worth.

The 4 Lessons to Teach Your Children About Finances

Teaching children about money management can build a solid foundation for lifelong wealth creation. Unfortunately, these lessons are not universally practiced, even by many adults.

There are 4 financial lessons that I believe should be conveyed to children:

1) Money doesn’t appear out of thin air -At the basic level, money results from trading one’s time for money. Work equals money and you should explain to your children about your work and the monetary and emotional importance involved in it.

The topic of whether it is okay to give allowance to children is still debatable. Even more in dispute is whether they should be paid for doing chores. Personally, I believe a small allowance is good and some compensation for chores will not spoil the children.

2) How spending money works – How to spend money can be divided into phases of:       a) limited resource spending: the children can spend but not more than what they’ve earned. If items are too expensive, they will have to choose between one item or another, not both.
b) Value Spending – once the child advances in their understanding, they can be taught about smart spending, such as: spending more for better quality, the value of discount sales, buying and sharing  toys among siblings, etc’.
c) Needs and Wants Spending – Further give your children control over their money by setting a budget for certain shopping events(such as ‘back to school’). The role of the parent is to explain the difference between wants and needs and staying within the budget.
3) Saving Money – when the children want to spend more than what they have, a parent should teach them about setting financial goals and money saving tactics. As a more advanced approach, you can teach them about interest they can earn if they choose to save.
4) The Importance of Giving – Charitable giving should be explained, starting with the value of sharing things. This can be followed by telling them about worthy causes they might be willing to give to.

Utilize the natural curiosity of children, but never force the education on them.

Other, more advanced, lessons could include: passive vs. active income, investing, saving for college, credit and debt, and even retirement.

Since children learn more by observation than listening, do practice good money management tactics yourself and your child will grow a more informed person.