"The future depends on what we do in the present."
I'm at a tavern with a college friend having some pizza and beer. We're sharing some laughs and having our usual friendly debates. We can't find a place to sit, so we're standing among the crowd. All of a sudden, all the TVs started showing the news, and everyone's phones started ringing. It's 2007, and the I-35W bridge going over the Mississippi River just collapsed at rush hour. Everyone was deeply concerned. Many of us found out later that we knew people, or at least knew of people who either just got across the bridge or were stuck in traffic before the bridge.
Sometime in the next several years, it's possible, but not likely, that there could be an earthquake, drought, flood, or typhoon in China. If something horrible like this does happen, it's less likely that the same people who felt high compassion in Minnesota will feel the same intensity of compassion (note: people can and will still feel compassion, if the story gets reported, but it won't be at the same level as it was for the people on the bridge).
The difference is the psychological distance for the China disaster is far greater than for the Minnesota disaster. It's the same thing for China residents. They will be far more concerned with a disaster striking their town than they will with a bridge collapsing in a city in the United States.
In her book, Loaded, author Sarah Newcomb says that "You will care more about what will definitely happen to you in the here and now than what might happen in the future to a stranger on the other side of the world."
What does this have to do with money? If you think about yourself in the future, that person is a real person. Yet, we don't often think about future us. The psychological distance between us and future us is so distant that our future self is unrecognizable to us. Thus, saving money instead of spending it can feel like giving money to a stranger.
Impulses and Dopamine
To unpack why future us seems like a stranger, we have to think about our impulses and dopamine. Dopamine is a chemical that gets released in our brain when we hit our target, win a jackpot, or get a notification on our phone. If your immediate response to something is, "YES!!", then the odds are you just received a dopamine hit. It feels good getting that hit. Spending our money also releases dopamine. When we have an impulse to spend, even when we can't afford to, it's because we crave the hit.
We can temporarily ignore our impulses using our willpower, but we only have so much. Meaning, if we spend all our willpower at work avoiding those cupcakes we know we're not supposed to be eating, the by the time we go shopping after work, we don't have as much left. We have a finite supply.
This brings us to the concept of discounting. You've heard of the time value of money - if you don't think you have, you have - which is basically how compound interest works. You can multiply an amount of money by the interest (this is very simplified) and arrive at what the amount will be in the future. Similarly, you can take a future amount and bring that amount back to today. The act of bringing that value back to today is discounting.
Discounting allows us to compare today's money with future money. Even though this is very much a math problem, we are horrible at discounting. We tend to have such a strong desire for stuff (and money) today - that is, our impulse control needs work - that we discount something too much. In other words, a future prize that is much bigger than a prize today will seem smaller when we improperly discount it.
For example, if we asked people whether they preferred a small prize today versus a large prize in a week, most people choose the small prize today - even though they know the compensation for waiting one week is high. Impulse wins, and we enjoy our dopamine.
Here is the funny thing; if we asked people if they want a small prize in one year from today or a large prize in one year and one week, people would choose to wait one week for the larger prize.
If you stop to think about that for a second you realize that it's the same question; will you wait a week for a larger prize? Yet people's answers are vastly different. It turns out that without the instant gratification monkey controlling us, we can make more sound choices.
Physical distance is very objective. One mile is one mile wherever you are (that's not exactly true - in nearly every place except the United States, one mile is about 1.61 kilometers). Physical distance means the same thing to everyone.
In the case of psychological distance, though, the distances are very subjective. Think about Sarah Newcomb's quote from above, "You will care more about what will definitely happen to you in the here and now than what might happen in the future to a stranger on the other side of the world." This sounds intuitive to most of us.
There are four aspects to psychological distance, and at least three of them have something to do with our relationship with our future selves:
Time (now vs. later)
Space (here vs. there)
Relationships (me vs. them)
Probability (guaranteed vs. impossible)
Psychological Distance - Time
Now versus the future is what discounting is all about. We know future us will get a bigger prize, or more money, but we don't care. Now feels closer to us than the future does. Since future us doesn't feel familiar we take more for current us at the expense of future us. The future is abstract. We know today.
Psychological Distance - Space
People who are physically close to us are given more thought than people who are far away. This is why I felt more compassion for people in Minneapolis on the bridge than I would for people on the other side of the world; they are close to me. Future us is not around interacting with us. It's hard to feel close to someone who is not here.