Stock market exuberance tempts impatient investors
to do foolish things. Trouble is, too many of us are
hard-wired to opt for instant gratification and forsake
long-term strategies – as the famous marshmallow
Anyone who attended summer camp as a kid likely
equates marshmallows with the fundamental
ingredient in making s’mores. When a psychologist
hears the word marshmallow, however, the first
thought goes beyond a taste treat to the question of
delayed gratification – and the difficulty to attaining it.
The marshmallow experiment
Stanford researchers first conducted the marshmallow
experiment in the late 1960s. Children were offered
the choice between 1) an immediate marshmallow or
2) two marshmallows, if they were willing to wait 15
minutes and not eat the original marshmallow sitting
in front of them. Most children in the study said they
would wait for two marshmallows.
Yet of more than 600 children who participated in the
original experiment, roughly two-thirds fell victim to
temptation. Only a third of the children waited the full
15 minutes and got rewarded with a second
But that is not where the findings of this marshmallow
study end. When experimenters went back to review
the test subjects nearly 20 years later, they
discovered that the children with the discipline and
self-control to delay gratification in this simple test
were more successful in nearly every measurable
facet of their lives.
Controlling for factors like age and sex, the “patient
subjects” had higher SAT scores, less likelihood of
substance abuse, larger salaries, performed better
academically, and were healthier than the subjects
who could not wait 15 minutes for the second
marshmallow as children. Researchers have
performed the test many more times since the original
experiment, with the same findings.
A world of immediate gratification
Delaying gratification is difficult. Overwhelming
evidence demonstrates that humans are not wired to
be disciplined, whether it is children with
marshmallows, adults firmly sticking to a diet or
investors maintaining a long-term strategy. You’ve
heard the statistics before: the majority of Americans
make New Year’s Resolutions and yet only 8%
successfully achieve them.
It is challenging to avoid instant gratification in a world
of Amazon Prime same day delivery, Keurig instant coffee
machines, and always-handy, incredibly connected
cell phones. Long gone are the days of
brewing a pot of coffee or waiting 30 seconds for dialup internet. Corporate executives rarely get the
flexibility to ignore quarterly earnings for the benefit of a five-year plan, and coaches tasked to rebuild a
sports program typically can’t afford two losing
seasons before getting fired.
The same need for instant gratification applies in
finance. Far more exciting and entertaining than
stories of diversification or long-term investing are the
explanation of why stocks fell yesterday, how this
morning’s economic data is going to affect interest
rates this quarter and where oil prices are headed
over the next year. This captures the media’s readers.
The ubiquitous explanations of what happened to
stocks yesterday and forecasts for the coming weeks
compel activity and complicate the somewhat simple
and successful process of long-term investing.
The evidence of discipline
Many investors understand the benefits of long-term
discipline, but the evidence suggests that few practice
it. Consider value investing, the basic concept of
favoring cheap investments over expensive ones.
Historical evidence demonstrates that value investing
often results in higher returns when compared with
growth investing – buying the more exciting, faster growing
The evidence to support the “value premium” is
considerable and it exists in nearly all markets and all
Along with the empirical evidence, there are several
rational explanations for the outperformance of value
stocks. A prominent one: Investors prefer good stories
of fast-growing investments and overestimate how
long that growth will persist. The result is that they
overpay for growth relative to value.
Nevertheless, some investors succumb to immediate
gratification and give up on value stocks during their
inevitable periods of underperformance. Sticking with
a proven strategy that disappoints in the short term is
Take the most extreme period of value stock
underperformance and the most well-known (or
perhaps most successful) value investor, Warren
Buffett. In the late 1990s, the internet had changed
the economic landscape and boring old-school stocks
were left for dead. Value investing was allegedly a
thing of the past and Buffett’s stock, Berkshire
Hathaway, lost more than half of its value over a 22-month period until February 2000. During that time,
growth stocks – using the tech-heavy Nasdaq
Composite as a proxy – more than doubled.
Doubts about Buffett’s age and ability to adapt to a
new environment and value investing, in general,
were rife and investors gave up en masse. Of course,
history confirms that this was merely one of the
inevitable periods of underperformance that all
investments, strategies or asset classes have relative
to others. Long-term investors who maintained an
evidence-based discipline were handsomely
Déjà vu all over again?
Remember the comments from David Rolfe, a
longtime shareholder of Berkshire Hathaway and the
chief investment officer at Wedgewood Partners? Mr.
Wolfe told his clients that he sold the firm’s stake in
Berkshire after decades of being a shareholder,
because of his frustration with Buffet’s huge cash
“Warren Buffett’s cash hoard of +$125 billion
continues to be a considerable impediment of growth,
rather than our previous hard expectation of a
valuable call option on opportunity in the hands of one
of the most elite capital allocators extant.”
Consider this: Berkshire’s cash went from about $23
billion in 2009 to $147 billion in 2020. In other words,
Warren has increased his cash position by 6-times
over a decade that included the longest bull market
on record. Do you think Buffett is about to abandon
his long-term value discipline?
The oft-quotable Buffett said, “The stock market is a
highly efficient mechanism for the transfer of wealth
from the impatient to the patient.”
Save your marshmallows
For centuries to come, kids will likely eat
marshmallows before 15 minutes elapse, and
investors will pay way too much attention to current
noise. But just as the children with a strong self discipline
end up more successful over the long run
(not to mention getting two marshmallows), so should
the disciplined investor.
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