While you may not view them as such, you make investment decisions every day. gives a very general definition of investment as the “commitment of resources to achieve later benefits.” Although often viewed in the context of financial decisions, the notion of investment generalizes well beyond money.

1. First, you’d want to weigh how much you value the present versus the future. By choosing to study, you’re missing out on all the fun activities you could be doing now. Enjoying these fun activities now may certainly feel more valuable than enjoying them tomorrow — or in ten years. But by how much, exactly? Does the promise of a great career and all it brings justify the sacrifice? This depends on your time preference.
2. Second, consider the uncertainty associated with these future rewards. Even if you study now, there’s still the risk that, due to sheer bad luck, you won’t perform well on exam day. Whether you will accept the risk depends on your risk preference.

(Investors undergo a similar process when determining interest rates across different maturities, which gives rise to the yield curve. I covered this topic in a previous article.)

Time Preference: Washing the Dishes, Now or in 15 Minutes?

For physicists, time is relative. For bankers, time is money.

Financial analysts spend their careers pricing complex contracts involving future payments — which is a good way to describe most financial assets, including bonds, stocks, and derivatives. That’s why they’ve developed a neat way to quantify the value of time: the discount function, which is, put simply, a way of determining any future payments’ .

Every person has a discount function that reflects their time preference.

To estimate your discount function, ask yourself how much you would pay now to receive $1,000 tomorrow, in a year, or in 10 years. Repeat this process for different time frames, and you’ve mapped your personal discount function. A person who enjoys spending, for instance, might accept smaller amounts just to get the money today, compared to someone who prefers saving. This type of reasoning is easily generalized to other types of decisions — such as the one with Reels and studying — although it’s not as easy to quantify them.

According to behavioral economists, people generally tend to be present-biased, which is — you’ve guessed it — characterized by an irrational preference towards the present (a good example is the phenomenon of ). This manifests as the tendency for people to make decisions that are suboptimal in the long run.

Put differently, washing the dishes in 15 minutes always sounds much better than it actually is. Especially after 15 minutes have passed.

Risk Preference

Your perception of risk is driven by how much you value certainty over uncertainty.

Most individuals prefer a guaranteed payoff over a fair but uncertain bet, making them risk-averse. Some, however, choose the uncertain payment — even if it leaves them worse off on average. Why would someone do such a thing? It’s either that people enjoy the uncertainty and consciously pay for it (in the form of an expected loss), or they see it as an effective way to generate income. While the former can be somewhat justifiable — in the sense that it’s difficult to argue against what someone finds enjoyable — the latter is simply an example of bad decision-making.

Each decision you make — or don’t make — reveals your time and risk preferences, and it’s likely that you typically default to one pattern of behavior, irrespective of context and situation. By analyzing these two preferences, we can identify four distinct behavioral archetypes, which in my view map quite well to what we observe in real life. The Sensation Seeker, The Great Spender, The Climber, and The Jumper each represent the extremes of the preference matrix.

• The Sensation Seekers prioritize the present over the future and are reckless in their approach to risk. Gamblers, for example, engage in high-risk bets with a high return potential over a very short time horizon — it’s a wicked combination that makes this archetype the perfect target for various get-rich-quick scams.
• The Great Spenders favor certainty — but only if it’s happening now. Within the financial realm, they tend to spend most of their disposable income on current pleasures. The Great Spenders are credit card companies’ favorite customers.
• The Climbers are future-focused but risk-averse. They are typically conservative in their investments, looking to preserve their wealth through low-risk, low-yield means such as savings accounts. Professionally, they are skeptical toward risky ventures in favor of climbing the corporate ladder.
• The Jumpers are a unique category. They think long-term and are unafraid of taking significant risks, making them the great politicians, scientists, entrepreneurs, and artists who drive technological and cultural progress.

Do Whatever You Want, But Know What You’re Doing

Have whatever goals you like — but ensure your actions align with them.

Applying Principles of Investment Analysis To Life Decisions: Risk, Reward, and Time was originally published in Brain Labs on Medium, where people are continuing the conversation by highlighting and responding to this story.

Europe’s current situation reminds me somewhat of Aesop’s where a swift but overconfident hare, pausing to nap during the race, ultimately loses to a slow yet persistent tortoise. The story shows how disciplined effort trumps talent paired with complacency — the race is not always to be swift. The most successful are keenly aware of this lesson. Even more so, they blend the best qualities of the hare and the tortoise.

If you were born in today’s Western Europe, congratulations: you’ve won the lottery! You get to live in one of the world’s most prosperous regions, with generous social safety that effectively removes many barriers to individual self-actualization and prosperity. Relative to most of the world’s population, Europeans are , , , , and  — a tremendous privilege. But there’s a catch: one does not simply enjoy privilege (nor allow it to degenerate into a sense of guilt, for that matter).

Privilege implies and requires responsibility; otherwise it collapses under its own weight.

It implies the responsibility to be put to productive use, for the sake of the unprivileged; it requires the responsibility to be sustained. It seems, though, that Europeans are starting to lose sight of this piece of common wisdom — much like Aesop’s sleeping hare.

Americans Just Work Harder

If current trends continue, Europe’s influence on the global stage will wane.

Much like a 40-something reminiscing about their prom king or queen days, Europe can’t rely on its past productivity successes.

• First, productivity growth cannot sufficiently compensate for the decline in working hours and poor demographic trends (which deserve their own discussion).
• Second, Europe currently lacks the conditions needed to generate further productivity growth (or even maintain the current level). The economy of the future is being built across the pond— eight out of the ten largest companies by market capitalization are headquartered in the US. These are highly productive and innovative tech giants: Microsoft, Apple, NVIDIA, Alphabet, and Amazon, to name a few. Companies like OpenAI and SpaceX need not even be mentioned. In contrast, Europe’s most valuable companies — such as LVMH, Nestlé, Hermés, L’Oréal, and Shell — dominate traditional industries with limited potential for deep economic transformation (admittedly with notable exceptions like Denmark’s Novo Nordisk and the Netherlands’ ASML). The situation looks even bleaker for Europe when we shift focus from established companies to startups — in 2024, the US is home to (privately held startups valued at over $1 billion), while Germany has only 29. Twenty-nine! Even in the renewable energy sector, where the EU aspires to be a global leader, it’s .

Europe Needs a Reality Check

Europe has every reason to relax — but only if it looks in the rearview mirror.

One of humanity’s great discoveries is the fact that the future can be transacted with.

Time Is Money

Interest rate is the exchange rate between present and future money.

Today’s economy — not unlike the society itself — is built on promises. Stocks, bonds, consumer loans, and mortgages all derive value from promises of future rewards. How much is the future worth compared to the present? What is the value of time? That’s a deep question. Fortunately, there is a surprisingly good proxy for that — interest rates. Interest rates can be thought of as the (annualized) price of today’s money, expressed in future money’s terms. This allows us to recast our question and ask more specifically: what is the appropriate interest rate on a hypothetical loan that is expected to be repaid at a specified future time (that is, at its maturity)? How does the appropriate interest rate depend on the maturity (of some hypothetical loan)— or, put more succinctly, what is the term structure of interest rates? That’s precisely the information encoded in the yield curve.

Unlike in Mesopotamia, when the interest rate was limited to 33% by the , interest rates — long-term interest rates in particular — today are determined by financial market participants. Market participants have a strong incentive to estimate the correct interest rate to price a future payment. But what is the “correct” rate and how does the market determine it? And what does maturity have to do with it?

No Two Interest Rates Are Created Equal

• First, you want to know whether you are going to get your money back. You would be taking on some credit risk that you would want to be compensated for.
• Second, you’d think about the things you could do with that money in the period if you don’t lend it. Sure, you can spend it, but you may also deposit the money in the bank (or invest it in the financial markets) if it’s offering — or you expect that it will do so in the future — a more attractive rate of return. If you lend the money longer-term, you want to be compensated for locking up your liquidity, making you unable to react to better opportunities now, but also those that may arise in the future (i.e., one that offers a better return on investment). A practical way of formalizing this is to say that you’d need to factor in your interest rate expectations.

Now, the appropriate level of compensation for each of these factors will depend on the key piece of information: the maturity of the loan, i.e. when you should expect to be repaid. Since different repayment periods may imply different expectations relating to these two components, the demanded interest rate will correspondingly be different. For example, if you anticipate a rise in short-term interest rates (e.g., bank deposit rates), and the offered long-term rates do not compensate for the expected increase, you may decide to keep your money at the bank instead of lending it for a longer term.

The yield curve represents the interest rate as a function of time to maturity.

These varying expectations associated with different future points in time give rise to the yield curve, which can be defined as a representation of the relationship between interest rates and time to maturity. That definition may come off as a bit too general; to which underlying loan does the curve-implied interest rate apply? Who is providing it, and to which borrower? That’s up to us to decide — yield curves can be derived for any borrower (if there is sufficient data). Nevertheless, economists are often interested in government bond yield curves, as government bonds are among the most abundant and liquid debt instruments. They also reflect the financing costs of the largest (and usually the most creditworthy) borrower in the country.

Yield Curves and the Business Cycle

Yield curves are so important because interest rates are so important.

Interest rates make their way into virtually all financial decisions. While the level of interest rates is indeed important, the yield curve provides an extra bit of information about how interest rates at different maturities relate to each other. This is often reflected in the shape of the yield curve. The most common way to characterize the shape of the yield curve is by its slope.

In times of economic growth, yield curves are typically upward-sloping, meaning that longer-dated instruments yield a higher rate of interest relative to those maturing earlier (). That’s because, even in times when interest rates are expected not to change substantially, investors need to be compensated for the possibility of a missed opportunity to capitalize on higher interest rates. The longer this period, the higher the demanded compensation; hence the upward-sloping shape. That’s called .

A rare but significant occurrence is the yield curve inversion, which is marked by short-term yields exceeding yields on long-dated instruments. Usually, the yield curve is described as inverted if the difference between the 10-year and the 3-month yield becomes negative. That’s usually a bad sign. It is often described as the harbinger of bad times — (although its predictive power has been recently).

• The cause argument. As the yield curve inverts and short-term yields increase past long-term yields, investor sentiment shifts toward short-term investments. This typically leads to an all-out increase in yields across all maturities, which hurts stocks — particularly those whose value lies in cash flows in the distant future (think growth stocks). A falling stock market is generally not beneficial for consumer and investor confidence. Moreover, banks tight their lending conditions as the economic gloom looms, and the pressure on their margins mounts as the cost of short-term financing rises (the banks need to pay higher deposit rates to their customers; however, ).
• The consequence argument. The central bank typically raises short-term interest rates when the economy is . This is usually accompanied by inflation as businesses struggle to keep up with demand. Higher short-term interest rates are precisely here to cool the economy, as they have a dampening effect on consumption, investment, and, therefore, output. Markets, of course, are perfectly aware of this and expect the economy to slow and, consequently, interest rates to be brought down. The expected fall in interest rates materializes as the inverted yield curve.

Why Should You Care?