Whenever my parents wanted to buy something, they remembered the swimming pool. Our backyard was large, flat, sunny, and square: perfect for a pool. Sadly, my parents, both lawyers, aren’t pool people. “Liability,” they said.
“So imagine how much money we saved when we didn’t get the pool!” my mom recalled recently. After my parents nixed the pool, whenever they deliberated on other big purchases — a family trip, a kitchen remodel — they looked at each other ironically. “Well, we didn’t get the pool,” they said, and felt immediately richer.
The odd thing about wealth is, it’s a feeling as much as a quantity. Ask people if they’re upper, middle, or lower class, and their answer will depend not just on the money in their bank accounts, but also on how researchers primed them to think about money beforehand. How wealthy one feels is often only moderately related to how wealthy one is. The authors of one 2006 paper in the Journal of Managerial Psychology even went so far as to conclude: “Rich or poor is a state of mind.”
How wealthy one feels is often only moderately related to how wealthy one is.
To an extent, anyway. “People aren’t just randomly saying, ‘I’m super wealthy,’ and really they’re at the bottom 20 percent of the income distribution,” says psychologist Elizabeth Dunn, who heads the Social Cognition and Emotion Lab at the University of British Columbia. For the average person, the correlation between objective and subjective wealth is around 0.5 or 0.6; a perfect correlation, where subjective wealth exactly matched objective wealth, would be 1.
In other words, “people aren’t stupid,” said Joe Gladstone, a consumer-behavior scientist at University College London, but there’s room for improvement. Which makes you wonder: Why wouldn’t we just feel as rich or as poor as we actually are?
For one thing, money can be an emotional topic, and our feelings about it are often synced to how we’re feeling more broadly. Anxious and pessimistic people may assess their financial situation too negatively, for example, while some people may be overly optimistic about their wealth due to fantasies of affluence.
How wealthy we feel also depends on what form of wealth we’re focused on. One particularly potent indicator is checking-account balance, which seems to sway subjective wealth more than any other type of asset. In one study, Gladstone had a large U.K. bank email financial surveys to some of their customers, and then compared the customers’ survey responses with their transaction history, income, and savings data. Even controlling for factors like total account balances, income, and spending, Gladstone found that having cash in your checking account was associated with greater perceived financial security and well-being than storing it in less visible places.
Anxious and pessimistic people may assess their financial situation too negatively, for example, while some people may be overly optimistic about their wealth due to fantasies of affluence.
For example, say two people each have Swiss bank accounts with $10 million in them, and then separate checking accounts. One of them has $1,000 in their checking account, while the other has just $20. Gladstone’s research indicates that the person with the $1,000 will feel more financially secure (and happier), “which makes no sense from an economic point of view,” Gladstone says. “But that’s not the point. For one of them, they go to the ATM every day, or they log on to their online bank and see a nice posted number that says you’re not going to have to worry. Whereas the other person sees this constant threat, this symbol of anxiety.”
Not all indicators of wealth generate that same feeling of financial security. Dunn notes that her house, which she bought in Vancouver several years ago, is worth much more money now than what she bought it for. But “it’s not like every time you walk in and out of your house it shoots out a little slip of paper that tells you exactly how much money you have,” she says. In turn, her house doesn’t have the same effect on her subjective wealth as her checking account does.
When we think about how wealthy we are, it’s all based on a reference point.
“So the extent to which we’re frequently reminded of our wealth really matters,” she adds, which also applies to the financial transactions we make — but those can go either way.
In some cases, spending money can actually make people feel richer, such as when they donate to charity. Alternatively, spending money on mundane obligations, like electricity bills and parking tickets, can also make people feel poorer.
Perhaps most importantly, though, subjective wealth hinges on comparison. “When we think about how wealthy we are, it’s all based on a reference point,” Gladstone says.
Neighbors, friends, and family are perhaps the most common reference points for wealth, which may help explain findings that four in ten American millionaires say they don’t feel wealthy, and that a majority of people worth more than $25 million still don’t consider themselves “financially secure.” Seeing people who are both richer and poorer than you are can also lead you to inaccurately assume you’re middle class, a phenomenon that writer Catherine Rampell has described as the “Middle Kingdom effect.”
But wealth reference points aren’t just based on other people. Let’s go back to my parents for a minute: The pool they never got served as a reference point for how much money they felt they could spend on big purchases.
“Spending is public, but saving is private.” We see our neighbours taking lavish vacations and buying new cars — not their debt or dwindling savings.
The problem, of course, is our reference points are often wrong. My parents had the same amount of money before and after they remembered the pool; the cost savings weren’t real. For social comparisons, Gladstone notes the critical obvious: “Spending is public, but saving is private.” We see our neighbours taking lavish vacations and buying new cars — not their debt or dwindling savings.
Still, these reference points can influence people’s purchasing decisions, life decisions, and even their happiness. “It’s the classic trope of, ‘Do you want to have the crappiest house on the nicest street in town, or do you want to have the nicest house on the crappiest street in town?’” Gladstone says. “And the reality is that all the research says the person with the nicest house on the crappiest street will be happier.”
But while feeling richer than you are “might day to day have this positive effect on well-being,” Gladstone says, “this inaccurate view of [your] money is going to have a potentially devastating consequence later on.” You may, for example, choose to spend too much every month and not save enough in your 401(k).
If you feel like you have less, you may also feel like you have less to lose.
You’d think feeling poor would make people thrifty, then. But it turns out, that isn’t great for financial decisions, either. Some research on scarcity suggests that feeling poor, even if you’re not, can incite brash purchases and other financial decisions that are “in a word, dumb,” Dunn says, like using a high-interest payday loan to buy a car. Dunn’s colleague at UBC, Jiaying Zhao, has found that if you induce the psychological sense of scarcity in anybody, they’ll make “similar short-sighted kinds of decisions.” If you feel like you have less, you may also feel like you have less to lose.
Which, in turn, can make it hard for people looking for help with their money to get the right advice on how to manage it. Asked whether subjective wealth or objective wealth matters more, a psychologist will give a very different answer than an accountant. But maybe that shouldn’t be the case, Dunn suggests. “An accountant rationally looking at somebody’s overall spreadsheet of debt and assets and net worth and income, and balancing all that out, is going to miss some important features of the psychology of money.” Indeed, it’s hard to put a price on peace of mind.
This article originally appeared on Science of Us: Article © 2017. All Rights reserved. Distributed by Tribune Content.