Category Archives: Money Psychology

Fewer Americans Living In Poverty

Fewer people in the US are living in poverty. According to the October 2017 annual report of the Hamilton Project of the Brookings Institute, the number of Americans living in poverty declined by 13%, or 6 million people, in the two years from 2014 to 2016. That’s encouraging news.

Not so encouraging is that 40.6 million people still live under the government poverty level. This is about one out of every eight Americans. The department of Health and Human Services sets the poverty rate at $32,580 or less for a family of six and $16,020 or less for two people.

Who are those officially classified as poor? Continue reading

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How to Make Sense of Big Numbers

If you are not a natural number cruncher, you may be like one of my clients who says, “When I see big numbers in an article, my brain just skips over them.” Unfortunately, skipping over numbers can lead to serious misunderstandings. Here are three questions to ask that can help you clarify those big numbers.

1. What’s the time period? The reported cost or savings of something is completely irrelevant unless you know the length of time over which it is calculated.

Continue reading

Huge Difference Between Millionaire and Billionaire

Would you like to build up a million-dollar nest egg by the time you retire? For middle-class earners, that goal is challenging but possible if you start at age 25 and save $1750 a month. Many married couples could do this by maxing out their 401(k) contributions. Or you could take the route that many people follow and build a small business into a million-dollar asset.

What if you want to accumulate a billion-dollar nest egg instead? Starting at the same age of 25, you would need to save $21 million a year. Good luck with getting any employer match on that.

There’s a vast difference between a million and a billion. Continue reading

Dangers of Comparing Diversified Portfolio to US Stock Market Returns

It may be entertaining to watch Donald Trump point his finger and curtly say, “You’re fired!” When a client says the same thing to me, it isn’t so funny.

I’m especially not amused if a client fires me because their diversified portfolio is underperforming the US stock market and they abandon the strategy. The result is often a financial travesty.

The February issue of “Inside Information,” Bob Veres’ financial newsletter, puts a name to this phenomenon: “frame-of-reference risk.” The term is used by Roger Gibson, Chief Investment Officer, and Christopher Sidoni, Director of Investment Research, of Gibson Capital in Wexford, PA. Veres reported on a presentation they gave at the American Institute of CPAs (AICPA) Personal Financial Planning conference in Las Vegas in January.

Gibson describes “frame-of-reference risk” as clients’ tendency to compare the performance of their diversified portfolios with current returns in the US stock market. He points out, “If the discrepancy gets too painful, they will fire you and abandon a diversified approach at the wrong time.”

Based on the emphasis the media gives the US stock market, one could easily conclude US stocks must be the largest, most important asset class in the world. Not at all. US stocks represent less than 10% of the world’s wealth and make up 10% to 20% of most diversified portfolios.

Neither do US stocks consistently produce the best returns. In the 1970’s, commodities dwarfed US stock returns. In the 1980’s, international stocks led the way. In the 1990’s, US stocks were the stars. In the 2000’s, the leader was real estate.

Yet most investors judge the performance of their portfolios by US stocks. They may compare the returns of a diversified portfolio with news reports about the S&P 500 and the Dow, which together include only 530 companies.

Between 1994 and 1999, Gibson’s multi-asset class strategy delivered a 13.05% return, which paled in comparison to the US market’s 23.55% return. He lost one-third of the assets he managed in 1999, as clients fired him. They abandoned their diversified investment strategy at just the wrong time to save themselves from the 2000-2002 US stock market downturn, when real estate and commodities soared. Gibson’s multi-asset class portfolios did 9.96% from 2000 to 2005, when US stocks rang up losses.

This pattern, familiar to many financial planners, is the sad consequence of frame-of-reference risk.

Another aspect of that risk is our human tendency to stay in a comfort zone where most of our neighbors are doing pretty much what we’re doing. One client even told Gibson, “I would rather follow an inferior strategy that wins when my friends are winning and loses when my friends are losing, than follow a superior strategy that at times causes me to lose when they’re winning.”

Unfortunately, this tendency can lead us into disasters. Diversified portfolios are once again underperforming the US stock market. Predictably, an increasing number of investors are abandoning diversification, right in time to get nailed.

Gibson and Sidoni’s conclusion seems to be that educating clients to stay the course is a no-win game. In their view, advisors need to craft a less efficient, lower-return long-term strategy that clients will consistently follow rather than a more efficient strategy that clients may abandon in mid-stream.

While that view seems pragmatic, it really misses the mark. Instead of dumbing down portfolios to match client’s dysfunctional money scripts, it would be a better outcome if advisors concentrated on helping their clients uncover and modify the money scripts that are driving their self-sabotaging behaviors. This approach can help keep clients from saying “You’re fired!” at the wrong time for the wrong reasons.

Buying Happiness With Discretionary Spending

Giving away money makes people happy. Spending money on others makes people happier than spending money on themselves. Spending money on experiences makes people happier than spending money on things.

Does that mean it’s okay to max out your credit card to take all 37 members of your extended family on a cruise for Christmas?

Not exactly.

Yes, research shows that some kinds of spending are linked to happiness. Andrew Blackman cites some of that research in an excellent article, “Can Money Buy Happiness?“, published online November 10 in The Wall Street Journal.

Before you pull out the plastic and start shopping, though, there’s one important point to keep in mind: Any spending to create happiness must come from your discretionary money. This is money we have available to spend for our lifestyle, after we’ve paid all our fixed expenses like rent, loan payments, utilities, retirement contributions, building emergency reserves, insurance premiums, etc.

Discretionary spending can include luxuries or extras like eating out, vacations, gifts, entertainment, and gadgets of all types. But it also can include items that may be necessities or fixed expenses like housing, vehicles, clothing, and food. For example, owning a car is a necessity for most South Dakotans. However, a 10-year-old Toyota Avalon with 90,000 miles on the odometer, well maintained, can transport you just as effectively as a new model. The older model costs around $10,000; the new one costs around $35,000. The $25,000 difference is discretionary spending.

If you want more discretionary money for happiness spending, like giving or experiences, you might choose to spend more frugally on necessities. The other option, borrowing for happiness spending, generally doesn’t work. Research finds that borrowing and debt creates unhappiness that pretty much cancels out the happiness created by the spending.

Elizabeth Dunn, associate professor of psychology at the University of British Columbia and co-author of the book Happy Money, puts it this way in The Wall Street Journal article: “Savings are good for happiness; debt is bad for happiness. But debt is more potently bad than savings are good.”

In a series of studies, Prof. Dunn found that the spending producing the highest amount of happiness was spending on others. She found it wasn’t the dollar amount given but the perceived impact of the gift that mattered. Seeing your money make an impact in someone’s life will produce happiness, even though the gift is very small.

The impact experiences have on our lives may be the reason we gain more happiness from experiences than from material things. Even though we tend to see tangible things as offering more value, the memories and learning we gain from experiences actually provide more happiness.

Creating experiences can involve the purchase of some stuff. Buying baseball equipment with the intention of playing with your children is one example. Buying a camper or a boat for shared family experiences is another. Of course, buying stuff to be used in creating experiences only creates happiness if you use it. We don’t gain much happiness from sports equipment gathering dust in the basement or a camper abandoned in the back yard.

After reading this research on the value of spending on giving and experiences, I came up with what might be the ultimate happiness spending scenario: Giving the gift of an experience that includes both the recipient and the giver. While I haven’t found any research validating that hypothesis, I am guessing this may be the perfect happiness two-for-one.

Maybe, if you can afford it out of discretionary money, taking the family on that cruise isn’t such a bad idea after all.

Investing Money In Happiness

It turns out money can buy happiness, after all—sometimes.

Having a good income and the security of money invested for the future don’t insure happiness, of course. They do, however, give us a foundation that can make it easier to find happiness. Part of the secret to using money to foster happiness is knowing what to spend it on.

First, spending money to lift your mood—the whole “retail therapy” idea—does not lead to happiness. It provides only a momentary sense of pleasure, which often in the long run fosters unhappiness.

There are ways to spend money that do create happiness. Here, based in part on several posts about money and happiness by Dr. Jeremy Dean on his site Psyblog, are a few of them:

1. Experiences. Research says you will find greater happiness spending your money on experiences rather than on stuff. Experiences live in our memories much longer and give us more emotional enjoyment than things, which can quickly lose their importance. In fact, just the anticipation of planning an experience often creates happiness. And if you want to take the happiness level up a notch, take a friend along with you.

2. Exercise. The number-one strategy people can use to feel better, increase energy levels, and reduce tension is exercise. Exercising can mean spending money on a gym membership, a personal trainer, and equipment. However, exercising can also be inexpensive. Walking, for example, requires little more than a pair of good walking shoes and—at least here in South Dakota—a warm winter coat.

3. Stuff that will provide you experiences. Buying things that create or are necessary for experiences count as happiness spending. Music is an experience that research says is a mood enhancer; even sad music can bring pleasure. Spending money on music might mean buying concert tickets, but it could also mean buying recordings, an iPod, smartphone, speakers, and similar equipment.

4. Stuff that supports doing what you’re good at. What are you good at and really enjoy? PsyBlog says spending money for things you excel at typically creates happiness. A set of golf clubs and a budget for green fees could be a great purchase if you’re good at golf—or even if you aren’t so good at the game but you enjoy it for the exercise and time with friends. The same goes for buying things to support hobbies, such as art supplies, garden plants, or quilting fabrics. Maybe you enjoy helping others, so charitable giving or spending money on volunteer opportunities would increase your happiness. I love researching almost anything, so spending money on research data can be a mood lifter for me.

5. Coaching/Therapy. Few things are more valuable for long-term happiness than hiring a good coach or therapist. Research shows talk therapy to be as effective as or better than antidepressants. In my co-authored book, Conscious Finance, I describe how spending $80,000 on therapy was the best investment I ever made in my own happiness and well-being.

6. Meditation. The biggest happiness bang for your buck might come from meditation. It isn’t free, but it’s very inexpensive. You will need to attend a class or buy an instructional video or book. I recommend Open Heart, Open Mind by Thomas Keating, but there are many others.

While we know that money by itself isn’t a source of happiness, we also know that having enough money to comfortably meet our basic needs does make us happier. In addition, we can consciously choose to spend in ways that buy happiness. Such investments may not provide financial returns, but they can provide significant happiness returns.

Do Overspending and Overeating Go Together?

Over the years, I’ve noticed a commonality among people with money problems. Many of them are also overweight. Is there a relationship between overspending and overeating?

Until now, I couldn’t be sure my experience was anything more than circumstantial. But I recently read about a 2009 study done by Dr. Eva Munster at the University of Mainz in Germany. It found that people who were in deep consumer debt were 2.5 times more likely to be overweight than those who were debt free. This confirms what I’ve observed over the past 15 years.

It isn’t possible to pinpoint one simple reason for this link. Among the causes I’ve seen suggested are overeating because of the stress of being in debt, difficulty buying healthful food with limited income, or an inability to delay gratification in both spending and eating.

Based on my work with people in financial trouble, however, I suspect a deeper root cause. Just as chronic money problems aren’t about the money, chronic weight problems probably aren’t about the food.

For supporting evidence, I went to an expert: my daughter. London recently took a graduate level course in previewing medicine. I asked her what the medical link between overspending and overeating might be. She explained that sugar is addictive and lights up the same part of the brain that narcotics do. It produces a euphoric response within the brain that calls for more of the substance when the euphoria subsides.

She wondered whether people addicted to sugar might overspend on junk food to feed their addiction. They might also spend money they really don’t have on diets, fitness centers, and the higher medical costs associated with being overweight.

I pointed out that I spend a lot on healthy food that costs more than junk food. I also spend money on a fitness center and medical costs to pay for the damage I do to my body compulsively working out. “Well, I guess my argument doesn’t hold much weight,” she quipped.

She pondered for a moment. “Oh, I think I got it. I’ll bet for some people spending money lights up the same part of the brain as sugar and narcotics?”

Bingo.

That is why the key to changing any addictive behavior—eating, drinking, using drugs, or overspending—is not simply about eliminating the substance or the activity. Something else just pops up to take its place. That’s why many people who successfully stop drinking gain weight or get into serious money problems. The brain just substitutes one dopamine producer for another.

The ultimate answer is a sort of “rewiring” of the brain to create new neuropathways that do not require the harmful substance or activity to produce the same euphoric event. The latest research on the brain tells us this rewiring is completely doable.

I’ve seen that permanently changing the most entrenched damaging money behaviors takes more than knowledge about money or budgeting. Experts on obesity tell us the solution to permanently losing weight rarely lies with learning more about nutrition or finding the right diet. Making deep life changes such as these requires looking into the past. This recovery process takes time, effort, and money. It’s a path that many people are just not willing to follow.

But there may be some good news. If the underlying causes for overeating and overspending are the same, then doing the work to recover from one is likely to help someone recover from the other, as well. It’s a sort of “two for the price of one” sale. In terms of long-term financial, physical, and emotional well-being, it seems like a bargain.