We look at how to change your behaviour so that the money you have – and spend – brings you joy
When it comes to money and happiness, people think it is straightforward: the more you have, the better. But that is only true to a certain point. Psychologist Daniel Kahneman and economist Angus Deaton found that happiness increases with wealth, peaking at earnings of $75,000 (around £57,000) a year. After that, the correlation flattens – more money stops making a difference.
Economists have talked about this paradox for a long time – once a certain level of income is covered, people buy bigger houses and more stuff, but they don’t seem to get happier as a result. Instead, a burgeoning body of research shows that we can boost our ‘subjective well-being’ – the geeky term for happiness – by reconsidering the way we think about money, and how we make financial decisions.
For most people, our saving, spending and investing habits are led by intuition. However, according to behavioural scientists, intuition can lead us astray. To help you keep your financial and emotional well-being on track, we tackle the three big questions: what kind of wealth makes us happy? How can we spend money in a way that increases our well-being? How can we tackle irrational intuitions and behavioural biases that can jeopardise it all?
1 Understand the kind of wealth that makes us happy
The first thing to understand about wealth is that it is relative. If you look at athletes standing on Olympic podiums, you might notice that bronze medallists look happier than silver medallists. Why is that? After all, there is a clear hierarchy of winners: first gold, then silver, and only then bronze. So one might expect that the athlete’s happiness would mirror this order, but it often doesn’t.
This phenomenon can be explained by the fact that people tend to compare their achievements to what “might have been”, according to psychologists Victoria Medvec of Northwestern University, Thomas Gilovich of Cornell University, and Scott Madey of Shippensburg University.
Bronze medallists are likely to compare themselves to those who did not get on the podium at all, whereas silver medalists might think they have come so close to taking the top spot – but failed to win gold. In the same vein, wealth is subject to social comparison.
The upshot is that those who count their blessings – and compare themselves down rather than up – are happier. As ever, keeping up with the Joneses is a sure way to undermine happiness. And yet it is an easy trap for all, except for Amazon chief executive Jeff Bezos, who is the richest person on the planet.
In an interview with Oprah Winfrey, Harry Potter author J.K. Rowling has said that going from being a single mother, who was “as poor as you can get in Britain without being homeless” to becoming the first billionaire author was akin to gaining magical powers. Wealth has given her more autonomy.
This is because the origin of your wealth is also important. Is it earned? Won? Or inherited? In a rare survey of its kind – with 4,000 decamillionaires [people with a net worth of over $10 million (£7.7 million)] – Harvard Business School researchers Grant E. Donnelly and Michael Norton analysed the happiness levels among the super-rich. They discovered that those who are happier than their peers have something in common: they have made the money themselves, instead of inheriting or marrying into it.
2 Spend money to maximise the happiness it brings
Buying ‘new stuff’ gives us a quick shot of dopamine, especially when we buy ‘vice’ items, such as ice cream with sprinkles, the latest iPhone, or a pair of high heels we will probably wear once. But this kind of pleasure wears off quickly. We are susceptible to what is called ‘hedonic adaptation’, returning to a stable base line of happiness over time, regardless of positive or negative experiences. This tendency means we easily get used to material goods and they don’t give us a permanent increase to our overall happiness.
The value we get from the pleasure of anticipation is stronger when it comes to delaying experiences rather than material goods. In an experiment from 1987, economist George Loewenstein asked participants whether they would prefer to get a kiss from their favourite movie star right away or three days in the future. People tended to choose the latter. More recent studies have shown that we savour waiting for experiences – but not purchases.
Our satisfaction with experiences can also increase over time. That is because they leave us with fond memories and stories for years to come. Experiential purchases connect us with other people, and the relationships in our lives tend to be the biggest reason for our happiness.
“We identify with all of our purchases,” says Cornell University’s Gilovich. Think of the clothes you wear or the furniture you choose.
“But no matter how identified we are with our material things, they aren’t us,” he says. “They are separate from us, whereas we are the sum total of our experience. And so experiences loom larger in our life narrative.”
The question of ‘who are we?’ tends to lead to: ‘What have we done? What do we plan to do?’
He says a big part of our well-being is the ability to tell a compelling story about ourselves – and experiences allow us to do that. What is more, many experiences involve skill building.
“It’s thinking ‘I wasn’t sure I was the kind of person who could climb this mountain’, but once you do it, it’s pleasing to know that you can,” says Gilovich. “That makes sense from an evolutionary perspective. The brain will secrete the kind of brain chemicals that produce happiness, when we’re out doing things and learning how to master the environment.”
Spend money on others
A group of researchers led by Norton of Harvard Business School gave participants envelopes of money. They were told that they could either spend the money (which was $5 or $20) on themselves by the end of the day, to cover expenses or buy themselves a gift – or, alternatively, they could give the money to someone else or to charity.
“We found that people who spent the money on themselves that day weren’t happier that evening,” Norton explains, “but people who spent it on others were. The amount of money, $5 or $20, didn’t matter at all. It was only how people spent it that made them happier.”
Once again, money increases our well-being when we spend it to invest in our relationships or to help those around us. In this context, it is encouraging to know that some 65% of Brits donated to charity in 2018, according to the Charities Aid Foundation.
3 Keep your irrational biases in check
Even once we know all of the above, we still need to bear in mind that we are not rational thinkers. If we were all as rational as we like to think, Las Vegas wouldn’t exist. Instead, we are emotional creatures when we make everyday financial decisions.
This idea has been gaining wider traction ever since the acclaimed psychologist Daniel Kahneman won the Nobel prize for economics with Amos Tversky for their work on behavioural economics.
Many experiments have shown that it is easier for us to part with money if we are paying by card or phone, rather than in cash. Increasingly, one-click purchasing, and same-day deliveries erode the friction of our shopping experience. While this is often framed as a matter of convenience, it also gives free rein to our impulsive side.
This is worrying, given that so many Britons are in debt. Some 8.3 million people in the UK are over-indebted, according to the Money Advice Service. This makes them highly vulnerable to financial shocks. Research by banking group ING shows that 30% of people in the UK say they don’t have any savings, with two-thirds of this group saying it is because they don’t earn enough. It is undeniable that the consequences of the financial crisis still reverberate through the system and that living costs have not kept up with incomes or assets, especially for younger generations.
Behavioural science also explains why we are not good at saving, argues Jessica Exton, behavioural scientist at ING, who says that the “tendency to discount the value of having things in the future means we prefer having them now”. This does not bode well for our savings.
Save for the long term
There are usually more savings to be had from revisiting your energy provider, home insurance policy or phone bill, rather than skipping the occasional take-out cup of coffee.
A focus on now at the expense of our future, means it is easy to put off making financial decisions that do not demand our immediate attention, such as switching to a cheaper energy supplier or checking whether we could be putting more money away for retirement, says Exton – “even if these actions would pay off in the long run”.
Apart from good budgeting, why not create a supportive environment for your savings habit? You could set up an automatic transfer from your current account to your savings account each payday. There are apps that will automatically round up the amount you spend on small purchases, such as baguettes from Pret, and put them into a savings account – and even apps that save whenever President Trump tweets.
Saving for retirement might seem like a long way off for some of us, but the risk is that we can underestimate how much we will need. The UK government used insights from behavioural economics – namely, the fact that we are lazy and prefer to stick with the status quo – to create the auto-enrolment scheme for pension savings. The scheme ‘nudges’ us into saving for retirement by default. The initiative is widely seen as a success.
Biases investors can avoid
When it comes to investing, there is an array of ‘predictably irrational’ biases to look out for.
“For retail investors, ‘home bias’ is very common,” says Clare Flynn Levy, chief executive of Essentia Analytics, a company that uses artificial intelligence to help professional investors counter their behavioural biases. Our tendency as investors is to stick with what we know. With stocks and bonds, this means we end up overexposing ourselves to companies and assets in our home countries.
“And yet, our fortunes do not have to be completely tied to the political situation or economic state of our own countries – there are plenty of ways to diversify internationally, and a rational investor will seek to do that,” says Flynn Levy.
Other common biases include the ‘endowment effect’, where people overvalue what they already own, and ‘loss aversion’. This means investors hesitate to sell a holding, even though it is losing them money.
To counter these biases, Greg Davies, head of behavioural science at consultancy Oxford Risk, recommends a simple mantra: if I didn’t own it, would I buy it now? In the words of decluttering guru Marie Kondo, it would be: “Does it spark joy?”
Consider a cooling-off period
Our disposition matters too. According to one study, about 25% of the population are tightwads, while 15% are spendthrifts. (The rest of us are ‘unconflicted consumers’, in case you wondered.) Neither tightwads nor spendthrifts are happy with their financial behaviour.
“Tightwads experience a lot of distress when they are considering purchases, especially optional purchases where it is unclear what they should do,” says Scott Rick, associate professor of marketing at the University of Michigan. “And that prevents them from spending the money they think they should spend on certain things, and they can kick themselves afterwards.”
On the other side of the spectrum, there are spendthrifts. They are prone to “acquiring things that don’t necessarily excite them that much, but they just can’t stop themselves”.
One solution for tightwads to feel less pain about spending money is to use frictionless payment methods. Meanwhile, spendthrifts could consider what else they could buy with that money.
Given that shopping is increasingly frictionless, there are more opportunities for everybody to be impulsive.
Davies says: “The most successful thing for all of us to do is to always build in a pause point – a cooling-off period.”
Whenever you are making a big purchase, or an investment, “train yourself to sleep on it first”.
Ask yourself: Can I leave it for tonight and make the decision tomorrow morning?
“If we all did that, we would improve decision making enormously,” says Davies.
With most financial decisions, a moment of pause can remind us to prioritise our happiness, and the happiness of those around us.
Money can buy happiness
Really good article to learn from as I retired at the age off 52 and this is a real good article as I saved and was abled to retire early now I have to be wiser how to spend and have a enjoyable and well deserved retirement