Beware of the wealth effect
It’s wickedly seductive to think, “If I made more money all my money problems would go away. “ Don’t be lured into a sleepy slumber by this money mirage. It might sound great on paper, but money is the most emotional piece of paper on earth, and the subconscious pull of the wealth effect can easily siphon away your newly found riches.
The wealth effect is a phrase coined by economists stating: people will typically spend more when one of two things is true: when people actually are richer, objectively, or when people perceive themselves to be richer—for example, the assessed value of their home increases, or a stock they own goes up in price. – Wikipedia
If you’re shaking your head head saying, “That wouldn’t happen to me.” Kick back and let me tell you a cautionary tale. I was witness to a crystal clear example of the wealth effect in action and the beautiful victim thought it would never happen to her. Her name is Sassy Sugar.*
When she started Millionaire Boot camp™ she was earning $50K. She had been doing Millionaire Boot camp™ only one month when she got fired. ( It happens to the best of us.) In a couple of months, she landed a new job. The starting pay $100K! This wild jump in pay produced some very clear results. When she started MB ™ her average spending was $4,200** monthly. However, just three months after getting her new job her average spending jumped to $5,100**. Increasing her spending by $838 per month!
She did not do anything crazy. There was no spontaneous trip to Paris, or a once in a lifetime clothing stampede. She could actually not say exactly where the additional $2500 had went. ( $838 x3 months= $2514) It was a little here, a little there, and poof! It was gone. It took her three months to believe that she was consistently spending more, and concede that the wealth effect was the culprit.
The wealth effect is so powerful because it’s subconscious. Each month Miss Sugar could “justify” the spending as one of life’s “one off” events. Her boyfriend had a birthday, she celebrated getting her new job by taking her mom out to dinner, she got a jacket for work, etc. It took three months, which is actually very speedy, to be able to see that her spending was not a “one off life event.” It was a trend. Her monthly spending had dramatically increased, and it increased the extact month she got her new job.
Moral of the story: Be on guard! If you get a raise, bonus, tax return, your house goes up in value you, your rich grandma had one foot in the grave, anything that suggests the possibility of more money. Have a plan. This helps you spend (that could include saving) the money in the way that best balances your short and long term goals.
Do you know what’s in your 401K? A free 15 minute call could save you $100,000. Call now. Your future self with thank you.
*Name has been changed
**Numbers have been rounded to the nearest $100 or $1000 to make them easier to digest.