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Does More Money Equal More Happiness?

January 23, 2013

More money leads to increased happiness – at least up to a certain point, according to an oft-quoted study from Princeton University’s Center for Health and Well-Being. The study found that happiness peaks at an annual income of $75,000, and established that day-to-day happiness – what the researchers refer to as “emotional well-being” – continues to increase as income rises to $75,000 and then levels off for higher incomes.

The study also found that people’s reflective view of how satisfied they are with their life – what the study refers to as “life evaluation” – climbs higher as income increases. In other words, when people contemplate how happy or satisfied they are with their overall station in life, the higher the income, the higher the satisfaction. Clearly money is not the only factor determining your happiness, but having it does help us enjoy more of the things that make life meaningful.

It’s All Relative
One of the interesting findings from this and other similar studies is that the influence of money on your happiness is relative once you move beyond meeting basic needs. It is not the absolute amount of income or wealth you have, but how you stack up against your peers. One of the amusing observations on this subject is Henry Mencken’s definition of a wealthy man as one earning $100 more than his wife’s sister’s husband.

Supporting this view of wealth is another study, referenced in a New York Times article:

“…economists David Neumark and Andrew Postlewaite examined the behavior of a large sample of pairs of American sisters, each containing a sister who did not work outside the home. The authors’ goal was to learn what factors might influence the other sister to seek paid employment. They rounded up all the things that are supposed to affect the decision to work — the unemployment rate in the local labor market, the wage rate, education. All of these factors had some impact, but relative income was the most powerful: a woman in their sample was 16 to 25 times more likely to seek paid employment if her sister’s husband earned more than her own.”

Are you kidding?! Up to 25 times more likely to seek paid employment – that is an unbelievable statistic and a powerful demonstration of how people change their behavior based on comparing their income to others.

The happiness-maximizing income of $75,000 is about 1 ½ times the median household income in the United States (which was about $46,000 in 2010, according to the Federal Reserve). According to the Fed, less than 30% of all households have income above $75,000. This figure supports the view that it is income relative to others that increases happiness. If you earn more than 7 out of 10 households, you probably feel pretty good about your situation and can enjoy some of life’s little luxuries.

Income Is Not Wealth
That being said, I suspect that overall happiness is more correlated to wealth than income. I’m always a bit perplexed by the focus on income instead of wealth – with income being what you earn each year and wealth being your total net worth. This bias shows up, not only in these studies, but in the ongoing political debate around raising taxes on the “rich.” To me, being rich is a reflection of your net worth, not your income (although there is often a link). As a simplistic example, if you had $10 million stashed away in a safety deposit box, you might have no income, yet would probably feel more financially secure than someone earning $100,000 each year and spending it all.

Your Financial Plan
What does this imply for your financial plan and investments? These findings should help emphasize that the accumulation of wealth is just a means to an end. You are probably investing with specific goals in mind, whether securing a comfortable retirement, buying a second home, or funding your kid’s education. You will likely be happy if you achieve your goals and unhappy if you don’t. But if you exceed your goals, and accumulate more money than you need, you may not be any happier than if you had merely met your goals.

Hence, when deciding on an investment strategy, it may be wise to select a strategy with the highest probability of successfully reaching your goals, and not necessarily the strategy with the highest expected return. Since expected investment return and investment risk go hand-in-hand, a portfolio with the highest expected return will also, in all probability, come with the greatest risk.

Sources:
“High income improves evaluation of life but not emotional well-being” D. Kahneman & A. Deaton, Princeton University.
The New York Times magazine, “Why living in a rich society makes us feel poor” (2000).
Federal Reserve, 2010 Survey of Consumer Finances.