January 13, 2012
Money is in the Eye of the Beholder
Perceptions of wealth are often more complicated than just net worth, a new study indicates. Photo courtesy of flickr user AMagill
A recent thread on the urban parenting site Urbanbaby.com asked a simple pair of questions: What is your household income, and how rich do you feel? The resulting contradictions of income and perceived wealth drew widespread remark—and some scorn. One commenter, from New York City’s Upper East Side, makes $350,000 per year and feels “so, so, so poor.” Another earns $1.2 million and feels upper-middle class, while a third, with an income in the $180,000 range in the D.C. suburbs, feels rich.
How is this all possible? Everyone knows the old platitude “beauty is in the eye of the beholder.” A recent psychological study indicates that wealth is just the same. A new paper, published in the January issue of Psychological Science by Princeton researcher Abigail Sussman, demonstrates that total net worth is not the only thing that influences perceptions of wealth, whether for ourselves or others.
If you were asked to consider two individuals—Mr. Blue, who has $120,200 in assets and $40,200 in debt, and Ms. Green, who has $80,200 in assets and just $200 in debt—who do you think is better off? Of participants in the study, 79% said Ms. Green, although net worth is the same for both. When assessing those with positive net worth, having a lower degree of both assets and debt was seen as better than having more of each.
On the other hand, when considering a pair of individuals with equal negative net worth—say, Mr. Red, with $42,400 in assets and $82,400 in debt, and Ms. Gray, with just $400 in assets and $42,000 in debt—77% of respondents more often said that Mr. Red was wealthier. Having more assets, as well as more debt, was generally perceived as better.
What’s going on? Why do the trends move in opposite directions depending on whether the individuals were in the black or red? Sussman explains:
People generally like assets and dislike debt, but they tend to focus more on one or the other depending on their net worth. We find that if you have positive net worth, your attention is more likely to be drawn to debt, which stands out against the positive background. On the other hand, when things are bad, people find comfort in their assets, which get more attention.
These findings are more than just interesting—they seem likely to affect real lending and borrowing patterns. A second part of the study asked participants to imagine themselves in each of the scenarios, and then say how willing they would be to borrow money for purchases like a bathroom renovation or television. Again, people with positive net worth saw themselves as wealthier—and more willing to take on a loan—if they had fewer assets and debt to start with, and the reverse held true for those with negative net worth.
The study’s conclusions challenge traditional assumptions of classical economics—and, Sussman says, can be crucial in understanding otherwise puzzling economical choices we see in the real world.
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This is not all that surprising and is only mystifying if one ignores context and alternate paradigms. Researchers tend to find answers in the field from which they originate rather than answers that are necessarily true.
If you are only looking at assets and debts you are essentially looking at the Balance Sheet of an individual. Just as in business, this is useful but incomplete. To understand how well an enterprise or individual is doing, you have to also know the Income Statement as well. The question of who is “better off” is analagous to the wisdom of Solon’s observation that we can call no man happy till he is dead.
If an individual’s balance sheet consists of solely a house (worth $120,200) and an outstanding mortgage ($40,200) then it is true that their net Balance Sheet value is a positive $80,000, which is good as far as it goes and that this net value is equal to that of an individual with $80,200 in assets and $200 in debt.
To assess the context though, you also need to know the Income Statement. If the person has just lost their job and has no incoming funds and has fallen behind in their mortgage payment, they are at risk of foreclosure with all the attendant transaction costs that go with that. They have moving costs, they have to incur the cost of a rental, they will have legal fees, etc. They will still have a net asset condition but it will be something less than $80,000 (to account for all the attendant costs) after the mortgage has been extinguished. Prospectively, they will be in a substantially weaker cost and risk position. People understand this which I think accounts for their weighting higher assets with higher debts as a worse scenario than lower assets with lower debts. The one scenario is inherently more risky than the other even though in net assets they are equal.
I suspect people are answering a different question than is being asked owing to differing definitions of “better off”. If by “better off” we mean solely the mathematical netting of assets and debts, then they are being somewhat irrational when they weight one scenario above the other even though the net numbers are the same. If, on the other hand, people interpret “better off” to mean both a present and prospective condition (i.e. incorporating anticipated risks rather than just a mathematical netting of figures), then they are perfectly correct that the prospects of an individual with more assets and more debts are more precarious than those of an individual with lower assets and lower debts.
The inverse scenario (negative net position where having higher assets accompanied by even higher debts is seen as “better off”) is also explicable. In fact we have an addage for this not uncommon situation. “When you owe the bank $100,000, the bank controls you. When you owe the bank $100,000,000, you control the bank.” If you are in debt, having any assets to work with (even if they are in hock) is better than having no assets and a large outstanding debt.
It feels as if this might be an example of reserchers finding what they are looking for; in this instance, a psychologist appears to find an interesting psychological quirk when instead, invoking Occam’s Razor, there is a simpler real world explanation – people take into account risk circumstances as well as the static condition when evaluating who is “better off”.
It is quite possible that there are some interesting and deep insights in the entrails of this study, but as reported here, there is nothing to see.
Comment by Charles — January 15, 2012 @ 11:34 am
The readers were correct to say that Ms. Green is better off. Yes, it is true that she and Mr. Blue do have the same $80,000 in net worth, but Green has a significantly lower interest expense. Ceteris paribus.
Comment by Wilson — January 15, 2012 @ 4:15 pm
It could simply be that people’s idea of “well-off”edness relates to the ratio of asset worth to debt. In the first scenario Ms. Green’s assets dwarf her debt by more than 400 times, while Mr. Blue’s assets are only three times his debt. A similar analysis provides the same answers in the second scenario, with no need for treating assets and debt differently.
There are reasonable explanations behind that sort of assumption, as well. Assume that one’s debts and assets accumulate by some process, and that (for the immediate future, at least) those debts and assets will continue to accumulate as they have. That is, Mr. Red’s assets will increase in value by two dollars for every dollar of debt he gains, and Ms. Gray goes $105 further into debt for every dollar of assets she gains. Clearly the actions of neither actor is sustainable, but if either can effect a lifestyle change to drag themselves out of debt it is Mr. Red.
Comment by Matthew Steel — January 16, 2012 @ 1:23 am
I find it hard to believe that anyone with a 6 figure income, regardless of debt, thinks of themselves as poor. my wife and I can live perfectly comfortably on 26,000/year. True, we don’t have kids or credit cards, nor do we owe anything. Only in the USA can someone with that much cash think they are ‘poor’. It’s disgraceful, and embarassing.
Comment by Matt — January 30, 2012 @ 1:54 am