Many aspects of your life are affected by how well-off you
feel. Money troubles are a significant
source of stress for people and for relationships. Decisions to make purchases and to donate
money are based on whether you feel like you are doing well. Election results are driven by whether people
feel as though they are doing well financially.
What factors go into making people feel rich?
This question was addressed in a nice paper in the January
2012 issue of Psychological Science by
Abigail Sussman and Eldar Shafir.
They had people evaluate pairs of people to determine which
one they thought felt richer. Some
people had both a high level of assets and a high level of debt. Others had a low level of assets and a low
level of debt.
Of course, the actual wealth of a person is determined by
the difference between assets and debt.
If you have more assets than debt, you have a positive net worth. If you
have more debt than assets, you have a negative
net worth. Because your overall
wealth is determined by the difference between assets and debt, it shouldn’t
really matter whether you reach that difference by having lots of assets and
lots of debt or few assets and little debt.
When the profiles being evaluated had a positive net worth
(more assets than debt), they were evaluated as being wealthier when they had
low debt (and few assets) than when they had high debt (and many assets). In contrast, when the profiles being
evaluated had a negative net worth (more debt than assets), they were evaluated
as being wealthier when they had many assets (and very high debt) than when
they had few assets (and only a moderately high debt).
Why does this matter?
In another set of studies, people were asked to imagine that
they were interested in making a significant purchase, but that they would have
to borrow money to make it. People are
often in that situation when buying cars, furniture, or appliances. They were shown pairs of profiles like the
ones in the study I just described and asked which person would be more likely
to borrow money (assuming that each could borrow at the same interest
rate).
The results were similar to those in the previous
study. When the profiles described
people with a positive net worth (more assets than debt) they were more likely
to borrow money when they currently had low debt than when they currently had
high debt. But, when the profiles
described people with negative net worth (more debt than assets), they were
more likely to borrow money when they currently had high debt (and also had
many assets) than when they had low debt (and also few assets).
That means that financial decisions like the willingness to
make a big purchase or to take on more debt are based on people’s current
feeling of how well off they are. This
feeling ought to be based on net worth (assets minus debt). But it isn’t.
This perception of wealth can be a particular problem for
people who have a negative net worth. If
you currently owe more than you own, then you have a bias to focus on your
assets. That means that the money you
have in the bank and other assets like stocks or home equity may cause you to
spend more and to consider taking on even more loans.
As the financial crisis of 2007 showed us, though, assets can
evaporate quickly sometimes, which can leave people with high levels of debt
and few resources to pay off that debt.
So, when considering whether you should borrow more money, focus on your
overall net worth. In addition, evaluate
how easily your assets could decline in value before saddling yourself with
another loan.
