Wednesday, January 25, 2012

The psychology of perceived wealth.

Studies have shown that not every dollar contributes equally to perceived wealth, people’s standing relative to those around them often predicts well-being better than net worth does, and increasing income trends are preferred over decreasing ones. Sussman and Shafir (at Princeton, where Kahneman has carried out his behavioral economics studies) show several factors that can influence the perception of wealth:
We studied the perception of wealth as a function of varying levels of assets and debt. We found that with total wealth held constant, people with positive net worth feel and are seen as wealthier when they have lower debt (despite having fewer assets). In contrast, people with equal but negative net worth feel and are considered wealthier when they have greater assets (despite having larger debt). This pattern persists in the perception of both the self and others.
In their concluding discussion,
…people have a robust preference for higher assets in cases of negative net worth and for lower debt in cases of positive net worth…debt appears relatively salient in contexts of positive wealth, whereas assets loom relatively large in contexts of negative wealth, and this differential salience has a corresponding impact on financial judgments and decisions.

…the present findings show how the appeal of a loan may depend on one’s perceived financial state. For a person who is in the red, a loan may provide an appealing infusion of cash, whereas for a person in the black, it might present an aversive incursion into debt. Conversely, people who are in the black may be tempted to diminish their debt, whereas it may prove unappealing for those in the red to lower their debt at the expense of their assets.

Remarkably, the same striving for financial wealth and stability can trigger opposing behaviors: preference for greater assets in some circumstances, and for lower debt in others. Such impulses may not always be aligned with what is best financially. People who are in the red and eager to borrow will sometimes have access only to high-interest loans. And people who are eager to clear their debt will sometimes do so even when their debt (e.g., tax-incentivized mortgages) is financially beneficial. Such psychology may be of great consequence. A remarkable 25% of U.S. households had zero or negative net worth in 2009 (for Black households, the figure was about 40%. Better insight into the determinants of perceived financial wealth and financial decision making could help shape behaviorally informed policy.

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