Can money buy happiness?

Can money buy happiness?
Yes, if you re poor.

Money is better than poverty, Woody Allen quipped, if only for financial reasons. If we re starving or homeless, money can bring a better life.

But beyond a certain point ” a surprisingly low point ” more money doesn t deliver more happiness.

A study of tens of thousands of people in 29 countries compared average life satisfaction in each country with average purchasing power (see Figure 9).^[1]It showed that in poor countries, purchasing power and life satisfaction are clearlyrelated. Yet once countries are half as rich as America, there is absolutely no relationship between money and happiness.

Figure 9: Life satisfaction and purchasing power in 29 countries

Looking within individual countries bears this out. Very poor Americans are less happy, but otherwise money does not affect happiness. Being one of the 100 richest Americans adds only a smidgeon to happiness.

Or consider a study of 22 lottery jackpot winners, who showed initial euphoria. It didn t last. Within a year, the winners were no happier than before.

More evidence: real purchasing power in three rich countries doubled between 1950 and 2000, yet happiness levels didn t rise at all. As countries become wealthier, depression soars, with victims also suffering at a much younger age.

The evidence is overwhelming. Being moderately well off means that you are happier than if you were very poor. But once you are well fed, clothed, and housed, getting wealthier probably won t make you happier.

In the nineteenth century, John Stuart Mill gave one excellent reason for this being true ” we don t want to be rich, we just want to be richer than other people. When our living standard improves but everyone else s does too, we don t feel better off. We forget that our cars and houses are better than before, because our friends all drive similar cars and have just as pleasant homes.

Right now, I m living in South Africa. Here, I feel rich. In Europe or America, I don t. My feeling has nothing to do with how well off I am and everything to do with how well off other people are. Living standards are much lower in South Africa, so I feel wealthy.

There s also the pain and hassle of making money. On April 8, 1991, Time magazine s cover story highlighted the price paid for successful careers:

• 61 percent of 500 professionals said that earning a living today requires so much effort that it s difficult to find time to enjoy life.
• 38 percent said that they were cutting back on sleep to earn more money.
• 69 percent said they d like to slow down and live a more relaxed life ; only 19 percent wanted a more exciting, faster paced life.
• 56 percent wanted to find more time for personal interests and hobbies, and 89 percent said it was important to them to spend more time with their families, something that their careers made difficult.

How are we doing now? Have many of us fled the rat race? Nah. We re still chasing more money for more time. The average working American now works 2,000 hours a year. That s two weeks more than in 1980! And the average middle-income couple with children now work 3,918 hours between them ” seven weeks more than just 10 years ago.

More money can be a trap, leading to more spending, more commitments, more worry, more complexity, more time on administering money, more desires, more time at work, less choice about how we spend our time, and degradation of our independence and life energy. Our lifestyle locks us into our workstyle.

How many houses or cars do we need to compensate for heart attacks or depression?

^[1]See Martin E P Seligman (2003) Authentic Happiness: Using the New Positive Psychology to Realize Your Potential for Deep Fulfillment, London: Nicholas Brealey.

http://flylib.com/books/en/1.522.1.36/1/

Fatal downside and Wealth effect

Although the overall expected value of dice game version A is positive, there is one situation in which you should not play it - when the potential downside would be fatal or disastrous for you.

http://spreadsheets.google.com/pub?key=te9MzyHoIN6EyuoHmfDxMaw&output=html

If you had just $1 in your pocket, played the game once, and failed to throw a six, you would be bankrupt.  The positive expected value of the game would be no help to you, since you would be unable to play any more - a fatal downside would have occurred.  In other  words, it is not enough just o look at the expected value of a decision.  The probability of a fatal or disastrous worst-case scenario has to be considered too. 

The presence of a fatal downside might temper your enthusiasm for a decision with a positive expected value, perhaps encouraging some kind of trade-off between expected value and the potential for exposure to a fatal downside.  You might be better finding another dice game perhaps a version that cost 10 cents to play, with a prize of 50 cents.  This would have the advantage of allowing you to stop playing before you went bankrupt, should you hit a bad losing streak.

By doing this, you would be spreading the risk around rather than going for an 'all or nothing' risk- trading off a better risk profile for a lower expected value.  (This approach to managing risk is known as 'diversifying'.)

In business terms, this translates into considering whether the downside of a risk, if it occurred, would result in bankruptcy or any situation from which the business could not recover.  The possibility of this, however remote, would have to be taken into account when contemplating a risk with positive expected value.

The fact that fatal downsides in investment loom much larger for smaller companies results in the 'wealth effect' - the relative ease with which larger companies can accumulate wealth.  They can take investment risk with positive expected values but serious potential downsides, because the fear of bankruptcy is more distant for them.  And the more positive-value decisions they take, the more money they accumulate and the more risks they can tolerate in their investments.  They can also afford to take more risks when considering and trying out new directions.  Individuals can also exhibit the wealth effect:  people with more cash saved up can afford to take bigger risks with their careers, perhaps allowing them to achieve greater successes.

It is the nature of know risk probabilities that the longer the run of risk taking, the closer one gets to the delivery of expected values.  This is how gambling becomes a science - with deep enough pockets (the wealth effect) and enough time, pay-offs come to reflect odds.  It is in the short run that 'luck' brings fortune or disaster.

It's All in Our Heads - the Negative Wealth Effect

DECEMBER 2, 2008, 12:01 P.M. ET
Essay
It's All in Our Heads
We spend how we feel -- even when our reality hasn't changed much at all

By DAVE KANSAS
My workaday financial life hasn't changed much in the past year. So why am I acting as if it has?
I don't splurge on expensive dinners anymore, and I walk rather than drive places. I compare grocery prices for the first time in years.
In fact, as I look around, I find my friends and I are making all kinds of thrifty decisions that would never have crossed our minds just a few months ago. And it's a stark reminder that the way we think about money can often be detached from our immediate, personal situation.
It doesn't make any difference that most of us continue to hold down the same jobs we had before unemployment rates started to rise. It doesn't matter that our personal circumstances are the same as they've been for the past few years. What matters, instead, is the vague uncertainty that has descended on us. What matters is our unknown future.
So even if our own lives have changed little, we cite a friend's lost job as a reason to worry afresh about our own financial situation. We forget -- or ignore -- that our friends also lost jobs during periods of robust economic health. But our fiscal lens shifts when we see dark headlines barking about dire problems at General Motors or the government coughing up hundreds of billions to try to save former titans like AIG.

Reversing the Wealth Effect

All of this, of course, is well known to economists. They call it the wealth effect, and it maintains that when people feel wealthier, because of rising home values or a climbing stock market, they tend to spend more freely. Many people don't extract money from their home or their investment accounts during such periods, but the simple sense of having more money opens up the wallet. More trips are taken, more meals are eaten at nice restaurants. The economy has benefited greatly from this wealth effect in recent years.
Until now, though, many of us have never lived through the wealth effect's evil cousin: the negative wealth effect that is roiling the economy as the consumer retrenches. Everything -- homes, portfolios, blue-chip companies, the local bank -- seems to be losing value. We still aren't extracting money from our homes or our investment accounts. But the simple sense of having less money closes the wallet. And the future -- always unknown -- seems a whole lot scarier.

That fear has certainly permeated my life. It first hit me this summer when shopping for produce at the grocery store. Though I had once worked as a dairy manager at a grocery store, I had seldom checked prices on everyday items. I just kind of assumed that prices were what they were and you got what you got.
Strolling through the produce department, I found myself comparing prices of fresh cherries, and deciding they were too expensive to buy. I also realized that I had stopped buying nice bottles of wine for dinner; it seemed silly to spend that much money when a cheaper wine would be just fine.
This same scenario played out in countless other small ways -- in what I no longer did or bought.
Home for the Holidays
Many other people I know, regardless of financial circumstance, are going through a similar process. My family in Minnesota has a big Thanksgiving event every two years. In the past, people have come from all over the U.S. and from Europe. We once had to use the kitchen of a local school to include everyone. This year, the confab had fewer attendees. Despite everyone doing well, and in some cases actually doing far better financially than in the past, they balked at the high cost of air travel.
My friends are also finding their spending and saving psychology changing. Most of them still have the same jobs and same basic costs as before, but their mind-set has changed. A friend of mine in finance talked about how he and his office have set up sandwich-making contests for lunch. They order in the basics from a supermarket and have at them. In better times, he'd talk about treating colleagues to lunch at a nice restaurant. He also recently said he's thinking about leaving New York. He figures taxes are headed sharply higher and the financial crisis will bite hard. And thinking about raising his family in New York causes too much economic "brain damage," he says.
A friend who works on a sports Web site in New York, recently married, has started questioning whether to close on a recently purchased apartment. Even though she and her husband have good jobs and can't get the deposit back, she's wondering if putting so much of her family money into real estate is the right move in the current climate. A colleague of mine at work is going through the identical math in almost the identical situation.
Everyone seems to have caught the same bug, with minds switching off the spend gene almost in unison. Walking past a posh French restaurant (prix fixe lunch: $45) near a fund manager friend's office, I asked if he'd ever gone there for lunch. He hadn't and added that it seemed like a "pre-crisis" kind of place.

Thrift and Fear

Thrift, of course, can be a good notion. Americans have for some time spent more than they've made, leading to the first so-called negative savings rates since the 1930s. This overspending, largely driven by borrowed money, occurred in the corporate and financial sector as well. It got us into the mess we're in.
Now, as individuals rediscover thrift, companies are going through their own process of "deleveraging," or reducing their credit-bingeing ways. And this is what has sent the economy into its downward spiral.
Upon taking office in 1933, Franklin Roosevelt declared that "the only thing we have to fear is fear itself." He was talking directly to people's psychology about money. If everyone put their money under a mattress and banks feared to lend, growth would not return.
It's hard to envision things getting to that level today, but fear, once it takes hold, can be difficult to turn around. And there's little question that fear about the future is having a negative impact on our financial psychology.
How to reverse things? For me, an increase in my savings will give me more confidence and less fear (although it certainly isn't going to do much to help the economy in the short run). I suspect that's true for a great many other people as well. The headlines will also play a role. Until the news moves from "crisis" to "confidence," it's hard to erase fear and concern about what's around the next bend.
Ultimately, things will get better, as they always have. Then we will once again be optimists and less afraid of risks. Until then, though, I think I'll just pass on the cherries.—Mr. Kansas is the president of FiLife.com, a personal-finance Web site owned by Dow Jones & Co. and IAC Corp.
Write to Dave Kansas at dave.kansas@wsj.com

http://online.wsj.com/article/SB122765006147657695.html