We are blessed to live in a country that allows individuals the opportunity to succeed and build wealth based upon their own hard work and disciplined saving habits. By saving and investing money, an individual can become wealthy. In most cases this is unseen by those who live around us. What is seen by most people are the new items purchased by our neighbors or an addition that a friend is putting on to their house, referred to as conspicuous consumption. There is a very pronounced and unfortunate behavioral tendency for those in close proximity to individuals with high conspicuous consumption to increase their own spending (justified or not) in an effort to “keep up with the Joneses”. People like to fit in and, as alluded to in a previous blog, most decisions we make are influenced or directed by emotions. Comparing ourselves to others may not be terribly wrong on the surface as it can provide a nudge to achieve greater things, but if allowed to rule the financial house it can lead to real problems.
The Federal Reserve Bank of Philadelphia published a paper based upon a study where economists observed what impact a lottery winner’s increased wealth and spending had on his or her neighbors. The results were quite clear as the neighbors of the lottery winner felt the need to spend more of their earnings on nicer, more expensive things to keep pace with the actions of the winner. Consequently, debt levels of neighbors increased drastically. The study concluded that for every $1,000 of lottery winnings, bankruptcies of close-proximity neighbors increased 2.4% from a base level of .46 bankruptcies per neighborhood. The households had increased their conspicuous consumption, spending more of their money on visible signs of wealth because they felt they had to do so to fit in. Their egos led them to spend too much for risk of falling behind, therefore putting strain on their financial household.
The irrationality of the behavior in the study is stark. Winning the lottery is not an action that one should reasonably expect to emulate. Therefore, mirroring the actions of someone who won a large lottery prize should not be expected. The desire to “fit in” drove those in the study, ironically, to emulate the actions of the outlier, not the group. With behavior like this, it is not hard to imagine how severe market bubbles (i.e. housing in 2008) come about.
Everyone’s financial situation is unique, and each person defines success differently. It is important in situations such as this to shut out all the social noise and remind yourself that you are trying to achieve your financial goals and that the person down the street may have a whole other agenda but that does not, or should not, influence your financial plan. In every aspect of your financial life, just as with investing, it is vital to stay the course.