Keeping Up With the Joneses

May 02, 2016

People like to fit in; it’s one of the simplest laws of human nature. Although we value the things that make us unique, most of us are careful to not let them make us social outsiders. There is strength in numbers, and conformity reassures us that we are making the right decisions.

Unfortunately, comparing ourselves to others can lead to real problems. Our egos can become sensitive – even irrational – when trying to protect the public image of our wealth and status. If left unchecked, the fear of falling behind our peers can destroy our financial security.

Meet the Neighbors

In a paper published by the Federal Reserve Bank of Philadelphia, economists tested and analyzed the social behavior of “keeping up with the Joneses” and the impact it could have on personal finances.

In their study, economists used six-digit postal codes to divide Canadian cities into micro-neighborhoods (13 households on average). They then observed financial changes in the neighborhoods after one of the households had won a lottery prize.

Whereas many researchers have documented the Sudden Wealth Syndrome of lottery winners (many of whom end up in financial ruin), this study instead focused on the winners’ closest neighbors. The researchers wanted to know how people responded when someone else suddenly had more money to spend.

The results were clear: for every 1,000 Canadian dollar increase in the size of the lottery prize, the number of bankruptcy filings among close neighbors increased 2.4 percent in the three years following the lottery win (the base rate was .46 bankruptcies per neighborhood). This effect was greater in low-income neighborhoods where prize values were higher relative to average incomes.

What happened?  When the asset sheets of the bankrupt neighbors were reviewed, researchers found that the houses had increased their “conspicuous consumption,” spending more of their money on visible signs of wealth (Rather than investments that go unseen). Accordingly, the ratio of visible to invisible assets rose with the size of the lottery winnings, suggesting that individuals were willing to spend more when their “Joneses” had won more.

Irrational Groupthink

While the study may simply confirm what many might have suspected, the irrationality of the situation is striking. Winning a lottery is not a reward or promotion – it says nothing about a person’s value or rank. Why would neighbors, who know the wealth was won by luck, compare themselves to a situation they can’t possibly copy? Furthermore, why try to emulate the neighborhood’s one winner, when “fitting in” should mean behaving like all the other non-winning households?

The problem is that wealth and status are relative to each person. Everyone has his or her own “Joneses.” When one house receives a windfall of cash and begins spending, it can set off a chain reaction. Our egos would rather let us spend too much than risk falling behind.

This arms race mentality is why the housing bubble of the last decade became so severe. It wasn’t just the opportunity to make money off real estate; it was the visibility of the changing wealth. Every day, people watched their neighbors buy and improve properties, knowing that they would have to do the same just to maintain the status quo.

Forgetting About the Joneses

A little social pressure isn’t necessarily a bad thing. It often provides a nudge towards positive action and helps us make good choices. But when it comes to money habits, trying to match (or exceed) those around you can lead to serious problems. Everyone’s financial situation is unique, and each person defines success differently. As difficult as it is, you need to shut out the social noise and ignore what others do with their money. After all, you’re trying to accomplish your financial goals – not theirs.

If we at Kemp Harvest Financial Group can help you in any way, please feel free to contact us.

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