A good chunk of traditional finance research teaches us how to make money, such as optimal investment strategies. But, there’s very little on how to spend it. Studies show surprisingly little relationship between money and happiness. One interpretation is that things that make you truly happy can’t be bought – but money can allow people to afford healthier food, better medical care, more varied pastimes, better education, and leisure time with friends and family. So an alternative interpretation is that people don’t know how to spend it.
That’s where behavioral economists and psychologists come in. Elizabeth Dunn (UBC), Daniel Gilbert (Harvard) and Timothy Wilson (Virginia)’s excellent Journal of Consumer Psychology article, “If Money Doesn’t Make You Happy, Then You Probably Aren’t Spending It Right” surveys a ton of research and distills it to eight succinct guidelines. I summarize five of them here.
1) Buy More Experiences and Fewer Material Goods.
People who fritter their money away on holidays or expensive dinners are seen as wasteful, as there’s nothing to show for it afterwards. Renovating your house or buying a better car are more prudent. But, it’s actually the former that has the greater effect than happiness. We adapt to things (such as a new conservatory or a flashier car) quickly. But, the memory of an experience (e.g. an African safari) remains with you long after the fact, and the anticipation of the experience also bring utility.
Moreover, “mindfulness” studies systematically find that unhappiness is correlated with mind-wandering. Experiences absorb you and keep you focused on the here and now, but you can be distracted by a dozen things while driving your car.
2) Spend Money on Others Rather Than Yourself.
Scientists believe that one major reason for humans’ large brain size is that we are more social than nearly any other animal. Thus, our happiness depends markedly on the quality of our social relationships. The “prosocial behavior” literature consistently finds that subjects report greater happiness after spending money on others rather than themselves – even though they anticipated that they would be happier doing the latter.
3) Buy Many Small Pleasures Instead Of Few Large Ones.
A variety of frequently small pleasures (in the authors’ words, “double lattes, uptown pedicures, and high thread-count socks”) dominate one big-ticket purchase, such as a front-row concert ticket. This is the well-known economic principle of diminishing marginal utility – a two-week vacation is less enjoyable than two separate one-week vacations. Indeed, studies show that happiness is more associated with the frequency rather than intensity of experiences.
The main reason is the surprise factor of a new experience. Two smaller vacations allow you to explore two different places. Moreover, variety exists even for “everyday” experiences – a beer after work is never the same as the last one, since it will feature different people and different conversations.
4) Buy Less Insurance
This principle doesn’t just apply to literal insurance, e.g. over-priced extensive warranties, but also the “insurance” that comes with a generous return policy. Customers prefer Amazon to eBay and Craigslist, despite it being more expensive, because of the option to return a product they don’t like. But, as Dan Gilbert discussed in his excellent TED talk The Surprising Science of Happiness, whether we like something or not doesn’t just depend on the item’s attributes – we can consciously choose to like it. Indeed, studies show that you like an item more if you don’t have the option to return it.
5) Beware of Comparison Shopping
Websites allow you to compare products on tiny details, which leads to consumers fixating on very small differences and ignoring the similarities on the major characteristics. They can thus miss the forest for the trees and choose the wrong product based on a minor attribute. In addition, doing so wastes substantial time on minutiae, particularly since we typically grow to end up liking the product we buy anyway if its major characteristics are correct (see point 4).