Is more money what you need to change your life or add value to your lifestyle? Will an increase in your net worth have a big impact on your life-or not? Are you willing to take risks to improve your financial picture? Or is it most important for you to minimize the risk of losing the money that is critical to your lifestyle? More than just dollars and cents, what your net worth means to you is really important.
The new field of behavioral economics sheds some interesting light on this question. Each dollar we earn over the threshold necessary for survival has less “marginal utility” to us than the previous one, because the first dollar satisfied our needs to some degree, and future dollars are used to satisfy less and less important desires. Economists call this “the law of diminishing returns”.
Since each additional dollar is worth less and less to us, we are more concerned with losing a dollar than gaining one. If we lose money that was intended to satisfy greater desires, we feel worse than if we don’t gain money that would be used to satisfy lesser ones. This is called “asymmetric loss aversion”, a fancy name which simply means that losing hurts more than winning feels good.
For example, if you had a million dollars in your investment account, you’d feel pretty good. Where do you go from there? It would be great to add another $500,000 to your wealth. But the idea of losing $500,000 of your stash is painful, much greater than the pleasure you might feel from adding more.
This idea becomes even more important when it comes to income. If you live an upper middle class lifestyle (no private jets or villa in the South of France, but you take nice vacations and you don’t worry about prices at the mall), a big raise may not appreciably add value to your life. Drop your salary by half, though, and you will definitely feel it.
Think about this as you clarify what money can and cannot do for you. Will additional money add very much to your lifestyle? Or can you add more enjoyment to your life by better managing what you have? What risks are you willing to take to earn more? Or are you leaning more toward playing it safe?
Don’t take risks with your survival money-the anticipation of great reward will not outweigh the risk of a possible downside. As humans, our bias from years of evolution is to be conservative. What strategy will suit you best at this time of your life? You decide.