What Is The Wealth Effect?
Are you in danger of falling prey to The Wealth Effect? Are your investments doing well? Is your house valued higher than when you bought it? Is the housing bubble coming back? In some areas of the US, it does seem to be happening. If so, you need to beware “The Wealth Effect.”
What Is The Wealth Effect?
The wealth effect happens to us when the value of our house goes up. We feel wealthier even though we don’t have more money. We anticipate how much profit we will rake in when we sell our house. So we feel like we can afford a wealthier life style. We treat ourselves to services, we go out to eat more often, we buy a new car, etc.
This is exactly what boosted the economy in the past and some economists long to have it happen again. It drives the economy and makes for more profits when consumers are out spending.
The wealth effect also enters our psyches when our investments are doing well. If you have stocks that are soaring or other investments that are doing very well, you feel rich. You are more likely to spend more in every category. Gifts and vacations get more expensive and even what you spend at the grocery store goes up. You have entered the trap known as lifestyle creep.
It might help the economy, but it does not help the consumer, namely you and me. That extra spending might help the economy, but it does not help the consumer, namely you and me. We have the same amount of money coming in each month, but the amount going out keeps going up. The credit card companies love this because all of this extra spending has to be on credit. We all know how that ends.
To make the situation worse, your real estate taxes could go up when you house is evaluated at a higher level!
What Goes Up Can Go Down
Reality check: profits are not real until you have sold that house or cashed in those investments. Since you still need a place to live, you have to factor in what it will take to pay for your new living space before you can say you have a true profit. How do those profits fit into your long-term goals? Do you need them for your retirement or other goals? Are you going to reinvest them? Those investments are not 100% guaranteed either. It’s probably not time to go on a big spending spree.
What Are Your Options?
If you want real wealth, cash in on that house. Sell when prices are high and move to a less expensive place. Unfortunately that isn’t always possible. So what are your options?
1. Earn more money with a higher paying job.
2. Earn more money by adding a second or third job.
3. Learn to live within your means by keeping to a budget.
Not everyone can carry out the first two options, but everyone can do the last one.
When you retire you can possibly sell that house, collect the profit (if any) and move to a lower cost of living area. If you are able to do that now, it could be a good move.
Until then don’t let the wealth effect sucker you into debt!
Click on any of the tags below this post for ideas on saving money.
maggie says
All you can do is to try to spend wisely within a sensible budget. Avoid debt as much as possible and pay down any debt you have as fast as you can.
sarah mazar says
really absolutely right informstion. You don’t have all that money in your house or your stocks or your car or any of your assets unless it’s liquid.
maggie says
Save, Spend, Splurge, it’s kind of a Catch-22. You feel wealthier, but you don’t have it in hand (liquid). Yet you can’t really keep it in liquid form all the time either. Just remembering that what goes up can go down can put it in perspective. Thanks for sharing your thoughts on this!
save. spend. splurge. says
This is absolutely true. You don’t have all that money in your house or your stocks or your car or any of your assets unless it’s liquid.