Income Effects

Introduction

In a recent Wall Street Journal article, Joe Pinsker examines the effect receiving a raise has on happiness. Behavioral economics has a lot to say on this topic, suggesting the effects of a raise are complex and multifaceted. The topic of the intertwined nature of money and happiness is an extensive one—and one that has spanned multiple disciplines from economics to psychology to sociology. While client happiness may seem beyond the scope of a Financial Professional’s purview, one could argue positively affecting the part of happiness attributable to income and finances has a high return for Financial Professionals (FPs) via: positive Word-of-Mouth (WOM), increased loyalty, more collaborative interactions, more productive communications, and increased risk tolerance (which can give FPs more latitude in facilitating clients’ financial goals).‍

Client Impacts

A change in a client’s income can have far-reaching effects on not only their happiness, but other aspects of their life as well. While increases, decreases, and stagnation in an individual’s income have different effects on a client, we are going to focus on the effects of an increase in client income. While many people would assume that a raise or other form of income growth would have a strictly positive effect on an individual’s happiness, this is not the case. While a client’s happiness may increase, due to something called hedonic adaptation—the finding that individuals quickly become accustomed to the good and bad things in their lives and those things stop having as strong of an impact on happiness over time—the effects are not long-lasting (usually two weeks or less).‍

From a non-psychological perspective, increased income can have the following financial impacts on clients:‍

• ‍Increased Savings: Higher income often allows for more money to be put into savings accounts, emergency funds, or retirement accounts.‍
• Debt Reduction: With additional income, individuals may be able to pay down debts faster, such as credit card balances, student loans, or mortgages, which can reduce interest payments and lead to financial freedom sooner.‍
• Investment Opportunities: Extra income might be directed towards investments in stocks, bonds, real estate, or other vehicles, potentially generating additional wealth over the long term.‍
• Improved Lifestyle: Increased financial means can lead to lifestyle enhancements, such as better housing, travel, education, healthcare, and other quality of life improvements.‍
• Increased Consumption: People may spend more on both necessities and luxuries, leading to a higher standard of living.‍
• Financial Security: More income can provide a greater sense of financial security and peace of mind, knowing that there is additional cushion for unforeseen expenses.‍
• Tax Implications: Higher income could potentially move an individual into a higher tax bracket, which might increase their tax liability. However, it also opens opportunities for strategic tax planning to maximize deductions and credits.‍
• Social Effects: More income can also affect social dynamics, potentially changing relationships and status within social groups.
• ‍Charitable Giving: With more disposable income, individuals might be more inclined to donate to charities, supporting causes they care about and possibly taking advantage of charitable tax deductions.

Many of these effects depend on the client and their financial situation prior to the change in income. So, as an FP what should you recommend if you want to have a lasting impact on a client’s happiness?

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