Why money can't buy happiness -or- the law of wealth's diminishing returns

by | Nov 21, 2007 08:04 AM ET

I had dinner with an old friend recently. It was a nice dinner, but it became obvious that my friend is not happy. Which is strange because my friend is rich. He has the house, the cars, the jet, the trips - he can do anything he wants, yet he is not happy. We talked about this a good bit. Everything in our culture seems to say that money means happiness, yet it clearly is not working out in my friend's case. I know a number of wealthy people, and as I thought about it more, I noticed that this is a trend.

In other words: if money can buy happiness, then rich people should be ecstatic. Yet they are not, at least in my experience. Either they are about as happy as the average person, or as with my friend at dinner, they are not happy at all.

Why does this happen? Why doesn't money buy happiness, even though our "culture" tells us constantly that it will?

As I thought about this more and more, I came up with the following idea. I call it The Law of Wealth's Diminishing Returns. To understand this law, let me give you an example.

Imagine that you are recently graduated from high school or college. You are in your first job so you are making basically zero money and (if you were in college) you have a ton of debt because of your college loans. Therefore you don't have a washer or a dryer, and you have to use the Laundromat. Let us further imagine that you are married, and you have a couple of kids, and you are using the Laundromat. Anyone who has been in this situation knows that it is no fun. You are schlepping all the laundry down to the Laundromat - including sheets, towels, stuff covered in poop because one of the kids has diarrhea this week, etc. You are sitting in the Laundromat while the clothes wash and dry because who knows - someone might steal your stuff. And you are trying to keep track of the kids, who really don't want to be trapped in the Laundromat for an hour and a half. Sometimes you get there and all the machines are full. Sometimes you go and it is raining or snowing. You know the drill. Laundromats tend to be no fun.

So you and your spouse finally scrape together $500, and you buy the cheapest washer/dryer set you can find on sale. Your beautiful new washer and dryer are now in your house, and they are installed and working, and you do your first load of laundry in them...

You know what? You are ecstatic! Your new washer and dryer are so amazingly great compared to going to the Laundromat that you can't believe it. It is incredibly freeing. It is wonderful! And this is a form of ecstasy that lasts. Even a year later you might be throwing a load on poopy kids underpants in the washer, and you think back to how it would have been at the Laundromat, and you smile at how nice it is to have your own washer and dryer. You are happy, and you are grateful.

What I would like you to notice here is the basic ratio between money and happiness. You spent only $500, and you purchased something that made you ecstatic. This new washer/dryer set is a miracle. It makes your life significantly better.

Fifteen years go by. Now you and your spouse are in a significantly better financial position. It is time to replace the old washer and dryer, so you go to the store and you pick out the latest and greatest front loading super washer and wonder dryer. The pair costs $3,000. They install it and the next day you use it and you are... well, it's nice. The dryer is a little bit quieter than the old dryer. And because of the super eco-features, you save a quarter on electricity every time you use the washer with hot water. A week later you really could care less.

Do you see what happened here? When you spent $500 for the first washer and dryer, you were ecstatic. That $500 investment made a huge difference in your life. But when you spent $3,000 for the replacement washer/dryer - six times more money - it really didn't have much of an impact at all. Spending more money didn't really make you any happier. In this case, you spent six times more money for pretty much nothing.

The thing is, this happens throughout our lives. Think back to getting your first car. My first car was a used Chevy Vega. I was ECSTATIC to have my own wheels. The car might have cost $2,000 in today's dollars, it was used, and it was ugly. But what that car meant was freedom. I drove that car about a hundred thousand miles. It was an amazing car, to me. The $2,000 invested in the car paid gigantic dividends in terms of happiness.

Will any car I ever buy bring more happiness than that $2,000 car? Probably not. I could spend $80,000 for the new Viper, and... it would be nice. I would enjoy driving it. But I am spending 40 times more money. The first car, for $2,000, brought ecstasy. The Viper, for 40 times more money, is nice. Now imagine a rich person who pays $1 million or more for a Veyron. It is a little faster than the Viper, but not much. And really, when are you ever going to go more than 90 MPH in either car, even if they can both go 200 MPH? Spending 12 times more than the Viper on the Veyron might not increase happiness at all.

Think about housing. If you are homeless and sleeping on the street, it is not optimal. Compared to being homeless, a $300 apartment is ten thousand times better. Now you buy a small house, and the mortgage payment is $900 a month. Having a nice house is, let's say, five times better than living in a $300 apartment. Twenty years later you buy a really nice house and the mortgage payment is $4,500. This house might be twice as good, in terms of happiness, as the $900 house. Now you become rich. You buy a 25,000 square foot mega-house and the mortgage payment is $100,000 a month. In practical terms, is the $100,000/month house really any better? The difference between homeless and a $300 apartment is gigantic. But the difference between a 4,000 square foot house and a 20,000 square foot house is marginal at best. In fact, for some people, a 20,000 square foot house might actually bring a bit of sadness, because at some level it is ridiculous.

You can see what is happening here. Wealth brings diminishing returns in terms of happiness. If you spend 10 times more for something - say $1 million for a Veyron vs. $80,000 for a Viper - it might not buy you any more happiness at all. And then what? You buy two Veyrons? Ten? That doesn't get you anywhere at all, because it enters the realm of ridiculous.

The funny thing is, once this equation is understood, there is a tendency to stop buying extravagant things and to live more modestly. People look for happiness not in material objects, but in other ways. It changes the perspective. For many people this seems very, very weird, because our entire "culture" tells us the opposite. But in this case, as you can see from the examples above, the "culture" may be wrong. Money cannot buy happiness because of wealth's diminishing returns.

Don't believe me? It does happen. The book entitled "The Millionaire Next Door" is about people like this. Warren Buffett (one of the richest people in the world) is described like this: "Famed for his integrity and modest lifestyle, Mr Buffett paid himself $100,000 (£62,000) in salary and a further $300,000 in bonuses last year. He still lives in the grey stucco house he bought in 1956 for $31,500." [ref]

Unfortunately, for some rich people it goes the other way. It is a strange and perverse process. Unable to buy happiness, and with a lot of money lying around, it becomes pleasurable to make other people miserable. This is the Ebenezer Scrooge model, often taken to bizarre extremes by large corporations. It is an unfortunate but not uncommon side effect of wealth, and the cause may be a misunderstanding of the law of wealth's diminishing returns.

How might you apply the principle of diminishing returns to your own life? One way is to break the cultural association between "things" and "happiness" in your own mind. It is not so easy to do this because every TV show, magazine, ad, etc. tries to convince you of the opposite, but it can be done. Another way is to spend time thinking about happiness. Research it. Read about it. Think introspectively about your own well being and what it is that brings happiness for you. You might be surprised at what you learn.

Since tomorrow is Thanksgiving, here is another thing to consider. Take stock and realize all the things you have to be thankful for. Be thankful for the little things and the big. Personally, I am thankful for Leigh and our four kids. I am thankful that I am able to write this article today, and everything that it implies in terms of employment, freedom, health, technology, etc. I am thankful for the washer and dryer for sure, along with the water and electricity to run them. If I didn't have the washer I'd thankful for the Laundromat - it sure beats washing things in the river.

Happy Thanksgiving.

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