Keeping up with Joneses

Keeping up with Joneses

Morning folks, 

In 2018, researchers from the University of Alberta and Georgetown University found that people whose neighbors won the lottery were more likely to end up bankrupt.

The researchers studied 7,337 lottery winners and bankruptcy filers in an unnamed Canadian province from 2004 to 2014. They focused specifically on winnings lower than C$150,000 and on winners who had remained in their neighborhood. 

Their findings showed that the larger the winnings of an individual the more subsequent bankruptcies there would be amongst those in that neighborhood. This was caused by individuals taking out unserviceable debt and making large conspicuous purchases — particularly on items visible to their wealthy neighbors, like cars. There was not, the study found, similar purchases of non-visible items like furniture. They also took riskier financial decisions, like keeping 100% of their money in stocks. 

The results were not surprising. For many decades economists have noted that people tend to increase their consumption in line with those around them. This is known as “Keeping up with the Joneses” — a reference to a comic strip of the same name that first appeared in 1913 and ran until the 1940s. In it, the social-climbing McGinnis family struggles to “keep up” with their neighbors, the wealthier Joneses, who are regularly mentioned but never seen. 

According to Joachim Klement, CFA and trustee of the CFA Institute Research Foundation, “about one-third of households evaluate how well they’re doing by using their neighbors as the benchmark, with work colleagues and family members being the next most common metrics”.

Let’s look at this through two lenses. The first is that of household income and budgeting. Living within one's means is crucial to financial freedom later in life. Without savings, you can’t be secure financially. Yet many people chose to live a luxurious lifestyle funded by debt in the belief that they will be able to pay it back at some point in the future — possibly due to a promotion that may never come, or an expected windfall that may never materialize.

Turning to the financial book de jour, ‘The Psychology of Money’, Morgan Housel makes some excellent points regarding the difference between being rich and being wealthy. 

“Someone driving a $100,000 car might be wealthy. But the only data point you have about their wealth is that they have $100,000 less than they did before they bought the car (or $100,000 more in debt). That’s all you know about them [...] Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes forgone and the first-class upgrade declined. Wealth is financial assets that haven’t yet been converted into the stuff you see.”

Treating everything like an investment is a good way to avoid this trap. Next time you’re tempted to make a large purchase, ask yourself, what else could I be doing with this money? What dividends is this flat-screen television going to pay me? What sort of return should I expect from this new BMW? 

That’s not to say one should cease consuming goods. It’s important to have forms of entertainment for your downtime, and depending on where you live, important to have a reliable form of transportation. These too are investments. Buying the cheapest used car is a false economy because you will likely have to spend a fortune on repairs. However, buying something expensive because you want to impress people is robbing yourself of future financial stability. That $10,000 you save, for example, by buying a more affordable car, could end up compounding multiple times over by the time you retire — long after you’ve sold the more expensive car for a fraction of the original price. 

Now let’s look at things from an investing perspective.

One of the key elements of successful investing is having a plan and sticking to it. When you're younger, with many years of earning ahead of you, you can be slightly more casual with this. You can afford to invest in riskier assets and modify your investing behavior as you learn more and gain more experience. However, as you get older, you need to have a plan in place for how you are going to achieve your goals.

‘Keeping up with the Joneses” can have a devastating impact on this. You see other investors making greater returns than you, and you start deviating from your plan. You take your well-diversified portfolio, designed for your own risk tolerance, and start loading it up on riskier and riskier investments. Perhaps you go fully into technology stocks or start investing in small-cap biopharmaceuticals without any expertise in that field.

Worse still, you start chasing stocks or other financial assets that have seen outsized returns. These FOMO (Fear Of Missing Out) investments are a dangerous trap for investors. A close friend of mine, with no investing experience, once declared to me that he was going to buy Bitcoin. I asked him what he knew about it that made him think it was a good investment. He couldn’t answer. I suggested he read a widely circulated white paper that explained Bitcoin and the underlying blockchain technology. This wasn’t an attempt to dissuade him, I just wanted to make sure he knew what he was investing in before he put serious money at risk. Long story short, he never got around to reading the white paper and didn’t invest. This was in December 2017, when Bitcoin was at $19,000 per coin. A year later, it was at $3,000.

Investing is an individual pursuit (though it can be much improved by participating in a community of like-minded investors). However, in the end, no one will ever look after your money better than you. Live within your means, save regularly, and invest according to your goals and risk tolerance. These are the keys to building wealth. Don’t worry about what the guy next door is doing.


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