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Bad Influence

Jonathan Clements  |  November 21, 2020

KEEP AN EYE on the neighbors. They could be the reason you’re poor and unhappy.

We all like to think we’re independent thinkers who weigh the evidence and reach our own conclusions—and yet there’s ample evidence that our views are heavily influenced by those around us, whether we’re choosing presidential candidates, bottled water or mayonnaise. This extends to financial matters, sometimes with grim consequences.

Stocking up. Studies have found that those who live near one another tend to invest in a similar fashion. For instance, a 2019 study of households in Finland discovered that nearby investors tend to buy the same stocks at the same time. An earlier study documented a similar pattern in the U.S. It’s also been found that family members influence each other’s investing, with a family member more likely to start investing if a parent or child also started within the past five years.

Is this word-of-mouth investing a bad thing? It depends who’s influencing you. If your neighbor is a fan of total market index funds, he or she may steer you onto the right path—and thereafter the two of you may encourage each other to stay the course.

But if your neighbor is always talking about whatever’s currently hot—bitcoin, Zoom, Tesla, you name it—there’s a risk you’ll find yourself dabbling in the same pricey merchandise, possibly to your regret. What to do? Whenever folks boast to me about their latest speculative bet or proffer some prediction about the market’s direction, I smile noncommittally and say as little as possible, in part because I don’t want their views to poison my portfolio.

Spending wildly. We’ve long known that folks often try to “keep up with the Joneses,” spending money to mimic their neighbors’ lavish lifestyle and to signal their own financial success. This is a dangerous game. We can end up spending heavily on items we don’t really care about, while also failing to save enough for retirement and other important goals.

But it turns out this game is even more dangerous than I imagined. A 2018 study from the Federal Reserve Bank of Philadelphia looked at the influence of Canadian lottery ticket winners on their neighbors. The study’s finding: “[T]he larger the dollar magnitude of a lottery prize of one individual in a very small neighborhood, the more subsequent bankruptcies there will be from other individuals in that neighborhood.”

It seems that, in an effort to keep up with the local high-spending lottery ticket winner, the neighbors engaged in their own conspicuous consumption. That often required borrowing money, resulting in bankruptcy for some. These bankrupt neighbors also started taking more risk with their investment portfolio, presumably as another way to finance their increased spending.

A similar phenomenon was found among the neighbors of recent Dutch lottery ticket winners. The neighbors were far more likely to purchase a new car in the months afterward. Why a car? It seems it’s all about the enduring signal that the new vehicle sends to others in the neighborhood. As the authors note, “Unlike an expensive party or vacation, a household’s neighbors are continuously reminded of [the family’s] new car.”

To fend off such foolishness, perhaps our best bet is to remember the lesson of The Millionaire Next Door: The wealthiest family in the neighborhood is often the family that you don’t realize is rich—because they aren’t wasting their money on new cars, expensive landscaping and designer clothes.

Eyeing unhappily. Since the early 1970s, inflation-adjusted per-capita disposable income has ballooned 135% in the U.S., and yet our reported level of happiness has barely budged. All this money, it seems, hasn’t bought happiness. Why not? We apparently care less about our absolute standard of living and more about how our income compares to others.

What if we have high income-earners as our neighbors? That makes things even worse. “I find that, controlling for an individual’s own income, higher earnings of neighbors are associated with lower levels of self-reported happiness,” writes economics professor Erzo Luttmer in a 2005 study that’s aptly titled “Neighbors as Negatives.”

This is a reason to avoid situations where you’re reminded that others are far better off. Maybe you shouldn’t seek out wealthy friends. Maybe you shouldn’t visit vacation resorts you can barely afford or buy a house in a town where most of your neighbors will be richer. In fact, I’m a fan of the opposite strategy—living where you can have the quiet confidence of the millionaire next door.

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HERE ARE THE SIX other articles published by HumbleDollar this week:

  • “As I read up on the cost of college, it hit me that I needed to change my thinking and fast,” recalls Andrew Forsythe. “The guy who would pay hundreds for a Hickey Freeman suit started clipping grocery store coupons.”
  • Don’t put off your retirement wish list until you fully retire, advises Dennis Friedman—or you may never get the chance to do the things you dreamed of.
  • “There are many roads to Rome,” writes Adam Grossman. “You shouldn’t worry if you want to use some of your funds in ways that others might deem emotional, idiosyncratic or inconsistent.”
  • Why do so many investors abandon stocks during market declines? It isn’t a lack of knowledge, says Joe Kesler, but rather “failing to accept in advance the psychological cost of being a buy-and-hold investor.”
  • Want to make sure you’re prepared for retirement—and make the most of it once you quit the workforce? Dick Quinn offers 10 pointers inspired by 10 U.S. and U.K. television shows.
  • Funds that use environmental, social and governance criteria are booming, notes Rick Connor. But what do you get when you buy these funds—and will they be a good investment?

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Never AssumeFuture Shock and Scary Stuff.

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