Does Cash Make You Happier Than Income or Paying Down Debt?

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happyfaceThe growing appreciation of behavioral psychology in investing is basically us admitting that we aren’t perfectly rational. When you make people automatically opt-in to 401(k) plans and make their contributions increase automatically, they save more. We value stocks more simply because we own them (“endowment effect”). We hate losing money more than we enjoy winning (“loss aversion”).

A recent research paper tells us (in my own words) that having liquid cash has a stronger correlation effect to happiness than having a bigger retirement portfolio, a higher income, or paying down your debt. This is coming from the NYT article Yes, Numbers Matter in Money Decisions, but So Do Emotions linking to the Kitces post Buying Happiness And Life Satisfaction With Greater Cash-On-Hand Reserves linking to academic paper How Your Bank Balance Buys Happiness: The Importance of “Cash on Hand” to Life Satisfaction. Here’s the abstract:

Our results suggest that having a buffer of money available in checking and savings accounts confers a sense of financial security, which in turn is associated with greater life satisfaction. The strength of this association was comparable to the effect of investments—which may themselves be liquid assets (e.g., money market accounts)—and slightly greater than the effect of debt status. By contrast, higher income and spending—the amounts going into or out of a person’s bank account—were not associated with increased financial well-being after liquid wealth was included in the model. This finding suggests that people with low liquid account balances may feel more economically distressed—and thus less satisfied with their lives—than their peers with higher balances, even if their incomes and spending, considered separately from their account balances, would predict high financial security.

Michael Kitces took the numbers from the paper and created this useful graphic:


I dug up some more specific numbers from the paper:

To put our results into context, we found that going from having £1 to having £1,000 (a 3-log increase) in one’s bank accounts each month—not rags-to-riches, but merely rags-to-sufficiency—is associated with an average gain of 2 points (10% of a 20-point scale) in life satisfaction by virtue of feeling more secure about one’s finances. However, because liquid wealth was log transformed, further increasing liquid assets from £1,000 to £10,000 (a 1-log increase) was associated with an expected increase of just 0.7 further points on the same scale.

There are diminishing returns with accumulating cash reserves past a certain size. Going from $1 to ~$1,500 in your bank account improves your life satisfaction more than twice as much as going from ~$1,500 to ~$15,000.

This is similar to the findings that happiness increases with higher income until $60,000 to $75,000 per year. Above that level, happiness still increases but at a much lower rate.

On a certain level, this is common sense. Having a hunk of cash available for emergencies should make you feel more secure. However, in purely mathematical terms you should feel the same if you put $1,500 into your retirement account or if you paid down $1,500 of debt. Money is fungible. But your mind doesn’t necessarily agree, and perhaps it is better to work within that bias rather than fight it.

Bottom line. It may not be rational, but putting money towards a modest cash cushion can make you happier than putting every last penny towards paying down debt or your 401(k) retirement account. After a certain point this “cash is king” effect diminishes. (I might carve out an exception for 401(k) matches that effectively double your money at no risk.)

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  1. I often wonder about the adjustment to that $75k level of happiness from region to region. Anecdotally, my increase in happiness when I went from $60k to 75K was outmatched by my happiness when I went from $75k-86K, and my life satisfaction has never been higher than when my salary went above $90k. But living in the Bay Area (HCOL) plus the added responsibilities of supporting a parent might make me an outlier.

    And cash in hand / liquid assets definitely makes me feel more secure despite knowing that I should be investing more of it. I prefer an abnormally high amount ($200k) as a reaction to being unemployed during the recession, that served us well when we had to suddenly buy a home this year. Of course that just reinforced my gut instinct to have lots of cash in hand! Though I do promise to reform a lot … 🙂

  2. I enjoyed this post and articles about the emotion/behavioral side of personal finance although I think it’s better to try and defeat irrationality than to just roll with it. I’m a little surprised that having zero debt doesn’t equate with more happiness as I’ve found that having debt is no fun at all.

  3. Like everything else, this varies by person to person.
    Living in Florida & making 45k a year in 2010 and making 6 figures now
    didn’t necessarily increase my happiness by 2x times.

    Quantifying feelings is an exercise in futility according to me though as a species we are very analytical & prone to doing these things haha

  4. Jonathan,

    Interesting data showing the correlation. Funny aside; I find that having about $200 USD in my wallet makes me feel better than the several credit cards with $50k limits. I would definitely miss the cards, but that couple of Benjamins tucked into a zipper pocket makes me feel good!


    The Wease

  5. Well said cash is king. Cash is the reason of happiness or sorrow in today;s world. If start investing wisely at the early stage of life it will be treasure of happiness for entire life.

  6. There certainly is a “security blanket” aspect to cash. It allows me peace of mind to know that we can cover upcoming or surprise expenses. I do, however, try to limit the cash savings to an emergency fund and or various “specific goal” funds (“new roof fund” or “vacation fund”). Beyond that, the magic of compounding interest is too enticing for me 🙂

  7. Huh. I guess this makes sense; I just never thought about it too much. For me, I got A LOT happier once I saw my debt balances go down. But a decent cash reserve has also saved my butt too many times to count, so I can see how having cash on hand is better than other wealth-building strategies. Ideally you need to incorporate all of them.

  8. I have the same thoughts -> when I have at least 10k in cash, I’m feeling great. When I’m at 5k in cash, I’m feeling a little more stressed.

  9. I definitely feel more secure having a greater cash balance. I used to throw all of my extra cash at my student loans but now that they are gone, I would rather pad the cash reserves than invest in my brokerage account. Thanks for pointing me to the NYT article.

  10. Interesting article and true. Cash reserves equate to peace of mind which in turn equals happiness. I guess it’s safe to say that the bigger your reserves the happier a person is. It’s really more of a peace of mind thing for me although I still invest my cash reserves to a liquid low-risk investment. I’d say increase your cash reserves and lowering your debt should go hand in hand.

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