How Perceived Wealth Triggers Spending Habits

You're in the elevator lobby of your 14th-floor apartment, scrolling through e-commerce deals, though you have no intention of buying. A neighbor enters, mentions the price at which an apartment in the building recently sold, and you're surprised to learn it's significantly higher than what you paid seven years ago. Upon entering your apartment, you unlock your phone again to find a discount on your 18-month-old phone model. Without much thought, you click 'Buy Now'.

- Anoop Vijaykumar

What's at play here is the "wealth effect," where an increase in perceived wealth—whether from rising home values or a surging stock portfolio—encourages more spending, even when actual income remains unchanged. First explored in 2001 by Karl Case, John Quigley, and Robert Shiller, the wealth effect was revisited in 2013, showing housing wealth significantly influences household consumption. A Visa study in the US found for every dollar rise in household wealth, spending rose $0.34—$0.24 from securities and $0.20 from housing. The reverse is also true: a decline in perceived wealth often leads to more cautious spending.

The mental trap: The wealth effect isn't based on actual cash but a psychological shift, much like the feeling of walking on a thick carpet. It creates a cushion of comfort encouraging spending, even if that cushion is illusory. Human psychology plays a key role. We prioritize short-term changes over long-term planning and fall into mental traps like "mental accounting," where we treat money differently based on its source. For example, people tend to spend tax refunds more freely than salary income.