Yesterday, as I was sifting through my bookmarks for future Simple Dollar articles, I came across this wonderful article by David Short:
In the article, Short outlines the magic number:
One of my favorite discussions on APViewpoint, which addressed “The Sad State of Happiness,” included an indirect reference to a popular 2010 academic study by psychologist Daniel Kahneman and economist Angus Deaton. Their topic was the correlation between annual household income and day-to-day contentment. They analyzed more than 450,000 total responses to a Gallup weekly survey of households across the 50 states and DC. The survey was conducted in 2009.
A report in the WSJ summarized their findings:
“It turns out there is a specific dollar number, or income plateau, after which more money has no measurable effect on day-to-day contentment.
The magic income: $75,000 a year. As people earn more money, their day-to-day happiness rises. Until you hit $75,000. After that, it is just more stuff, with no gain in happiness.”
Kahneman and Deaton distinguish between two concepts of happiness.
- Emotional Well-Being: the day-to-day experiences that make life pleasant or unpleasant
- Evaluation of Life: one’s overall life satisfaction
The $75K number is the benchmark for the first of the two. As Deaton explained, “Giving people more income beyond $75K is not going to do much for their daily mood … but it is going to make them feel they have a better life.”
To sum up this quote, Short refers to a research study by Daniel Kahneman that indicates that an income above $75,000 a year (adjusted for location, of course) does not do anything to increase personal happiness. Incomes above that level might generate additional opportunities, but it also introduces additional challenges that counterbalance the opportunities.
Let’s step back for a minute. $75,000 a year isn’t very much above the average annual household income in America, which is around $61,000 a year as of this writing. Kahneman’s study says that any income above $75,000 (again, adjusted for location) won’t make a person happier.
To me, this leads to an obvious question: If an above-average income doesn’t add to personal happiness, why would a person ever pursue an above-average income? If it doesn’t actually make you happier, why take on the stress and intensity of work that offers such a high wage?
Well, there’s one big reason. Financial independence. Early retirement. Whatever you want to call it.
Let’s say you have a job where you earn $100,000 a year. You take a quarter of that and bank it immediately for the purposes of retiring early or reaching financial independence. Then, you have $75,000 to live on – the optimal number for happiness from that study.
But what happens to that $25,000? Well, if you invest it well, it will grow at an average rate of 7% a year. Leave it alone and repeat this for 25 more years and you’ve got enough money in the bank to withdraw $75,000 per year and have that balance live for a good 30 years. Add in even a little bit of Social Security to that when you come of age, and you’ll have enough to live at that happiness number for the rest of your life.
Start doing this when you’re 24 and you’ll be out of the workplace, living at the level you need for happiness for the rest of your life, starting at age 50.
What if you’re making more than that? If your income is $125,000 a year, you put aside everything over $75,000, you invest it reasonably, and you repeat it for just 18 years, you’ll be able to live the rest of your years at that “happiest income level.” Start at age 25 and you’re done working for life at age 43.
The higher your actual income, the earlier you can pull this off.
For many people, this might seem like one of those, “That’s great, but it’s not practical for me” articles. But before you jump to that conclusion, I want you to go back to that old maxim of personal finance: Spend less than you earn.
You see, that $75,000 number assumes that the person is making the purchasing decisions of the average American. And, as the data shows, the average American makes a lot of suboptimal spending decisions.
Take a look at , which indicates that most Americans buy most of their products in a name brand version rather than a store-brand version, a decision that costs significant money with every shopping trip and offers no real benefit. American households , resulting in inflated energy bills for zero benefit. The average American cable TV bill is $100 per month, yet the average person .
A person who lives a completely normal life but applies some common-sense frugal strategies to it, like buying store-brand goods most of the time, cutting back to a basic cable package (or completely cutting the cord and using only streaming services), and making their home more energy-efficient by air sealing their home and installing LED light bulbs, can easily save thousands of dollars a year.
Let’s say that this strategy reduces the “optimal happiness” salary down from $75,000 to $60,000 per year, which is completely reasonable. Suddenly, this path to financial independence is at least open to anyone making an average American salary and above.
But that’s not all. What about putting in extra effort to boost your income now so that you can retire early later?
For example, you might spend some of your spare time taking classes or getting a certification that can help you get a better job or get a promotion in your current workplace. Maybe you can spend some time starting a side business, like perhaps starting a YouTube channel about your passion. Maybe you could even get a second job, or take on some freelancing opportunities.
You don’t need to earn a whole lot from such efforts to completely change your outlook. If the average American stepped up to the plate and earned even a 20% increase in their income, that person goes from about $61,000 a year to about $76,000 a year. Couple that with being just a little frugal and that person suddenly can put away $16,000 a year toward early retirement — while still living at that “maximum happiness” level.
What’s the take-home lesson here? I think it’s threefold.
First, more money doesn’t mean more happiness above a certain point. The evidence is clear: personal happiness hits a cap at around $75,000 a year in household income. Anything above that doesn’t provide additional joy, or counterbalances it with additional challenges.
Second, it only takes a small shift in frugality and a small shift in income to produce major changes to your life and outlook. If you can cut your spending by 20% thanks to frugality while simultaneously raising your income by 20% thanks to good career choices, you’ve suddenly freed up a ton of money to save for the future. A family can go from below the “happiness point” to not only being there, but having enough extra money beyond that to rapidly save for retirement and perhaps even retire early.
Third, your actions provide far more control over your situation than you might think. This is really the underlying message behind being frugal and working a little harder. Your actions – your little day-to-day choices – are going to directly turn into more money in your checking account and, provided you’re smart with it, more money in your retirement account.
In the end, money can in fact buy you happiness, but it doesn’t come from using that money to buy more and more and more things. It doesn’t come from buying grander and greater vacations, or shinier and bigger and newer cars. It doesn’t come from a giant house or an amazing wardrobe or a bunch of gadgets.
It comes from living a reasonable life, choosing your pleasures wisely, and building toward a future where you have complete control over how you use your time and energy.
Happiness comes from freedom, and money can certainly buy that on a personal level.