Is Your Wealth Just An Illusion?

Most investors take for granted the vast array of financial tools, platforms and calculators that they have at their command through a smartphone, tablet or laptop.

Fast internet connections give up-to-the-minute access to the current balances of pension and savings accounts.

But some of these tools can give a distorted impression of net worth.

A recent paper published by Microsoft research looked at the illusion of wealth and poverty.

The research looked at if publishing figures of money’s worth in terms of what a lump sum can buy rather than simply presenting the amount as a lump sum.

Lead author Daniel Goldstein explained that expressing the same figure in different ways can help with the addressing the psychology of how savers regard their nest eggs.

​​Lump sum or monthly payment?

“People are more sensitive to amounts of money when money is expressed in terms of monthly amounts compared with lump sums,” said Goldstein.

“This sensitivity can set up an interesting situation in which monthly amounts are perceived as less attractive than lump sums at low levels of wealth.

“At higher levels of wealth, however, monthly amounts of money seem more adequate than lump sums because people more accurately judge just how much a higher a monthly amount can buy them.​”

To prove the point, he asked savers whether they would prefer to receive a pension pot of $1 million or $5,000 a month for life.

The key is $5,000 a month is the income $1 million will generate, so effectively, they are the same amount of money.

How savers regard their cash

Goldstein asked his subjects about their thoughts if their monthly retirement income went up from $500 a month to $5,000 a month and a lump sum of $100,000 increased to $1 million.

The result was people were more impressed by their monthly income increasing tenfold than they were their lump sum increasing by the same amount.

Middle-aged savers also felt they could get by easier when their income was broken down into a monthly amount rather than expressed as a lump sum.

“When presenting information to people nearing retirement age, some retirement plan providers only display account balances, making the lump sum conditions from the present studies like the real world,” said Goldstein.

“The results speak to at least two decision-making issues present in the modern retirement space: the annuity puzzle and the tendency to claim social security benefits early. We recommend that projected monthly income be presented before, and therefore be made more salient than, any information on account balances that is presented in one’s pension statement.”

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