Can You Earn Your Way Out of a Spending Problem?

Most of us believe that all our financial problems would disappear if we could simply make more money. Is this true?

Keynes’ Prediction

In 1930 John Maynard Keynes, perhaps the most famous and celebrated economist ever, wrote an essay entitled “Economic Possibilities for our Grandchildren”. In this essay Keynes made a prediction of what life would be like in the year 2030.  He predicted that the standard of living would be eight times higher in 2030 than it was in 1930.  He also predicted that the work week would fall to fifteen hours per week and many of us would go crazy trying to meaningfully use all of our extra free time.  How have Keynes’ predictions turned out?

On the economic front Keynes did very well indeed. By the year 2010, eighty years after his prediction, real per capita income in the United States was 5.6 times higher than it was in 1930.  With still twenty years to go until 2030 Keynes’ prediction looks to be remarkably accurate.

Keynes did not fare so well when he left the realm of economics to predict human behavior. In fact, Keynes prediction of the consequences of this projected wealth have turned out to be laughably wrong. 

In an age of abundance never known before in the history of the world our problem is not, as Keynes’ predicted, too much free time. Instead we are working as much as ever.  Debt is near record highs, as is stress.  We spend too much, save too little, and have little of worth to show for it.  Clearly as a society we have not been able to earn our way out of our spending problem.

Lottery Winners

I know what you are thinking. The story above, while interesting, is about societal wealth over a period of eighty years.  It doesn’t apply to an increase in individual wealth over a much shorter period of time.  Are you sure?

As I write this the United States is gripped by Power Ball fever. The biggest jackpot ever, worth more than $1 billion, was split between three lucky winners last weekend.  Would winning the lottery solve all your financial problems?  I am sure you would like to find out.  Like a friend of mine, you are probably thinking, “Just give me one chance to prove that winning the lottery wouldn’t ruin me.”

Researchers at Vanderbilt University studied winners of Florida’s Fantasy5 lottery game from 1993 to 2002. While the sums were not as grand as the Power Ball winners, the prizes of between $10,000 and $150,000 were still significant.  How did winning these prizes affect the financial futures of the winners?  The researchers looked at bankruptcy rates to find out.  

For the first two years after their stroke of luck the winners’ bankruptcy rates were significantly lower than for the general population. However, within three to five years after their win this advantage disappeared and the dream turned into a nightmare for many.  In fact, in years three through five the bankruptcy rates of winners was quadruple that of the general population.  Clearly winning the lottery didn’t solve the financial problems of many winners, and for some it made things significantly worse.

Pro Athletes

Pro athletes earn more per year than most of us earn in a lifetime. If anyone could earn their way out of spending problems it would be our sports heroes.  Do they?  Sadly, for the majority the answer is, “no”.  Knicks center Patrick Ewing identified the problem during an NBA work stoppage when he famously said, “Athletes make a lot of money but we spend a lot too.”

Sports Illustrated, in a 2009 article titled “How (and Why) Athletes Go Broke” reported that:

• By the time they have been retired for two years, 78% of former NFL players have gone bankrupt or are under financial stress because of joblessness or divorce.
• Within five years of retirement, an estimated 60% of former NBA players are broke.

One interesting case study is Allen Iverson, the perennial all-star point guard for the Philadelphia 76ers and Denver Nuggets. Iverson reportedly earned over $200 million during his career but is now in financial distress.  Divorce papers filed in 2012 show a healthy monthly income of $62,500 but monthly expenses of $385,000 plus. 

During his playing career Iverson’s nickname was The Answer. If the question is, can you earn your way out of a spending problem? the answer is provided by The Answer.  Absolutely not. 

You and Me

I probably still haven’t convinced you. You know you will never win the lottery or make the kind of money a professional athlete makes, but you are convinced that if you could just double or triple your income all your financial woes would disappear.  Experience suggests otherwise.  As we make more our expenses seem to rise just as quickly. 

In his classic book The Richest Man in Babylon, George S. Clason described this condition perfectly when he wrote, “Now I will tell thee an unusual truth about men and sons of men.  It is this: That what each of us calls our ‘necessary expenses’ will always grow to equal our incomes unless we protest to the contrary…All men our burdened with more desires than they can gratify.” 

The reason for this, according to George A. Akerlof and Robert Shiller, in their new book Phishing for Phools, is that, “Free markets produce continual temptation.”  As we make more new temptations are opened up to us that we wouldn’t have considered before, and before long we feel as financially stretched as we did before the increase in income. 

As suggested by Clason, it is possible to “protest to the contrary”, and the tool for doing this is a plan and a little discipline, otherwise known as a budget. Without a budget you are likely to spend any increased income quickly, sometimes more than once.

Increasing your income is a worthy goal. For the poor it is essential and for the rest of us it is desirable.  However, unless you also consider the spending side of the equation an increase in income will not solve your financial problems.  As Keynes, lottery winners, and pro athletes have discovered, you can’t earn your way out of a spending problem.