Research indicates that individuals perceive those who diligently earn their income as having higher financial literacy, greater incomes, and a willingness to undertake prudent financial risks.
Moreover, national survey data employed by policymakers to evaluate the connection between hard-earned income and financial risk-taking also exhibit a positive correlation between the two factors.
Risk tolerance
However, recent findings from the University of Notre Dame challenge this conventional wisdom by revealing an intriguing pattern. According to the study, the more strenuously an individual consumer works, the less inclined they are to jeopardize their earnings through investments and other avenues.
Essentially, when comparing two individuals, the person who puts in greater effort is likely to exhibit a higher risk tolerance. However, when examining an individual in isolation, they tend to display reduced risk tolerance when engaged in intense work and heightened risk tolerance when not exerting such significant effort.
“Consumers feel greater psychological ownership over their earnings when they work hard for them, which makes them value these earnings more and be more averse to losing them,” the researchers explain. “So, they choose less risky investments and invest less.”
Financial planning
The research team conducted four experiments and an additional supplemental study, employing a distinctive paradigm designed to align incentives and capture the causal relationship between diligent earning and risk-taking.
Participants engaged in a microcosmic financial cycle spanning three to six periods (equivalent to months). They exerted effort by performing tasks such as repeatedly pressing the “S” key on their keyboard or transcribing Dutch poems to earn money. At the conclusion of each period, participants were presented with opportunities to risk their earnings, commonly in the form of investment prospects.
“We show that when controlling for the individual, more effortful earning actually leads consumers to take on less risk, despite their riskier options having greater expected returns,” the authors explain.
Negative association
The study’s identification of a negative association between effort and risk holds significant potential for influence. The authors highlight the enduring phenomenon of people diligently striving to earn money, which has only intensified amidst the COVID-19 pandemic, persistent high inflation, sluggish wage growth, and other pertinent factors.
“The temporal gap between effortful earning and spending/investing decisions has always been short in some industries,” they say. “Individuals working for tips often receive daily compensation and technological advancements are further reducing this gap, helping more workers get paid immediately after work—for example, Walmart employees can be paid daily—and allowing earnings to be immediately spent or invested. The shorter the gap between earning and investing, the more influential our effect will be.”
The study offers backing for interventions aimed at automating the process of asset accumulation by channeling income directly into investment plans. Such measures hold the potential to prevent consumers’ diligent efforts from undermining their investment choices.
