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How Money Can Buy You Happiness

New research is suggesting that happiness is determined not by how much money one earns, but rather, how one spends it. University of British Columbia associate professor Elizabeth Dunn explains why. Photo: Getty.

Can money buy happiness? Researchers and psychologists think the answer might be yes, at least to some degree. Does this mean Warren Buffett is happier than you? Not necessarily. The link between money and happiness is more nuanced and intuitive than you might imagine.

Let's take a look at three fascinating studies that document a link between money and happiness.

The Connection Between Spending on Experiences and Happiness

University of Colorado psychology professor Leaf Van Boven conducted a study in which he found spending money on life experiences, rather material possessions, is generally correlated with higher levels of happiness. On the other hand, the level of happiness associated with owning material possessions, such as cars, appliances and televisions, depreciates over time.

In other words, if you have a limited amount of money, you'll be happier spending it on experiences rather than stuff. Examples of memories that tend to result in higher levels of happiness are hiking in the Rockies, camping along the Appalachian Trail, spending a day at the beach and learning how to salsa dance.

Van Boven found that people will even remember not-so-great experiences fondly. Memories become happier in hindsight. This is referred to as "nostalgia bias" or "recollection bias."

Van Boven also found that people have a tendency to remember the fun parts of an experience over the bad parts. For example, the thrilling view from the top of the Grand Canyon is more likely to be remembered than the fact the kids were whining in the car.

Furthermore, spending money on experiences lacks the "keeping up with the Joneses" effect. One person's trip to Italy doesn't make another person's trip to Napa Valley, California any less meaningful.

The researcher recommended purchasing objects as a means to an end. You need the proper equipment in order to go skiing, but the emphasis isn't on buying the nicest equipment. It's about utilizing the equipment as tools that allow you to reach your ultimate end goal: creating memories on the family ski trip.

You also don't need to spend money on expensive experiences. Spending a day throwing a Frisbee or kicking a soccer ball at the local park can induce as much happiness as a more expensive outing. The bottom line is to focus on activities and experiences, rather than possessions, and to only purchase material objects as a means-to-an-end.

Savings Can Increase Feelings of Freedom

A team of researchers at the University of Wellington in New Zealand surveyed 420,000 people about their relationship between money and happiness. They found that money has a positive impact on happiness insofar as it gives people increased freedom.

"While wealth can provide you with more choices, it's really having the ability to realize your dreams that leads to greater happiness," said Ronald Fischer, a coauthor of this research study.

People who have some amount of discretionary money have the choice to move to a different neighborhood, make a career change, return to school for a higher degree, launch a business or travel overseas.

Having these choices available has a greater impact on happiness -- even if people never act upon them, the researchers found. In other words, the freedom to choose, rather than the choice itself, is what creates happiness.

Happiness Doesn't Matter Past an Income of $75,000

Perhaps the most famous study about the correlation between money and happiness comes from Princeton University researchers Daniel Kahneman and Angus Deaton. They analyzed Gallup Poll data from more than 450,000 United States residents during the recession in 2008 and 2009. They discovered that doubling your income increases your life satisfaction, across all socioeconomic brackets.

Okay, that doesn't sound like major news, does it? But check this out: When people were asked to assess how many hours of the previous day were enjoyable, money mattered only up to the first $75,000 in household income.

Sound contradictory? Let's rephrase it: Doubling your income increases long-term overall satisfaction. But on a day-to-day level, the correlation between money and happiness disappears after you have enough money to pay your bills.

"We concluded that lack of money brings both emotional misery and low life-evaluation," wrote the Princeton researchers. "Beyond $75,000 in the contemporary United States, however, higher income is neither the road to experience happiness nor the road to relief of unhappiness or stress." If you're supporting a family on $30,000 annually, boosting your income by an extra $10,000 can improve your day-to-day happiness. But above a certain point -- which the researchers say is $75,000 per year -- higher income doesn't necessarily correlate with more happiness.

To be fair, $75,000 is a blanket number that won't apply to all financial situations. A family of eight living in Manhattan on $75,000 isn't in the same situation as a child-free couple living in Little Rock, Arkansas on that same income. In other words, $75,000 isn't an iron-clad rule -- it's more of a general indicator of the concept of enough.

The Relationship Between Money and Happiness

What's the takeaway from this research? Emphasize experiences rather than possessions. Focus on earning enough money to feel secure. At the same time, be aware an infinite amount of money will not make you infinitely happier.

Money and happiness correlate up to a point, after which the link diminishes. Don't buy the latest and greatest gadgets, clothing, or cars, especially if your budget is tight. Instead, choose to spend your limited money on forming memories with friends and family.

Paula Pant is the founder of Afford Anything, a website that helps you build wealth and maximize life. Afford Anything is an online movement against tired old financial advice that says you should skip lattes and chain yourself to a desk for 40 years. Paula Pant launched the site after she quit her 9-to-5 job, traveled to 32 countries and became a successful entrepreneur and real estate investor.

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