With increasing reports of a “K-shaped” economy in the U.S., the divide between those who can save and invest and those who can’t is growing wider.
In fact, The Wall Street Journal reported that American investors are feeling good about their money and spending more on restaurants, business-class airline tickets and home improvement projects (1). JPMorgan Chase noted the growth of the top 30 AI stocks has added $5 trillion to household wealth nationwide this year.
Meanwhile, Bank of America data shows spending for higher-income households rose 2.7% in October year over year (2).
So what does this look like in real life? Meet Renee. She just turned 40 and has finally paid off her student loans. She owns a condo in a small city and has built solid equity. She has also been contributing modestly to her company’s 401(k) for several years. For most of the last decade, though, she felt perpetually underwater, living paycheck to paycheck.
Now, with the last of her loans gone and more room to save, Renee has crossed over into a new financial category: a positive net worth. She feels proud of how hard she worked to get here, but she’s also noticing a new feeling creeping in, the urge to splurge.
Here’s why the wealth effect can quietly derail your finances if you’re not careful and how to keep your spending in check when it feels like you’ve finally earned a break from strict budgeting.
The wealth effect refers to the tendency to spend more when assets like stocks, retirement accounts and real estate rise in value, even if your cash flow and monthly budget stay the same. While it’s clearly fueling spending across the country, economists warn it can also lead to debt or risky financial decisions.
“When people feel wealthier on paper, or when their income increases, they often feel like they can do more,” Erica Cameron, a partner at wealth-management firm Cerity Partners, told the Wall Street Journal (3).
For Renee, that shows up as a new wardrobe and a long-held dream: a month-long vacation in France.
But even with her student debt behind her, can she really afford it?
A 2023 Visa study found that for every $1 increase in household wealth, consumer spending rose by 34 cents. That’s far higher than the pre-pandemic wealth effect of about 9 cents per dollar (4). Renee, it turns out, is far from alone.
For many people whose wealth is tied to stocks or the housing market, that feeling of being flush may not last.
“All of this can go away pretty quickly, ” Cameron said. “We could have a 20% housing correction. We could have a 20% or more market correction.”
