Don't Let Wealth Impede Good Decisions

The accumulation of wealth can become it's own reward, affecting spending and charitable decisions.

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Scrooge McDuck used to treat his money vault as a swimming pool, diving in and out of huge mounds of coins. Numbered Swiss bank accounts would have been more effective, but not much of a sight gag for a cartoon. And, I'm betting, not nearly so satisfying on a visceral level. Nope. Not much beats wallowing in money. Ask the hedge fund guys.

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It turns out that there are lots of real-world Scrooges—people who simply enjoy the reality of having that big pile of accumulated wealth. In fact, they enjoy it so much that they reduce their spending because, in economist-speak, the utility of wealth is greater than of consumption. The utility of wealth also explains why wealthy people don't give more money to relatives and charities while they're alive, according to a recent study by Louis Kaplow, a professor of law and economics at Harvard.

Kaplow says that patterns of spending and giving by wealthy people vary from what researchers would expect to see, but that the differences can be explained when taking into account how much people enjoy just having money around during their lifetimes. Why? Money helps make people feel safe, successful, and superior, if not smug.

Because wealthy people in fact consume less than expected, they actually wind up having more money to give away. Kaplow says actual bequests are greater than would be expected. However, while tax and estate rules would favor giving more money away during their lifetimes, this wealth effect causes many people to forgo such activities and, instead, pass on wealth largely through their estates when they die. They also don't give as much away to charities during their lives.

"Although charitable giving is exempt from both gift and estate taxation," he writes, "there is a substantial income tax incentive to give during one’s lifetime." That's because such gifts are deductible from income taxes. Deferring such gifts and wealth transfers "seems all the more surprising," he observes, because it also means forgoing "the joy of observing descendants or charitable beneficiaries make use of the gifts and the praise or status one may receive, and also the fact that earlier gifts may be more valuable to recipients."

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Charities have been dealing with this wealth effect for a long time and try to develop effective strategies to counter it. Based on Kaplow's research, one effective approach would be to develop trusts and other legal agreements that allow charities to benefit from the use of a wealthy person's funds while providing the person with the comfort that, in theory, he or she could regain control of the wealth if they wanted. Maybe that mound of coins will no longer reside in the wealthy person's vault but it is still their pile of money, and they could play with it once again if they wanted.

In this year of deep recession, fortunate indeed are those with more money than they will spend over the rest of their expected lifetimes. If you're one of them, congratulate yourself. Next, please consider sacrificing some of that wealth effect and, instead, giving money right now to people and organizations who just might be able to use it better than you can.

Happy holidays.

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