As a former financial planner in Denver, I get involved in a lot of interesting personal finance discussions. Recently, a writing colleague was remarking on the difference between getting money one time, and having a new stream of money. In particular, he noticed that while the latter should be better, the former is actually the more fun of the two.
Psychology of Money
One of the interesting things about money is that it is so concrete a mathematical concept, and yet, so nebulous as an actual artifact in our lives. On the first hand, money is easily understood as an exact match of mathematical numbers. For any decision, a spreadsheet-type answer is easily obtained. Higher interest rates are better for savings, worse for borrowing. Saving more is better than spending more, and so on. However, the reality is that the higher interest rate from an online bank that is less convenient and useful might not actually be better. And, is having an extra $5,000 in the bank really better than having spent a week seeing the great museums in Italy?
Which brings us to the freelance writer‘s incongruous concept of steady income versus unreliable, extra income.
Most people have a steady income. Even freelancers often have a stable, or “usual,” component of income. Human beings naturally adjust to this amount of income over time. So, for example, if our friend typically earns $5,000 per month, then his lifestyle will inevitably adjust to this amount of income.
This is what makes automatic savings like 401k plans, or IRA plans, so important. When the money is not there to get used to, the lifestyle does not adjust to use that money. Many people use this same concept by having extra money withheld from their paychecks by the IRS in the form of over-withholding for income taxes by claiming too few things on their W4 Form. Even though they know this is an interest free loan to the government, it also means that their lifestyle does not expand to take up that part of the income that they never see becomes it comes directly from their paycheck.
For people with variable income, like freelancers, the same thing occurs when new clients come on board.
If our freelancer above gets a new client that brings in an extra $300 per month, then, eventually, his spending and savings habits will encompass that additional $300 until it isn’t actually “additional” any more at all, but just part of normal. This happens even if the money is responsibly earmarked as additional savings.
If, on the other hand, our freelancer gets a client that only has sporadic work offering $300 during some months, that money cannot be counted upon. So, the lifestyle never adjusts. That means every time that extra $300 shows up, it really is extra. It’s a guilt free way to have an extra night out, or to buy a nice gift for a spouse, or whatever. But, in the former case, doing the same thing with that same $300 is not using an extra windfall playfully, but instead taking away $300 that should be going to savings. That’s a very different mentality.
In the end, the steady stream of income is indeed better, but psychologically, a little variability will generally allow for a less rigid, and more fun, few of money, even if the amounts are the same.