Consumers generally hold the belief that individuals who work hard for their money tend to have higher incomes, possess greater financial knowledge, and are more inclined to take calculated financial risks. Policymakers also rely on national survey data that indicates a positive correlation between effortful earning and risk-taking behavior.
However, recent research conducted at the University of Notre Dame challenges this conventional wisdom. The study reveals that, on an individual level, the more effort a consumer puts into earning money, the less willing they become to take risks with those earnings, both in investments and other areas. In other words, when comparing two individuals, the one who works harder tends to exhibit higher risk tolerance. Yet, within a single individual, increased effort leads to decreased risk tolerance, whereas reduced effort correlates with higher risk tolerance.
The forthcoming study, titled “Working Hard for Money Decreases Risk Tolerance,” is authored by Christopher Bechler, an assistant professor of marketing at Notre Dame’s Mendoza College of Business, in collaboration with Samina Lutfeali, Szu-chi Huang, and Joshua Morris from Stanford University. The research sheds light on the psychological dynamics underlying risk aversion and the perception of earned income.
To explore this phenomenon, the research team conducted four experiments and an additional supplementary study. They employed a unique approach that created an incentive-aligned environment to measure the causal impact of effortful earning on risk-taking behavior. Participants engaged in tasks over several periods (ranging from three to six months) within a simulated financial cycle, where they had to exert effort to earn money. This involved activities such as repetitive key presses or transcribing Dutch poems. At the end of each period, participants were presented with opportunities to invest their earnings, typically involving different risk levels.
The results indicated that, when accounting for individual factors, increased effort in earning money actually led consumers to assume less risk, despite the riskier options potentially offering higher expected returns. The study highlighted the negative relationship between effort and risk, which carries significant implications. Notably, the research team emphasized the relevance of their findings in the context of the COVID-19 pandemic, ongoing inflation, and stagnant wage growth, where individuals are striving harder to earn income.
According to Bechler, the time gap between effortful earning and spending/investment decisions has traditionally been short in some industries. For instance, those working for tips often receive daily compensation, and advancements in technology have further reduced this gap. Workers can now be paid immediately after completing their shifts, as exemplified by Walmart’s daily pay option. Consequently, earnings can be readily spent or invested, amplifying the influence of the effort-risk relationship observed in the study.
The findings of this research support interventions that automate the allocation of assets, channeling income directly into investment plans. By doing so, individuals’ hard work can be safeguarded against undermining their investment decision-making process.