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It’s natural to feel rich when your home’s Zillow estimate goes up or your 401(k) balance hits new highs — even if you haven’t sold a single property.
This psychological phenomenon, known as the “money effect”, leads people to spend more based on paper gains rather than actual cash. While this can promote economic growth, it also creates a dangerous trap that can derail your financial stability.
Here are the warning signs that you may be falling prey to this.
You are spending based on portfolio performance
The wealth effect states that rising asset values – whether stocks or real estate – make people feel financially secure enough to spend more, according to research. National Bureau of Economic Research. The study found that for every dollar of increased stock market wealth, consumer spending increases by 2.8 cents annually.
The trap comes when you start treating unrealized profits as disposable income. If you’re upgrading your lifestyle—buying a new car, booking expensive vacations, or dining out more often—because your investment accounts look healthy, you’re caught in the wealth effect.
Problem? The market may suddenly reverse, causing your habits to become expensive but your wealth to disappear.
Your expenses increase with home value estimation
According to cited studies, housing assets trigger a stronger spending response than stocks Market. When home prices rise, owners feel richer and spend accordingly – even if they still live in the same house.
This becomes dangerous when homeowners use equity through cash-out refinancing or home equity lines to fund discretionary expenses. You are essentially borrowing on an asset whose value may decline, turning the paper asset into real debt.
You’ve stopped saving because your net worth looks strong
One of the most deadly signs is to reduce your savings rate as your net worth is increasing. Wealthy households save less as asset values rise, giving them confidence that their investments will see them through retirement Moody’s Analytics Report Cited by the Wall Street Journal.
When the market corrects it creates vulnerabilities. Without a steady flow of savings into the accounts, you have no recourse if asset values decline.
You are underestimating lifestyle inflation
The effects of wealth often manifest as a gradual decline in lifestyle. Every time your assets appreciate, you justify slightly more expensive options: trading up to a luxury car, moving to an expensive neighborhood or enrolling the kids in exclusive private schools. These commitments become fixed costs that do not adjust downward in the market.
The top 10% of earners in the US now account for almost half of total consumer spending, making their behavior highly dependent on asset prices. Luck.
how to protect yourself
The antidote is treating paper assets exactly like paper. Base spending decisions on stable income sources, not portfolio balances. Maintain consistent savings rates regardless of market performance. And before making major financial commitments, stress-test your plan against a 20% to 30% decline in asset values.
Remember: Unrealized profits aren’t real money until you sell. Living as they are is a trap that can turn temporary market euphoria into permanent financial regret.