The Psychology Of Poverty
Research sheds light on the vicious circle of poverty
Poverty is a vicious circle.
Living in poverty takes such a toll on our mental health that it causes us to make short-sighted financial decisions, making it difficult to ever escape poverty.
That is the one-sentence summary of a 2014 study titled “On the psychology of poverty.”1
In this post, I’ll review the findings from this paper on how poverty and the stress that comes with it cause us to make bad financial decisions that can further entrench someone in poverty.
I make the same caveat that the researchers do in their paper. None of these findings blame anyone for their poverty but illustrate how the human brain responds to the unique stress caused by poverty and how that impacts money-related decisions.
Poverty creates extreme risk aversion
If you want to build wealth, you need to be willing to take risks every once in a while.
As the researchers in this paper point out, poor people are much less likely to take financial risks than wealthy people for two reasons:
They have higher levels of risk aversion—they prefer low-risk options.
They are more likely to discount future payoffs—they choose less money today rather than more money at a future date.
It’s easy to understand why t both of these points when we state the obvious truth that poverty means having a razor-thin margin of error with money.
If you feel like you can’t afford to ever make a mistake, you’ll be more likely to make the safe choice every time.
If you don’t have enough money to cover your basic needs, you will value getting money in your hands as quickly as possible—even if that means settling for less.
The researchers pointed out that people living in poverty are far more likely to experience negative income shocks than the wealthy. A negative income shock can be devastating as the poor are more likely to be either shut out of credit markets or only be exposed to predatory credit products like payday loans.
The researchers also point out that poor people’s lack of access to credit combined with a lack of cash savings plays a significant role in why someone in poverty would choose less money today than more money in the future.
Risk aversion and present bias present significant barriers to someone pulling themselves out of poverty—let alone building wealth.
Increasing income beyond the minimum wage often requires risk and the capacity to delay increased income. Many high-paying jobs require some form of certification, whether it be a 4-year degree, a diploma, a certificate, or acquiring technical skills. That requires investing time and money—resources that are scarce for anyone living in poverty.
As I have written in the past, all wealth is generated from income. Personal finance writers exaggerate the virtues of “frugality”—but never forget this essential truth about frugality:
Frugality helps those with a solid income build wealth.
Frugality helps those with a low income to scrape by.
When it comes to building wealth, it all starts with income.
One of the reasons it is so difficult to escape poverty is that living in poverty reduces our willingness and capacity to take risks and give up money today to get more money in the future.
Pick up your copy of The Financial Freedom Equation
Financial Freedom = income from work you love + investment income > living expenses.
Achieving that definition of “freedom” is much faster and more enjoyable than the path to “early retirement.” I wrote an entire book about how to do it.
Pick up your copy of the book here
(Upgrade to a paid subscription and get it for free here.)
Financial “self-control” is a luxury for the middle and upper-class
One study concluded that “self-control” is a limited resource.2 The more often you have to exert self-control, the more your self-control reserves are depleted, making it more likely you will fall into temptation in the future.
When someone is living in poverty, their budget for non-essential spending is close to zero. That means spending as trivial as a pack of chewing gum has consequences for their budget. Living in a capitalist society with constant bombardments of advertising and next to no money for non-essential spending means your reservoir of self-control quickly runs dry.
The study used the classic definition of self-control: relying on willpower to avoid overspending. As I have covered in the past, depending on willpower is a reactive form of self-control and much less effective than proactive approaches to self-control. But no matter how you slice it: the more often a non-essential purchase requires self-control, the less likely you’ll be able to maintain financial self-control.
This is why I have a particular disdain for online trolls who blame people’s financial struggles for indulging in trivial luxuries like a cup of coffee or a Netflix subscription. They hold poor people to an impossible standard (never spend money on anything) and shame them when they fail to meet that impossible standard.
Poverty and mental health
The authors of 'On the Psychology of Poverty' point to several studies examining poverty's impact on mental health.3
A meta-analysis of 115 studies examined the link between mental health and poverty in low and middle-income countries and found that 79% of studies found a link between psychological conditions such as depression and anxiety and common measures of poverty such as food insecurity and low economic status.4
Poverty causes stress; that is a headline that will surprise nobody.
What is often under-discussed is the role that the type of stress caused by poverty has not only on our mental health but our physical health.
A 2006 study found that lower economic status was associated with higher cortisol levels.5 According to the Mayo Clinic, the long-term health risks of elevated cortisol include:6
Anxiety
Depression
Digestive problems
Headaches
Muscle tension and pain
Heart disease, heart attack, high blood pressure, and stroke
Sleep problems
Weight gain
Memory and concentration impairment
A 2010 study found a link between infants who grew up in low-income households and were more likely to have higher cortisol levels later in life.7
These are correlational studies; they tell us that poverty is associated with poor mental and physical health. The authors went a step further and examined 25 studies that examined if poverty is the cause of these health outcomes. 23 of the 25 studies showed at least a partial causal relationship between poverty and poor health outcomes.
So, with some degree of confidence, we can say that poverty wreaks havoc on our mental and physical health, and those outcomes can be seen in infants as young as 12 months old.
A problem with no easy solution
The purpose of this article was to highlight the mental and physical toll that living in poverty has on people.
I will not pretend that I have some magic solution to end poverty.
I believe this highlights the importance of financial education and the importance of a financially stable environment for children. Many of the techniques we’ve discussed in the Money on My Mind series can be a useful starting place for anyone who is going through a lot of money-related stress.
Know someone who could benefit from the lessons we review in this publication? Share the link for the free signup, or consider gifting a subscription.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
Haushofer, J., & Fehr, E. (2014). On the psychology of poverty. Science, 344(6186), 862–867. https://doi.org/10.1126/science.1232491
Muraven, M., & Baumeister, R. F. (2000). Self-regulation and depletion of limited resources: Does self-control resemble a muscle? Psychological Bulletin, 126(2), 247–259. https://doi.org/10.1037/0033-2909.126.2.247
Haushofer, J., & Fehr, E. (2014). On the psychology of poverty. Science, 344(6186), 862–867. https://doi.org/10.1126/science.1232491
Lund, C., Breen, A., Flisher, A. J., Kakuma, R., Corrigall, J., Joska, J. A., Swartz, L., & Patel, V. (2010). Poverty and common mental disorders in low and middle income countries: A systematic review. Social Science & Medicine, 71(3), 517–528. https://doi.org/10.1016/j.socscimed.2010.04.027
January-February 2006 - Volume 68 - Issue 1 : Psychosomatic Medicine. (n.d.). Journals.lww.com. https://journals.lww.com/psychosomaticmedicine/Abstract/2006/01000/Socioeconomic_Status
Mayo Clinic Staff. (2021, July 8). Chronic Stress Puts Your Health at Risk. Mayo Clinic; Mayo Foundation for Medical Education and Research. https://www.mayoclinic.org/healthy-lifestyle/stress-management/in-depth/stress/art-20046037
Saridjan, N. S., Huizink, A. C., Koetsier, J. A., Jaddoe, V. W., Mackenbach, J. P., Hofman, A., Kirschbaum, C., Verhulst, F. C., & Tiemeier, H. (2010). Do social disadvantage and early family adversity affect the diurnal cortisol rhythm in infants? The Generation R Study. Hormones and Behavior, 57(2), 247–254. https://doi.org/10.1016/j.yhbeh.2009.12.001
Very on point. I grew up in poor city (and although my family was in the "middle class" in retrospective it feels like middle-class is just a masked level of poverty) and up until later in life found out I was sick, stressed and somehow impaired. Poverty causes trauma and not everyone is affected the same way by poverty. One of the major endevour from my parents was to procure me education and (public) university. Later, I got into self development (without knowing by then it was a whole area on its own) and found lots of answers. I appreciate you write about this complex and difficult to solve problem.