What Is Social Comparison?
Social comparison refers to the innate human tendency to evaluate one's own opinions, abilities, and circumstances by comparing them with those of others. This pervasive phenomenon is a core concept within behavioral finance, a field that examines the psychological and emotional factors influencing investment decisions and financial markets. It suggests that individuals often derive a sense of self-worth and social standing not from objective measures, but from how they perceive themselves relative to their peers or chosen reference groups.
This comparison can be upward, where individuals compare themselves to those perceived as superior, or downward, where they compare themselves to those perceived as inferior. Both forms of social comparison can significantly impact an individual's financial perceptions, financial goals, and overall investor behavior.
History and Origin
The concept of social comparison was formally introduced by social psychologist Leon Festinger in his seminal 1954 paper, "A Theory of Social Comparison Processes."12, 13, 14, 15 Festinger's theory posited that individuals have a fundamental drive to evaluate their opinions and abilities, and when objective, non-social means are unavailable, they turn to comparing themselves with others.11 This drive to understand one's standing relative to others forms the bedrock of social comparison theory. Early research highlighted how people compare themselves to similar individuals to gain accurate self-evaluations, and how these comparisons can motivate individuals to improve their performance or simply feel better about their current situation.10
Key Takeaways
- Social comparison is the psychological process of evaluating oneself by comparing with others.
- It is a significant component of behavioral finance, influencing financial perceptions and decisions.
- Comparisons can be "upward" (to those perceived as better off) or "downward" (to those perceived as worse off).
- While it can motivate improvement, social comparison often leads to irrational financial choices, such as excessive spending or chasing returns.
- Understanding social comparison helps investors mitigate its potentially negative effects on their portfolio management.
Interpreting Social Comparison
In a financial context, social comparison manifests in various ways, often subtly influencing how individuals perceive their wealth, income, and investment performance. The popular idiom "keeping up with the Joneses" perfectly illustrates this phenomenon, referring to the tendency to compare one's material possessions or lifestyle to those of neighbors or peers.8, 9
This form of social comparison can lead to cognitive biases where individuals may feel compelled to spend more, take on more debt, or engage in riskier investments to match perceived external standards. For instance, an investor might feel successful if their portfolio's returns are higher than their friends' but dissatisfied if their returns lag behind, even if their own returns are objectively strong. The interpretation of one's financial standing often becomes relative, rather than absolute, driven by the comparison group. It can also influence an individual's risk tolerance, as they might take on undue risk to keep pace.
Hypothetical Example
Consider two friends, Alex and Ben, both 35 years old, who started investing around the same time. Alex, an avid follower of financial news and social media, frequently sees posts from peers boasting about high returns from speculative equity markets or popular "meme stocks." His own diversified portfolio, while growing steadily and aligned with his long-term financial goals, has not experienced the rapid surges some of his online acquaintances claim.
Ben, on the other hand, rarely engages in financial social media and focuses solely on his predetermined investment plan. When Alex learns that a former college friend made a significant profit on a single, risky stock, he experiences a strong urge to reallocate his own portfolio into similar volatile assets, despite understanding the underlying risks. This is an example of upward social comparison driving Alex towards a potentially less suitable investment strategy, deviating from his original, sound plan, due to a perceived lag behind his peers.
Practical Applications
Social comparison has profound practical implications in finance, influencing everything from individual saving habits to broad market bubbles.
- Consumer Spending: The desire to "keep up with the Joneses" can drive conspicuous consumption, leading individuals to spend beyond their means on luxury goods, larger homes, or expensive vacations, often financed by debt rather than savings.
- Investment Decisions: Investors may make suboptimal choices, such as chasing past performance or investing in faddish assets, if they see others profiting from them. The influence of social media on investment behavior, where individuals compare their investment choices and returns, has become increasingly evident.4, 5, 6, 7 A 2014 Reuters report highlighted the growing impact of social media as an investing tool, noting that a significant percentage of individuals made investment decisions based on financial blogs.3
- Financial Planning: Financial advisors recognize the impact of social comparison and often counsel clients to focus on their personal financial goals and circumstances rather than external benchmarks or peer performance. This approach is crucial for sound diversification and long-term financial health.
Limitations and Criticisms
While social comparison is a natural human tendency, it carries significant limitations and can lead to detrimental financial outcomes. A primary criticism is that it can foster irrationality and discontent. Constantly comparing oneself to others, especially those perceived as having more, can lead to chronic dissatisfaction, anxiety, and feelings of inadequacy, regardless of one's actual financial standing.2 This phenomenon is underscored by research from the Federal Reserve Bank of San Francisco, which explored the effect of relative income on financial distress, linking the "keeping up with the Joneses" mentality to increased financial struggles.1
Furthermore, social comparison often relies on incomplete or biased information. People tend to present their successes publicly while hiding failures, creating an unrealistic benchmark for others. This can exacerbate loss aversion and other heuristics, pushing individuals into financial decisions that contradict their best interests or risk tolerance. Engaging in continuous social comparison can distract from personal financial goals and prudent portfolio management.
Social Comparison vs. Herd Behavior
Social comparison and herd behavior are related but distinct concepts within behavioral finance. Social comparison is primarily a psychological process involving an individual's evaluation of their own status, abilities, or opinions relative to others. It is about how individuals perceive themselves and their situation, leading to feelings like envy, satisfaction, or a desire for self-improvement. While it can precede action, the core of social comparison is the internal mental assessment.
Herd behavior, conversely, describes the phenomenon where individuals in a group act collectively, often without centralized direction, by mimicking the actions of a larger group. In financial markets, this often involves investors buying or selling assets simply because many others are doing so, rather than based on independent analysis. While social comparison might create the desire to invest like a successful peer (e.g., due to confirmation bias), herd behavior refers to the actual collective action that ensues. One influences perceptions, the other drives observable market movements.
FAQs
How does social comparison affect financial planning?
Social comparison can derail sound financial planning by prompting individuals to spend more than they can afford, take on excessive debt, or make irrational investment decisions to match the perceived lifestyles or wealth of their peers. Effective financial planning encourages individuals to set and adhere to personal financial goals based on their unique circumstances, rather than external comparisons.
Can social comparison be positive in finance?
While often associated with negative outcomes, social comparison can sometimes be a positive motivator. For example, observing a peer's financial discipline or successful portfolio management could inspire an individual to improve their own financial habits or deepen their understanding of investing, provided it doesn't lead to impulsive or inappropriate actions.
Is social comparison a type of bias?
Social comparison itself is a fundamental psychological process, not a cognitive bias. However, it frequently leads to biases, such as framing effect, anchoring bias, or overconfidence, especially when individuals selectively compare themselves to unrealistic or incomplete benchmarks.