Sunday’s New York Times Magazine highlighted what is, to my mind, one of the most important economic insights to come out of the past year: even as our material wealth has grown over the past 30 years, our incomes have become less secure. More so than in the past, families find that a year of high income can be followed by a financial bust. Seen from above, “the economy” appears to be flowing along smoothly; but hidden beneath the surface is a growing turbulence in the economic fortunes of individual families.

And as this article in Sunday’s Los Angeles Times points out, the problem is especially acute for the poor, whose incomes are more volatile, and for whom temporary financial setbacks can mean homelessness or worse.

Now, if people were comfortable with this kind of volatility, this wouldn’t really matter. But the evidence suggests that they’re not: for most of us, the threat of losing income looms larger than the prospect of a windfall. (This is a phenomenon explored by the so-called “prospect theory” developed by Nobel laureate Daniel Kahneman and Amos Tversky; Kahneman was mentioned in yesterday’s post on TV, kids and happiness.) So rising volatility in income may undermine people’s sense of economic security, even if, on average, they have more material wealth.

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  • At some level, it should come as no surprise that rising incomes are accompanied by rising volatility. Professional investors are used to the idea that, over the long haul, increased risk yields increased rewards. That’s why stocks are usually considered better long-term investments than bonds: year to year, stocks are riskier, rising and falling more each year than bonds; but (in theory, if not always in practice) if you can manage to hold on to stocks through the roller coaster of ups and downs, the ultimate payoff is greater.

    But what’s natural for big-time investors is less natural for people who are living paycheck to paycheck. For most of us, stability and predictability have every bit as much a claim on our psyches as does the potential for hitting the jackpot. Which may be one reason why, in our increasingly risk-based society—where individuals are expected to bear the risks of an increasingly turbulent economy, while managing for themselves their own health care and retirement plans—people are no more satisfied with their lives than they were when they were materially poorer. (See related post on this subject here.)