Increasing Income and the Temptation of Lifestyle CreepSubmitted by Castlebar Asset Management on February 5th, 2016
When you get a big raise or a significant promotion you naturally want to celebrate. This may include treating you and your spouse to dinner out or a vacation you have been talking about for years. It might also mean you are going to increase your spending to coincide with your new income growth. Lifestyle creep is something that impacts people in different stages of life. It is particularly important to recognize and avoid before it impacts your financial goals.
What is lifestyle creep?
Lifestyle creep is when your standard of living increases as your discretionary income rises because you start to earn more money or your expenses drop. As you start to receive raises or expenses like student loans or mortgage are paid off, the additional money you now have is spent rather than placed into savings. Items that used to be luxuries now are considered essentials to your daily life.
Why you need to recognize and avoid lifestyle creep.
Avoiding lifestyle creep may seem like a prudent financial move but as we earn more, naturally we are going to want to spend more. The common assumption is that you will see consistent earnings growth throughout your entire career. There is strong evidence which challenges this assumption. Two studies from the Federal Reserve of New York and Department of Labor show our assumption that income will continue to grow throughout our adulthood is NOT TRUE. Most earnings growth occurs in 20s and 30s, slows down in 40’s and turns negative in 50’s.
This information is the key to why we need to avoid lifestyle creep. The temptation is always strong to push off saving for our financial goals until later and enjoy living in the moment. Our assumption that we’ll be able to save more later may prove to be a challenge. If our income could be declining in our 50s this may be when we have planned to play catch up. After years of self-generated inflation you could be squeezed having to save more to reach your financial goals while income is deflating.
How does lifestyle creep sneak up on you?
Buying a bigger house: As you mature in your career this can coincide with starting a family or seeing your family expand. Since you can afford a bigger house having a larger income the draw is there to upgrade to more square footage. With a larger house you’ll see your mortgage increase as well as other expenses like utilizes, maintenance, taxes and insurance. Before you move to a more expensive house check your budget and run the numbers to see what the other items will cost you before you move.
Upgrading or leasing a better car: We have all had a car that we’ve had our eye on. It may be a dream car from your teens or a bigger SUV to make hauling all of your kids’ stuff around easier. Upgrading your car is one of the easiest ways we see lifestyle creep enter your life. You can afford the bigger car or lease payment but this recurring bill will have a big impact on your monthly budget.
Splurges become necessities: The things you use to treat yourself to become everyday habits. Your occasional Starbucks on the way to work becomes a daily ritual or you ditch your brown bag for lunch and start going out for lunch every day. These seemingly small costs become large numbers at the end of the year.
Eating out more: Going out to dinner and too nicer places may seem like a reward for your new income. Americans are spending more eating out than at home and this is another way that lifestyle creep can impact you. If you go out to dinner more, your babysitting budget will also see a bump as well.
Hiring out chores: Your time is worth more and it seems like you have less of it. You may hire someone to take care of your lawn, clean your house or do your laundry. These chores that you took care of yourself are now a recurring expense. It can feel great to have someone else check these items off your list, but you may wish you had mowed your own lawn if it means you have to work an extra year to afford your retirement.
Better threads: Upgrading your wardrobe is another way lifestyle creep can affect you. With more discretionary income you may start to buy nicer clothes, stop shopping the sale rack first or go to full price stores opposed to discounters.
Steps to avoid lifestyle creep
Max out retirement accounts: The easiest way to avoid lifestyle creep is for the money never to see your bank account. If you increase your 401(k) contribution until you reach the max contribution level, you’ll be saving more for your retirement goals while not having the temptation of spending more.
College savings for your kids: If you are behind on starting or need to be contributing more towards your kids college savings or 529, taking any raises you have will help address this. Also when you children are out of school you’ll be able to spend that money on yourself.
Stay on budget: If you are sticking to a budget you should stay as true to your current budget as possible even when you start to get raises. If you are not using a budget and tracking things than you should start. You should remember to add some room in your budget for splurges. This will help to prevent lifestyle creep.
Pay off debt: Before you reward yourself with any purchases or bump up your 401(k) contribution you should revisit your debt situation. If you have credit cards, student loans or other non-mortgage debt outstanding this may be an opportunity to tackle it.
Set bigger savings goals: If your emergency fund is not up to par than you should look to address it. If you have other short term goals that you are saving for use your increased income to focus in on that and avoid the temptation of lifestyle creep.
You should reward yourself as your income rises but don’t lose track of your financial goals. Don’t let the golden handcuffs of lifecycle creep in your 20s, 30s and 40’s impact retirement.
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.