Ryan Frailich, CFP®
A Simple Rule for Battling Lifestyle Inflation
Lifestyle creep. Lifestyle Inflation. Keeping up with the Jones’. By whatever name, it’s well-documented that for most people, as earnings increase, spending goes up right with it. Before you know it, you’re earning double the first salary you got coming out of college, but have just as many expenses to go with it. New car. No more roommate because you live alone now! Three happy hours per week have replaced your old two drinks on Friday. Upgraded hotel rooms.
Realistically, everyone should increase spending as their income increases, because who wants to live like their 22 year old self forever. That sounds terrible. My first house out of college had a massive floor furnace that burned our feet, a washer/dryer that required a series of pans and paint trays and tubes to run water outside of the house instead of all over the floor, and the ceiling once caved in while it was raining. Picture a ceiling fan throwing incoming rain to all corners of the room. Yep, that was where I lived. At the time I didn’t realize just how terrible it was but somehow I don’t think I’d be ok with that house now.
The challenge then becomes: how do I hold myself to a system of giving my current self some increases in living, without taking too much from the wants I have in 5 years, or even, if you can imagine it, 35 years?
One of the most effective ways to balance between the paragraphs above is to set a rule of spending 20% of any new influx of cash, while committing the other 80% to reducing debt or increasing savings. This rule has three primary advantages:
1) It provides a clear structure to drive decisions around new cash.
2) It ALLOWS you to inflate your lifestyle, but at a healthy amount.
3) It’s entirely flexible for small amounts, like finishing a student loan payment of $100/month, or large amounts, like getting a new job that has a $15,000 annual raise.
How does this work in practice? Let’s look at three different scenarios that come up.
Scenario 1: At your annual review you get a raise of $5,000. Congratulations! A raise of $5,000 works out to $417/month, which is substantial to most everyone I know. Since we know that money that hits the checking account gets spent, you want to make sure this new cash doesn’t sit there for long. You’re going to take $333/month and put towards your highest priority within your financial plans, whether that’s building your emergency fund, paying down high interest debt, or if you’re lucky enough to have checked both of those boxes, increasing your retirement, home, or other longer term savings. Plus, you’ve now got an additional $83 to spend on whatever makes you happy, whether that’s a couple restaurant meals, a better gym membership, concerts, new books, or whatever else you find fulfilling. Enjoy!
Scenario 2: You’ve been paying $300 per month for your car, and you just fully paid it off.
First off, kudos to you for paying the car off in full. It’s a major financial milestone, and provides a significant boost to your monthly cashflow. Let’s apply the rule above. Sweet, $60 you can spend as you please. Enjoy. Now allocate and automate the $240 to other important financial goals. I’ve even seen people take the $240/month and continue saving it in a specific savings account to use for future car repairs and eventually, to purchase a new car altogether. If you drive that car for another 5 years, you’d have $14,400 saved up to buy a car. Even assuming you’ll have to spend a chunk of that on repairs, it’s safe to say you’ll be more than ready to put a significant down payment towards your next car.
Scenario 3: You got a tax refund of $1,000.
Great! A sudden influx of cash is wonderful because it lets us turbo charge whatever we see as our biggest financial priority. First, pass go, collect your $200, and spend it as you wish. Take the $800 and knock out your nagging credit card debt or use it to start that travel fund you’ve been meaning to get going.
But wait, Ryan, why shouldn’t I just save all of it? Yes, of course, the math says if you have high interest debt or are only saving 8% for retirement or don’t have a full emergency fund, then you should put every dollar you have towards those things. But baby steps matter. Progress matters. Trying to make the best use of every single dollar, every single day, is no more effective than deciding to cut out sugar entirely when you’re currently eating Frosted Flakes for breakfast and doughnuts for lunch. It’s a recipe for failing, and then feeling bad about your having failed, and then spending money to make yourself feel better, only now you feel even worse because you failed at budgeting in the first place and then compounded it by trying to spend out of your sadness. If humans were robots, sure, but we’re not, so give yourself just a little slack.
The beauty of this is that it is a wholly flexible rule for anyone, in any situation. It even works if you’re someone who gets a new job with a $50,000 bump from your previous salary. It gives you a framework to have pre-decided what you’ll do well ahead of actually having the dollars, so your past self can hold your future self responsible for not blowing it. Help your future self out by committing to this, and you’ll look up in a decade and be astonished at how much financial progress you’ve made.