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Understanding (and Avoiding) Lifestyle Creep

Understanding (and Avoiding) Lifestyle Creep
Harrison Fant, CFP®, AIF®
August 9, 2019

Over the years we’ve seen plenty of research and studies claim that increases in income don’t correspond to increases in happiness. One such survey, using data from the Gallup World Poll, found that the optimal household income for emotional well being was between $60,000 and $75,000 per year. The research shows that beyond that threshold, the correlation between income and happiness flattens pretty dramatically. For many Americans – especially young professionals just getting started in their careers – this may seem like a bogus finding, but by going beyond the headlines we learn that a common reason for that drop-off in financial satisfaction is lifestyle creep.

The idea of “lifestyle creep,” or “lifestyle inflation,” is that as your income increases so does your spending. It’s an easily-understood concept, but that doesn’t stop most of us from falling victim to it. When you receive a pay raise or a bonus it’s only natural to want to celebrate – you’ve worked hard for that money and now you want to reap the benefits! Unless you’re careful, though, that kind of thinking can lead you to create a new baseline for your spending. What you once considered an extravagant splurge may eventually become your new normal. This is especially true in the age of social media, where all of us are constantly comparing our own lifestyles to those around us. Those unhealthy social comparisons and unfulfilling material pursuits are a leading cause of drop-off in financial happiness as your income continues to rise.

As your income – and expenses – increase throughout your career, it becomes increasingly important to plan for the unexpected. The old saying “make hay while the sun shines” is particularly applicable in a time where 78% of American workers say they are living paycheck to paycheck. Lifestyle creep can be a major factor in many of these cases because people choose to increase their spending, not their savings, as their income goes up. Here are a few of the risks associated with lifestyle creep and how to protect yourself against them:

Hazard – Unemployment: Unemployment can deal a crippling blow to your family’s financial plan, particularly in a one-income household. How long could you comfortably cover your ongoing expenses if you or your spouse were to unexpectedly lose your job? At what point would you start to cut back on your variable expenses?

Protection – Emergency Funding: At Atlanta Financial, we always recommend keeping three to six months’ worth of expenses in the bank to protect against a sudden loss in income. While holding cash might seem boring to most people, making sure you have enough “cushion” in a savings or money market account can go a long way towards helping you cover an unexpected loss of income.

Hazard – Disability: Similar to unemployment, the risk of losing your income due to a disability that prevents you from working can be devastating to your financial security. And while it may take a few months to find a new job, a disability could last much longer or even be permanent.

Protection – Adequate Insurance: As your income and expenses increase, so too does your need for proper insurance to protect yourself and your family. In the case of an illness or injury where you’re unable to return to work, a disability insurance policy will serve to replace some of your income for as long as you’re disabled.

Hazard – Insufficient Savings: In general, Americans are not very good at saving money for retirement. When you’re just starting your career, it’s common to think that you can’t afford to save and that you’ll save more as you make more. The trouble with that plan is that as our income increases so does our cost of living, and that higher cost of living doesn’t get magically reduced when we retire.

Protection – Pay Yourself First: As with most habits, the hardest part of saving for retirement is getting started. If you can commit to saving a certain percentage of your income early in your career it becomes much easier to meet your savings goals as your income grows. By making it a priority to grow your savings rate before you increase your spending rate every time your increase rises, you can help hedge against lifestyle inflation.

Because it can affect young professionals and retirees alike, lifestyle creep is one of the most common problems we encounter at Atlanta Financial. The risks and preventative measures outlined above are just a few of many considerations associated with lifestyle creep. By working closely with one of our advisors, we can help you plan for the short- and long-term impacts of an inflating lifestyle and ensure you are prepared for any potential problems that may arise.

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