Why You Should Not Fall Into The Lifestyle Creep Trap

Sometimes I see individuals live lavishly, supported by their current income. However, they pay absolutely no heed as to whether such a lifestyle can be maintained when the cash flow subsides. What if they lose their job? What happens when one eventually stops working? How does the lifestyle adjust to the new reality? Will they be able to claw back on their lifestyle? As people earn more, they upgrade their lifestyle. On the face of it, there is nothing wrong. But the psychological impact of that upgrade and the financial ramifications are huge.

Over a decade ago, American financial advisor and planner Michael Kitces began educating people on this subject. I remember his mow-the-lawn example. I used to mow the lawn, but now I got a little more money. So, I’m going to pay someone to mow my lawn. Once I pay someone to mow my lawn, I rarely go back and mow the lawn again.

We do it with cars. The more expensive car becomes your price point. Once you are associated with a luxury car, it’s hard to go back to a “lesser” model. Similarly, once you buy a new car, it’s difficult to buy a used one again. Or maybe, even the number of vehicles in the family. Or the fact that you have a driver.

We do it with houses, too. When you stay in a 3-bedroom house, you would not want to shift to a 2-bedroom one. When you stay in a particular locality, you don’t want to shift to a lesser elite address.

We do it with all aspects of our life. Eating out is now fine dining; you only drink imported wine and beer; only branded wardrobe; the latest iPhone; a Rolex; vacation abroad.

This is “Lifestyle Creep”. The income supports this ascent up the social ladder, while investments stay at a meagre constant. You are saving less because your spending is high. Yet, it is this spending that has established a demand on your future income. So to retire, you have to have the money to maintain this lifestyle.

Take two individuals of the same age, earning the same amount, living within their means, and with nil debt. The one who spends 75 per cent of his take-home pay will have a longer road to financial independence than the other who spends 55 per cent of his take-home pay. When they retire, the one with the extravagant tastes will need much more money to maintain that lifestyle. Remember, all spending is inflationary. Be it on the Nike shoes, eating out, or frequent travel. Lifestyle creep is always accompanied by lifestyle inflation, and it makes retirement much more expensive.

Here’s how to enjoy lifestyle creep without wrecking your finances.

Pick Your Poison

It is natural to upgrade your lifestyle when income increases. It is perfectly normal to spend more when you earn more. Just don’t let it be at the cost of your financial freedom.

The danger with lifestyle creep is that it is insidious and one never really realises it. It “creeps” up on you, which explains the term. So if you are not cautious, your lifestyle costs will increase at a much higher rate than your income. Years from now, you will find yourself in a tough spot.

I know someone who doesn’t seek to upgrade his lifestyle when it comes to his wardrobe or things around the house. But when it comes to culinary matters, he upgrades. The places he eats, the coffee machine he wants to buy, and so on. Pick on areas, you desire an upgrade, while letting the others be at status quo. Or, maybe you are most comfortable with your lifestyle and want to upgrade your travel—the mode of transport, the flights and the hotels you stay in.

Individual upgrades are rarely detrimental; but cumulative lifestyle upgrades are. Recognise the difference between what you can afford and what truly aligns with your goals.

Let Savings Also Creep Up

Contrary to our intentions, many of us don’t actually increase our savings when we get a raise. As income rises, don’t do the mistake of keeping your savings (which eventually are utilised to buy assets) constant. Let your savings also rise proportionately.

At my previous organisation, they came up with a few thumb rules. These are guidelines, not truths written in stone. You can use them as a benchmark to figure out the right balance to suit your circumstances.

• Spend twice your years to retirement. If you are going to retire in 10 years, spend 20 per cent of your raise and save the remaining. If you are going to retire in 20 years, spend 40 per cent of your raise and save 60 per cent. The closer you are to retirement, the more cautious you should be about upgrading your lifestyle and more aggressive about saving.

• Save your age, as a percentage of the raise. If you are 50 years old, save 50 per cent of the raise. This is significantly more relaxed than the above rule. If you are 56, you should save 56 per cent of your raise, even if you are just two years away from retirement.

• Save at least 33 per cent of your raise. This is straightforward. If your take-home income increased by Rs 1 lakh, you should save Rs 33,000.

Design your own formula if none of these work. Someone in their 20s, earning very little, will obviously want to spend just to make life easier. That is fine, as long as they are investing at least a small amount consistently. A young couple, both earning well, may accordingly decide how much to invest (or not) depending on whether they are going to inherit property, or want to have children. But broadly, if you are close to retirement, try and save much more. In fact, if you are living well with your earnings, maybe you can stash away the entire raise.

Let Your Assets Also Creep Up

Savings must culminate into assets that appreciate over time. If you invest in stocks, make a list of stocks you want to invest in or increase exposure when the price is right.

If you are investing systematically into mutual funds, use the systematic investment plan (SIP) hack to enhance your portfolio. Check out the step-up or top-up of your SIP. With absolutely no effort on your part, you can scale up your investments in a disciplined way every year.

Let’s say you have an SIP of Rs 5,000 for 10 years, earning a return of 12 per cent per annum. If you decide to go with no annual step-up, you would have invested Rs 6 lakh and earned a lump sum of over Rs 11 lakh.

If you decide to go with a step-up of 20 per cent, it means that your investment increases by that amount every year. After the first year, it will increase by Rs 1,000 (20 per cent of 5,000). The following year, it will increase by Rs 1,200 (20 per cent of 6,000). The total invested amount would be over Rs 15 lakh and the lump sum around Rs 25 lakh.

There Is Always A Balance

You don’t have to save your entire raise, neither do you have to spend it all. The more aggressively you save, the less you spend since there is only so much extra money. The less you spend, the less goes in upgrading your lifestyle. The less you upgrade your lifestyle, the less is the pressure on future expenses. However, it is up to you to decide how much the savings should be, and where exactly you deserve a lifestyle upgrade.

By Larissa Fernand, Behavioural Finance Expert