Lifestyle Creep and How to Avoid It

Lifestyle Creep and How to Avoid It
31 Mar 2017

No I’m not talking about the plot of a scary movie.  Though the idea of Lifestyle Creep could possibly be a Hollywood Blockbuster.  I’m talking about the idea that over time, as we earn more, we spend more, oftentimes without consciously making the decision.  The trouble with this is that it occurs without us noticing.  The only way to combat it is to have a game plan.  Perhaps the easiest way to discuss Lifestyle Creep is to look at a couple of hypothetical examples.

Two Stories, Different Results

Let’s take a look at a hypothetical typical couple.  They begin their careers making $40,000 between the two of them and decide to start saving.  After checking their budget, they determine that they can afford to put $10,000 into their retirement accounts.  They continue to work for the next 40 years, but never change their contributions from the $10,000 mark.  Let’s suppose they earn 6% over the life of their investment accounts.  They would be walking into retirement with approximately $1.5 million in their investment accounts.  Not bad considering they made total principal contributions of $400,000 over their investment life.

The issue is when we start to take a look at inflation.  Even if we discount this by the rate of their contributions to $30,000, they would need to create about $97,800 in the future at a 3% inflation rate to have the same purchasing power.  This is a distribution rate of nearly 6.3% in order for them to sustain the same lifestyle they have grown accustomed to.  Granted this is not taking social security or other incomes into the equation.  I would argue that most investment professionals wouldn’t think that a 6.3% withdrawal rate is sustainable over any long period of time.

What if this same couple increased their retirement contributions by 2%, then spent the rest on themselves.  Over the same time frame, they would make contributions of approximately $604,000 to their retirement accounts.  Given the same rate of return, this would grow to be approximately $2 Million or approximately 30% more than our other hypothetical example.  Using the same assumptions above, our distribution rate is now approximately 4.8%, rather than 6.3%.  Clearly, the small changes can make a huge impact.

What’s the difference?

In terms of their lifestyle, I would argue that initially there wouldn’t be a noticeable difference between how the two households were run.  As we progress into the future, we may start to notice some staggering differences.  Does this mean that the second scenario couple would be sacrificing in excess?  Is not having Lifestyle Creep going to affect their quality of life?

I would imagine that if we looked at them many years into the future, they wouldn’t tell us that they have given up too much.  As you recall, they have been able to increase their lifestyle continuously each and every year.  Maybe not to the extent as the first scenerio, but they have increased it nonetheless.  They have also put themselves into an interesting situation as they are now used to living on less.  They could certainly bump their lifestyle up to the same level of the first couple and be able to sustain it for a longer period of time.  My guess though is that they would have become used to a slightly lower lifestyle.  This allows their investments to continue to sustain them for an even longer period of time.

One thing that we cannot forget in the Personal Finance world is that one decision will impact the future outcome.  What we do today can have huge implications for the future.  Small changes in our current lifestyle can mean living the future lifestyle we desire. Or having to pick up part time work in retirement to cover the income gap.  This is just another demonstration of the importance of having a plan.  This allows you to affect your future circumstances, rather than your circumstances affecting the future you.

 

Today is the day, make it count!
Casey

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Casey Mushrush

Have a question or want to see a post written about a specific subject? Send me an e-mail at casey.mushrush@premieriowa.com. I am involved in many of the educational elements of Premier Investments of Iowa, including appearances on WMT Radio, WHO Radio, KXEL Radio, and KCRG Television. In addition, I am a frequent guest host of the Premier Pulse, a personal finance education video blog. I partner with my clients to develop a specific set of financial goals based on their personal situation. We analyze their state of affairs, map out a course of action, and implement a written financial plan based on their own circumstances. We design and implement a long term investment strategy guided by the principles of asset allocation and based on personal risk tolerance. I utilize behavior coaching to help clients deal with the emotional aspects of investing and stick to their long term plan. Additionally, I am responsible for the practice management of an Office of Supervisory Jurisdiction. I aid our advisors by ensuring they are running their businesses in a compliant manner, as well as providing direction and suggestions on process improvement and implementation.