If you (or you and your partner) have established financial independence with what you have and have figured out how to get out of credit card debt among other things, you’re in a pretty good place financially. You’d think positive changes in your income—a raise or bonus, say—would only improve your financial standing, but thanks to lifestyle creep, this isn’t always the case.
What is lifestyle creep?
Lifestyle creep, sometimes called lifestyle inflation, is when living expenses and non-essential expenditures grow with income. Lifestyle creep can make activities or items that seemed like luxuries when you had a lower income or standard of living—lengthy vacations to exotic locales, top-of-the-line appliances, brand new cars, frequent meals out at high-end restaurants—seem like essentials. Essentially, it’s your lifestyle and standard of living creeping up to levels you wouldn’t have been able to maintain earlier in your life. In bad cases of lifestyle creep, this unnecessary spending can cut into savings. “The telltale sign of lifestyle creep is the mental or audible reflection, ‘How did I ever make it on less?’” says Katie Waters, certified financial planner at Stable Waters Financial. “We have found that clients are often in denial about their excessiveness and alter their definitions of moderation as their income increases.” Waters says she frequently sees clients who are determined to take an extended vacation, upgrade their homes, and buy new cars—with all those so-called (and costly) must-haves, convincing them to also add to their retirement savings can be a challenge. “None of [these luxuries] are forbidden or gluttonous on their own,” Waters says. “The creep lies in mandating that you have all of them: the house, the cars, the travel budget, the kitchen/backyard/basement/bathroom remodel, the private schools.” Lifestyle creep is most visible among high earners, but anyone can fall into this trap. Who hasn’t justified eating out more often every week after receiving a 1 or 2 percent raise? Living within your means can seem straightforward when your means are small. You can tell yourself that, after your next raise or bonus, you’ll simply save more money and keep everything else the same. But the siren call of a more costly lifestyle is difficult to resist: If you’re making enough money to afford a larger apartment, shouldn’t you move to a larger apartment? You may be able to afford that higher rent, but that increased expense will cut into your savings. “The number one culprit of lifestyle creep is spending on your credit card and paying it off every month,” Waters says. “Just as work expands to the time allotted, expenses will expand to the credit limit given—or in this case, to the income provided. Chances are, your credit card bills when you first earned a salary were much, much lower than they are now. This increase in your average monthly balance over time, especially if plotted on a graph, is the physical evidence that you’ve succumbed to lifestyle creep.” Improving your standard of living and spending more on life’s luxuries as your income increases isn’t objectively a bad thing, but when that habit cuts into your savings efforts—whether for retirement, an emergency fund, or a 529 plan for a child’s education—it can be a major financial risk. As Waters says, “Something’s got to give.”
How to avoid lifestyle creep
If you’re in possession of enough money, it is possible to have your mansion and save for retirement, too: It just takes the same moderation and planning you used when you had a smaller income. If you can, head off lifestyle creep from the beginning by giving your raise or bonus money a purpose immediately. This can be to pay down debt (you’ll thank yourself later for an extra student loan or credit card payment), save for a house, or add to retirement accounts: You want to make sure that money isn’t floating around in your account where you can see it. This way, you won’t be tempted to spend it on a non-necessity. You can enjoy your extra money, but you need to be intentional about it and do so in moderation. “When you get a raise, it is crucial to allocate those funds automatically each month starting with the second paycheck,” Waters says. “Otherwise, you will absorb it into your lifestyle and you’ll never be able to untangle it from the quagmire. For bonuses, we say carve out an amount and splurge. Treat yourself! But for the rest, allocate it to your goals that need it.” If you fear you’ve already fallen prey to lifestyle inflation at any level, you can still turn your spending around. If you are putting all your expenses—fixed living expenses and variable, splurge spending alike—on your credit card, Waters recommends rearranging so only routine, fixed monthly expenses such as mortgage payments, utilities, gym memberships, and the like are on the card. This will keep your balance manageable. “The monthly variable costs—food, clothing, personal care, gifts, purchases for the home, the list goes on—are where the statement balances creep up,” Waters says. “We prefer that clients calculate their monthly discretionary spending, cross-checking to ensure it allows them to meet their savings goals, and then physically separate out that money into a separate checking account each pay period.” Separating your money this way means there’s a fixed amount you have to spend on non-essentials. Instead of spending all the way up to your credit limit, you’ll only be able to spend the money you’ve already budgeted for discretionary spending. Waters calls this account a Play Account or Spending Account: It should include the costs of all the activities you truly can afford each month, while still setting aside as much as possible for retirement and other savings goals. To calculate how much discretionary money you can set aside each month, Waters suggests doing a three-month spending study. Print out statements—likely credit card and checking account statements—from the last three months that show all the money you spent. Categorize all non-essential expenses, calculate a monthly average, and add all of it together to find your monthly Play Account budget. (It may need some balancing to ensure you’re still accomplishing your savings goals.) Waters says she has clients set up recurring transfers to fund the Play Account with the allotted amount of money. Everything in that account is available to be spent within that month or pay period: “This frees our clients up from needing to track their spending, and instead requires them to simply check the balance of the account frequently and use the amount and time until their next infusion of cash to make decisions about spending,” she says. Expenses, taxes, insurance, and savings should all come before non-essential spending in this calculation. Make cuts as needed until expenses are 50 to 55 percent of your gross income: Waters says this allows her clients to balance a good retirement with their lifestyle. (Most people she sees put 63 to 68 percent of their income toward expenses before making adjustments.) “As with all things, the secret to managing your finances like an adult is a constant strive for balance,” Waters says. “Have fun along the way, but don’t let the tail wag the dog.”
