Beware The Lifestyle Creep
I once knew a guy who was a top executive at a very successful communications company. Obviously, I never knew how much he was making, but I think it would be reasonable to assume it was a hefty 6-figure salary, as well as other benefits. He had a beautiful house in the most desirable part of the city, a luxury car, and was always dressed in expensive suits.
Then, out of nowhere, there was a shakeup within the company and he found himself unemployed for the first time in decades. Within 18 months, he was broke.
How could this happen to someone making so much money for such an extended period of time?
Let’s look at a more extreme example.
Terrell Owens is regarded as one of the greatest American football players of the last 30 years. In 2004, he was paid $10 million just as a signing bonus to join the Philadelphia Eagles. Over the course of his career, he earned approximately $80 million. Yet, just one year after retirement, he too was broke. This appears to be a big problem within the NFL, with almost half of professional players running into financial difficulty by the time they are fifty.
Lifestyle creep, also known as lifestyle inflation, is a phenomenon that occurs when, as an individual spends more resources on their standard of living, previous luxuries become seen as necessities. Typically this occurs when someone gets a big promotion causing a boost in income. However, it can also occur when there are decreased costs of living, for example, when a mortgage is paid off. Anything that causes discretionary income to increase, can lead people to begin to spend frivolously — perhaps buying a second home or joining an exclusive sports club.
More insidious, perhaps, is that former one-off treats, like going to an expensive restaurant, or even buying a daily cup of coffee, become logged in the individual’s brain as a right, rather than a choice. This is particularly common as young adults migrate from their days of student living to the professional world, where they can go from having very little disposable income to having an abundance of it. It doesn’t help that others in their social group will also be experiencing the same improvements, leading them to compare their lifestyle to others. It is also around this time that they will get wider access to credit, which can compound the issue.
It doesn’t happen all at one time. It’s gradual, leading many people to not notice until they become laden with debt or spending well outside their own means.
The negative impact of lifestyle creep can be most obviously witnessed when there is a sharp decrease or loss of income, which is why it’s seen so commonly in professional athletes, who go from making millions a year to nothing when they get too old. This is exactly what had happened with the executive I knew. He was living outside his means, even with his extravagant salary. His financial situation was dependent on that salary being consistently maintained, or even increasing. When it went to zero, he suddenly realised that his cost of living had become outlandish, and the money he thought would see him through a comfortable retirement, disappeared rapidly.
How can this be avoided?
It all comes down to discipline in your saving and investing. A good rule of thumb is to be saving at least 10% of your take-home pay. However, to prevent lifestyle creep, experts suggest that as your income increases, you should try to save 75% of every extra dollar, until you’re saving closer to 20% of your take-home pay.
This can be difficult. It’s hard not to get excited about a big pay raise and want to celebrate with some long-desired luxury purchases. One good tip is to always “pay yourself first”. This means setting up a direct deposit to put money into your savings as soon as you are paid each month. This is the total opposite of what most people do — saving what they have leftover at the end of each month. That way, in order to overspend, you actually have to take action and remove money from your savings account, rather than simply not take any action. It’s a small but important psychological nudge that could see you greatly improve your financial future.