The slow creep of lifestyle inflation can have significant long-term implications. The key to enjoying your success now — and maintaining that standard later — is ensuring your savings rate increases more than additional spending.
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Lifestyle creep happens when your expenses increase alongside your income. As you earn more, it’s easy to spend more freely, perhaps without much thought. As income increases, it’s only natural to want to improve your lifestyle, and there’s nothing inherently wrong with that, either, up to a point. Without keeping tabs on the cumulative effect of daily financial decisions like business class upgrades or pricey dinners, it’s easy to lose track of how much you’re saving versus spending. After all, as the name suggests, lifestyle creep happens slowly.
For high earners, there’s enough cash coming in that makes it easy to cover just about any upgrade, so the cost can seem small when considering the big picture. But unless you’re tracking your saving and spending, you risk getting used to a lifestyle that you can’t support once you stop working. So the key to enjoying your success now — and maintaining that standard later — is ensuring your savings rate increases at least as much as your additional spending.
When Do Lifestyle Upgrades Become An Issue?
Improving your quality of life as your income increases is normal. We don’t know what the future holds, so it’s important to enjoy life while saving for major milestones like retirement. But there are a few ways for lifestyle creep (or lifestyle inflation) to become a problem:
- Lax financial management can turn into wasteful spending on things you don’t use or buy on a whim
- Locking yourself into unsustainable fixed costs
- Indulging so often you lose the enjoyment but continue anyway
- The keeping up with the Jones’ mentality
- A ratio of spending to saving that is so skewed it jeopardizes retirement
Again, the goal isn’t to save every dollar you can for retirement. It’s important to enjoy life today, too. Here’s how to consider the cost of lifestyle inflation and how to balance both.
What’s The Cost Of Lifestyle Creep?
The slow creep of lifestyle inflation can have significant long-term implications. After all, most people want to maintain their pre-retirement standard of living in retirement. Lifestyle inflation can be a double-edged sword: it means less money leftover today to invest for the future and greater income needs in retirement. The key to spending responsibly is ensuring your savings rate increases faster than your lifestyle costs.
Assumptions
- Starting portfolio: $3,000,000
- Milestones: 20 years until retirement, 30 years in retirement
- Current baseline annual living expenses: $200,000
- Current annual savings potential (before lifestyle inflation): $70,000
- Annual inflationary increase: 2.50% (applied to annual savings and required retirement income)
- 7% annual rate of return with 12% volatility
- Analysis excludes all tax implications
Scenario 1
Using the savings potential of $70,000 above, in scenario one we assume additional lifestyle spending of $50,000 per year (roughly $960/week, 25% more than their current expenses), leaving $20,000 to be invested for retirement. In turn, this increases the annual expenses to $250,000 per year in retirement (today’s dollars) to maintain the standard of living.
Using a Monte Carlo analysis and applying the list of assumptions above, the probability this investor will be able to maintain their lifestyle in retirement without running out of money is 75%. We typically look for a success rate of at least 80%.
Scenario 2
Now assume the investor spends an extra $25,000 per year on quality of life improvements (about $480/week, 12.5% more than their current budget). This increases the annual savings to $45,000 and reduces the retirement replacement income to $225,000. The result is a healthy probability of success of 85%.
The higher margin of safety can translate into flexibility and options later on. For example, in other variations of this analysis the investor could increase spending to $240,000 per year in retirement or retire two years earlier with the same level income of $225,000 and still stay above the 80% target success rate.
Balancing Today’s Wants With Future Needs
You can only spend a dollar once. But there’s also no prize for being the richest person in the graveyard. Being intentional about how you spend and save your money can help you maximize both. So before upgrading to business class, run the numbers to see how all your incremental lifestyle improvements add up relative to your savings.
Disclosures
Examples in this article are strictly hypothetical and for illustration purposes only. Past performance is not indicative of future results. This is a general communication for informational and educational purposes only. This article is not personal advice or a recommendation for any specific investment product, strategy, or financial decision. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. If you have questions about your personal financial situation, consider speaking with a financial advisor.
Return and volatility assumptions used in this analysis are hypothetical in nature and do not reflect the actual or expected future performance of any specific index, security, or investment strategy. Transaction costs and other investment expenses were not considered in this analysis. For simplicity, the components of return are not considered, therefore the analysis assumes the entire return is price appreciation.
