TJ PorterBy T.J. Porter, WCI Contributor

Lifestyle inflation—and the associated increase in spending—is something that’s very easy to which physicians can succumb. After spending years in school and living on a smaller income, you’ll suddenly be earning hundreds of thousands of dollars per year. What harm could come from spending a bit more?

The truth is that lifestyle inflation when taken to extremes, can be significantly damaging to your financial life. Understanding what lifestyle inflation is, how it impacts your finances, and having strategies for handling it are key.

 

What Is Lifestyle Inflation?

Lifestyle inflation is a phenomenon that often occurs as people get more established in their careers and increase their earnings. When someone earns more, they tend to spend more money on their lifestyle. After all, if you’re used to living on, for example, $60,000 a year and now earn $100,000 per year, you now have an extra $40,000 a year to do with as you please.

Common symptoms of lifestyle inflation include doing things like going to restaurants more frequently, taking more vacations, or driving more expensive cars.

The problem with lifestyle inflation is that maintaining that lifestyle now becomes more expensive. If you buy a pricey car or a bigger house, you need to pay a larger mortgage or auto loan until you pay off that loan. Continuing to take as many vacations as you’ve grown accustomed to requires more spending on travel.

That increased level of spending means that you’ll be saving less of your money—at least as a percentage of your income—which can have major implications for your finances. There are also important quality-of-life considerations.

More information here:

Moving The Goalposts – Attack of the Lifestyle Creep

 

The Hedonic Treadmill

When it comes to lifestyle inflation, one very important concept to understand is the idea of the Hedonic treadmill. According to this theory, people tend to have a baseline level of happiness. Changes in their life can cause them to be happier or more unhappy, but over time they’ll generally revert to that same baseline of happiness.

If something good happens to you—such as an exciting event in your life, a vacation, or winning an award—chances are it will make you happier than you typically are. But eventually, the effect will fade, and you’ll revert back to your baseline. Similarly, something negative—such as a death in the family or an injury—could make you unhappy, but over time, you’ll recover and return to your typical level of happiness.

According to the idea of the Hedonic treadmill, lifestyle inflation only buys temporary happiness. Sure, buying a nice sports car may be exciting and a lot of fun for a while, but eventually you’ll get used to driving a fancy car and it’ll just feel normal, putting you back at your baseline.

What’s worse is that once you’ve adapted to having a nicer car, if your circumstances change and you need to go back to driving the basic sedan you once drove, you’ll be less happy than you were before your lifestyle inflated. That means that you’ll need to maintain your higher level of spending just to stay as happy as you were when you inflated your lifestyle.

 

How Much Money Do You Need to Be Happy?

Though the old saying states that money can’t buy happiness, surveys and research have shown that money is a key component of being happy with your life.

Depending on the survey or study, the magic number falls somewhere between $60,000-$100,000. Generally, people who make less than that amount get happier as their earnings increase. Once their earnings hit that magic number, the Hedonic treadmill starts to kick in and additional income doesn’t lead to any additional happiness.

These surveys aren’t the most scientific out there, and there are obviously other factors at play. And remember, $100,000 will go a lot further in Kansas than California, for example, but they’re still useful to illustrate the real effect of the Hedonic treadmill and that spending more money on things won’t truly make you happier.

More information here:

How to Avoid the Traps of Lifestyle Creep

 

Lifestyle Inflation and Retirement

Lifestyle inflation doesn’t just affect your immediate spending habits and financial situation. It also has a big impact on your retirement plan.

A common rule of thumb, popularized by the Trinity Study, is the 4% rule. This rule states that when you retire, you can withdraw 4% of your investment portfolio each year, adjusted for inflation, and have better than 95% odds of not running out of money over the next 30 years. So, if you spend $80,000 per year, you need an investment portfolio of $2 million to sustain that spending in your retirement.

Lifestyle inflation means that you spend more money each year. That increases the amount that you have to save to maintain your desired lifestyle during retirement. Depending on the scale of your lifestyle inflation, it may also cause you to save a smaller percentage of your income over time, making it harder to reach your retirement goals.

Consider this example:

Two physicians want to retire as soon as possible. Neither has any significant savings, and both recently got a raise from $100,000 per year to $200,000 per year after tax.

One continues to spend $100,000 per year and saves the remaining $100,000. The second experiences lifestyle inflation, increasing their annual spending to $160,000 and only saving $40,00 each year.

To retire with a $ 100,000-a-year budget, the first doctor will need to build a nest egg of $2.5 million. The second doctor, spending $160,000 each year, will need to save $4 million. Right away, the first doctor has the advantage because they need to save $1.5 million less to reach their goal. Compounding their advantage, the first doctor can also save more each year because they spend a smaller percentage of their income.

Assuming average returns of 6% after inflation, the first doctor will have $2.5 million saved after 16 years. The second doctor needs to save much more money to retire but saves less each year. To accumulate $4 million by saving $40,000 per year, they’ll need to work for another 34 years.

 

How to Deal with Lifestyle Inflation

As with everything, moderation is key. Living like a resident for your entire life isn’t realistic. You should feel free to enjoy the reward of your long years of education and hard work. At the same time, spending every penny you make and increasing your spending as your earnings rise won’t lead to happiness, and it could place you in a precarious financial position.

Use these tips to deal with lifestyle inflation:

 

Make a Budget and Track It

One of the easiest ways to fall into lifestyle inflation is to do so accidentally. If you’re used to making a certain amount and your income rises, it’s easy to feel like you have a bunch of extra money kicking around and that spending it couldn’t hurt. Building and following a budget helps you be mindful about your spending and saving, and it can help you avoid accidentally giving in to lifestyle inflation.

 

Avoid Purchases That Come with Ongoing Expenses

lifestyle creep

Some things that you spend money on are one-time purchases. Buying a new television or going on a vacation are both one-time expenses. Once you make the purchase, you don’t have to keep spending money.

On the other hand, a purchase like a new car or a bigger home comes with associated, ongoing expenses. On top of having to pay your mortgage or auto loan, you’ll need to pay for upkeep and maintenance and other ongoing expenses, meaning that your purchase has a long-term impact on your budget and spending.

 

Try to Save a Consistent or Increasing Amount of Your Income

A good way to balance improving your lifestyle without going overboard is to make a savings target based on a percentage of your income.

For example, you might make it a goal to save 30% of your income. If you make $100,000 per year, that means saving $30,000 per year. If you get a raise to $150,000, you’d dedicate $15,000 of that additional income toward saving but give yourself the freedom to spend $35,000 more each year.

More information here:

Spend Intentionally

 

The Bottom Line

It’s natural to want to increase your spending and to buy nice things as your income rises, but it’s important to make sure you don’t fall prey to lifestyle inflation. Getting too loose with your money as you start to earn more can lead to long-term financial problems and make it more difficult to retire.

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