Increasing Income and the Temptation of Lifestyle Creep

When you get a big raise or a significant promotion, you naturally want to celebrate. This may include treating you and your spouse to dinner out or a vacation you have been talking about for years. It might also mean you are going to increase your spending to coincide with your new income growth. Lifestyle creep is something that impacts people in different stages of life. It is particularly important to recognize and avoid before it affects your financial goals.

What is lifestyle creep?

Lifestyle creep is when your standard of living increases as your discretionary income rises because you start to earn more money or your expenses drop. As you begin to receive raises or payments like student loans, cars, or mortgage are paid off, the additional cash you now have is spent rather than placed into savings. Items that used to be luxuries now are considered essentials to your daily life.

Why do you need to recognize and avoid lifestyle creep?

Avoiding lifestyle creep may seem like a prudent financial move, but as we earn more, we are going to want to spend more. The common assumption is that you will see consistent earnings growth throughout your entire career.  There is strong evidence that challenges this assumption. Two studies from the Federal Reserve of New York and the Department of Labor show our assumption that income will continue to grow throughout our adulthood is NOT TRUE. Most earnings growth occurs in our 20s and 30s, slows down in 40s, and turns negative in 50s. 

This information is the key to why we need to avoid lifestyle creep. The temptation is always strong to push off saving for our financial goals until later and enjoy living in the moment. Our assumption that we’ll be able to save more later may prove to be a challenge.  If our income could be declining in our 50s, this may be when we have planned to play catch up. After years of self-generated inflation, you could be squeezed having to save more to reach your financial goals while your income is deflating. 

How does lifestyle creep sneak up on you?

Buying a bigger house: As you mature in your career, this can coincide with starting a family or seeing your family expand. Since you can afford a bigger home, the draw is there to upgrade to more square footage. With a larger house, you’ll see your mortgage increase as well as other expenses like utilities, maintenance, taxes, and insurance. Before you move to a more expensive home, check your budget and run the numbers to see what the other items will cost you before you move.

Upgrading or leasing a better car: We have all had a car that we have dreamed of buying. It may be a dream car from your teens or a bigger SUV to make hauling all of your kids’ stuff around easier. Upgrading your vehicle is one of the easiest ways we see lifestyle creep enter your life. You can afford the bigger car or lease payment but this recurring bill will have a big impact on your monthly budget.  Car payments can be a budget buster.

Splurges become necessities: The things you used to treat yourself to become everyday habits. Your occasional Starbucks on the way to work becomes a daily ritual or you ditch your brown bag for lunch and start going out for lunch every day. These seemingly small costs become large numbers at the end of the year.

Eating out more: Going out to dinner and to nicer places may seem like a reward for your new income. Americans are spending more eating out than at home and this is another way that lifestyle creep can impact you. If you go out to dinner more, your babysitting budget will also see a bump as well. 

Hiring out chores: Your time is worth more and it seems like you have less of it. You may hire someone to take care of your lawn, clean your house or do your laundry. These chores that you took care of yourself are now a recurring expense. It can feel great to have someone else check these items off your list, but you may wish you had mowed your own lawn if it means you have to work an extra year to afford your retirement. We are big fans of trading time for money, but it has to make sense in your budget.

Better clothes: Upgrading your wardrobe is another way lifestyle creep can affect you. With additional discretionary income you may start to buy more expensive clothes, stop shopping the sale rack first, or go to full-price stores as opposed to discounted ones. Before you ditch Target and TJ Max for Lululemon and Nordstrom understand how it fits with your cash flow plan.

Steps to avoid lifestyle creep

Max out retirement accounts: The easiest way to avoid lifestyle creep is for the money never to see your bank account. If you increase your 401(k) contribution until you reach the max contribution level, you’ll be saving more for your retirement goals while not having the temptation of spending more.

College savings for your kids: If you are behind on starting or need to be contributing more towards your kids college savings or 529, taking any raises you have will help address this. Also when your children are out of school you’ll be able to spend that money on yourself.

Stay on budget: If you are sticking to a budget, you should stay as true to your current budget as possible even when you start to receive raises. If you are not using a budget and tracking purchases then you should start. You should remember to add some room in your budget for splurges. This will help to prevent lifestyle creep.

Pay off debt: Before you reward yourself with any purchases or bump up your 401(k) contribution, you should revisit your debt situation. If you have credit cards, student loans, or other non-mortgage debt outstanding, this may be an opportunity to tackle it.

Set Bigger Savings Goals: If your emergency fund is not up to par then you should look to address it. As your income grows so should your savings and investment goal. Saving 20% of your income when you earn $100,000 is great but when you earn $200,000 or more your percentages will need to climb as well.

Bottom Line

You should reward yourself as your income rises but don’t lose track of your financial goals. Don’t let the golden handcuffs of lifecycle creep in your 20s, 30s, and 40s impact reaching your long-term goals. 

Andrew Comstock, CFA