“…for any income tax rate above 20%, the average American must take on debt to support their lifestyles. So where is this money going exactly?”

Financial Friday: How Lifestyle Creep is Ruining Your Financial Health

18 min read

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Welcome to The Wealthy Healthy, the podcast and blog dedicated to inspiring better mental, physical, and financial health. Today’s Financial Fridays episode is an exploration of the very common instance of increases in income, increases in general wealth, or increases in job title leading people to inflating their lifestyles in what’s called lifestyle creep or lifestyle inflation. Spoiler alert: it’s essentially the worst thing you can do for your actual financial health, status, and realized wealth.

Survey after survey after survey reveals an interesting, and harrowing, trend in American culture. Despite being a wealthy, developed country that many call — for good reason, in many cases — the “land of opportunity,” most Americans are in a financial situation in which they have little to no savings to their names. To give you a few of the most recent figures, a Google Consumer Survey for GoBankingRates.com found that around 62% of Americans have less than $1,000 in a savings account and 21% have no savings account at all. Now, there’s a little bit of a possible semantics issue here – there are probably many people who have money that isn’t being kept in what would strictly be called a savings account — I myself have a few accounts yet keep less than 15% of my net worth in a traditional savings account.

But with that having been said, many other surveys still point to very similar results when assessing other criteria of savings or financial health. A 2015 survey by Bankrate.com found that 62% of Americans have nothing saved that they can access in the event of a $1,000 emergency room visit. Ignoring the unusual coincidence that both surveys came to figures of 62%, this is more an affirmation that the “savings account” wording might only explain away a fraction of a fraction’s worth of the results — certainly not enough to mar the original finding.

In an emergency situation, 28% of the Americans surveyed in the Bankrate study suggested they’d turn to family and friends for a loan, or knowingly place themselves in credit card debt — which in itself is another story for another day, no doubt. So again, maybe this is an issue of liquid savings and savings accounts and checking accounts — perhaps Americans are keeping piles of money in accounts that aren’t as easily accessed for emergencies, such as 401ks, Roth IRAs, 403bs and so on.

Well, a 2016 report by the Economic Policy Institute suggests that nearly half of American families have no retirement savings at all. That’s pretty rough, so let’s find some actual dollar amounts. The EPI also reported that the mean — so the average amount saved in for retirement purposes by American families — is a little under $96,000. But of course we all know how averages work… if you take 10 families and 9 have absolutely nothing saved but the 10th has $10,000,000 saved, your average is $1,000,000. Not super informative. The median would be more informative, and that reveals a similar story to what we’ve been discussing so far: the median for all families in the U.S. is $5,000. From ages 56 to 61, the median total savings including retirement savings is $17,000.

On episode 2 of the show, I go more in depth on the math behind financial independence, the level of accumulated wealth necessary to support your lifestyle expenses without work, so if you’re wondering what retirement savings should look like, refer to that episode for advice and a breakdown of the easy math behind it.

The reason I bring up all of those harrowing numbers though is that there is a simple explanation for why so many Americans are one paycheck away from credit card debt, let alone in such poor positions to actually comfortably retire. Now of course there are a bunch of potential explanations for and sources of money problems so let me knock out those objections first: yes, coming from a poor family, growing up in a low income or crime-ridden area, experiencing medical emergencies, theft, accidents, legal trouble, divorce, these are all things that can have a damaging effect on financial health, but my guess is that these factors alone can only explain a minority of cases of financial hardship.

Enter the concept of lifestyle creep, or lifestyle inflation. From a 2013 study by the Bureau of Labor Statistics, the average American’s income BEFORE taxes is about $64,000, while the average annual expenditure is $51,000. In fact, comparing that to the BLS’s study from two years prior, the average income was nearly identical but spending was $1,400 less on average in 2011 compared to 2013. So what does that mean? The average American isn’t earning any more, but they are spending more. And keep in mind the average salary is BEFORE tax and the expenses are, of course, after taxes. This means that for any income tax rate above 20%, the average American must take on debt to support their lifestyles. So where is this money going exactly?

Of course, a majority goes to housing, transportation, and insurance associated with each. The average American in 2013 spent $1,429 a month on housing. The typical rent cost in 2016 is around $1,200 depending on size — this means that, if we’re standardizing these expenses, a TYPICAL american is spending $200 a month more per month than they should. Of course, mortgages can cost more than rent, but this is exactly the point. The first big area where Americans inflate their lifestyle is housing. Upgrading to bigger houses in better neighborhoods is accepted as the commonplace, American dream, “what you’re supposed to do” lifestyle.

The next area is transportation, an average of $9,000 a year or $750 a month. There was a 21.1% increase in spending on vehicle purchases from 2014 to 2015. Americans spend an average of $33,560 on a car. $33,560! For a car! I can totally understand that expenditure for someone who is a car person AND a high-income earner purchasing their only car. Even people who need a larger truck for family or occupational needs could be purchasing a great used vehicle — a quick Google search turns up tons of 2006 Ford F150s under 100k miles and under $10,000, and similar GMC pickup trucks around the same. These cars are notoriously able, with proper care, to last insane numbers of miles before requiring replacement.

And here’s something interesting: the average American spends $1,315 a year on education. This is the single smallest expenditure analyzed by the BLS. Do a Google search for BLS Consumer Expenditure reports and look for yourself. More than double is spent on entertainment, more than double on eating out, triple on new vehicle purchases, 50% more on apparel and services… these education costs typically refer to students loans and their associated interest and late charges. So while this is a little devil’s advocate on my part, as I wish education were free and easily accessible for everyone in the U.S., it is interesting to consider where priorities lie.

So assess your own situation. Are you living within your means, enough that you’re able to sock a little bit away for savings? Look at your house or rent, your car – these are your big expenses. Of course, taking a look at the small expenses is important too, as it’s clear Americans are likely spending too much on material goods and eating out. I don’t necessarily advocate for major decreases in “entertainment” spending, as long as it’s within good reason, as I think these are the types of expenses that truly have a net positive effect on enjoyment of life and the mental health benefits that come with it. Outside of keeping a roof over your head and food on the table, one of the better things money can buy is great experiences, whether it’s small trips, concerts, hobbies etc.

Now, what’s the key to avoiding this lifestyle creep? There are a few really simple strategies that I think most people can start right now, nearly regardless of what their current financial situation looks like. So even if you already have a luxury car and a mortgage that’s stressful to keep up with, some of these basic adjustments can help.

First thing’s first, and that’s to pay yourself first. Do this however you need to, but the best way to go about this is to automate, such as an automatic contribution to your employer 401k with each paycheck. With most providers this is very straightforward to change up or down as you need, and by setting this up you guarantee that you can’t be tempted by the money as it will feel like money you never had in the first place. If you can commit just 10 or 15% of each paycheck in this manner, you’ll find ways to cut back in other areas of your life to make the portion of your paycheck you DO receive cover your expenses effectively. If you’re comfortable at that level, increase your savings rate until you’re close to stretching — the higher you can get your savings rate while still enjoying your life to a reasonable extent, the better. Check out episode 2 on financial independence for the math behind this, but suffice to say that it’s the RATE at which you save that influences how soon, or if ever at all, you’re able to retire or have the freedom to choose anything you like as a career.

Now… if you can’t survive on 85-90% of your post-tax paycheck, and you’ve made an earnest effort to decrease unnecessary spending, then odds are you should be focused on increasing your salary. People often ask how they should invest their money when they have a low salary — one of the best things you can invest in is yourself. Dedicate time and money as needed to improve your skillset and make you more employable. This might come in the form of taking classes at night to chip away at a degree, or in independent study programs, online education, books and more. Even if you have a degree and earn a good income, you should be spending some time and money on keeping up in your space, or getting ahead. Your ongoing education will help you maintain your ability to continue earning a high income, or to begin earning one. These things don’t happen overnight, but getting started now will get you to that finish line faster than you realize.

The second easy change to make is to break down your expenses — really spend an hour or two with your credit statements — and identify areas where you’re spending on things you don’t need. I’m not saying cut out all of these things — just identify those areas. If you’re able to afford those extra expenses, and they bring you more happiness and enjoyment than material upgrades, then keep them around. But just knowing where your money is going can help you cut down spending you decide is low priority, and to keep in mind spending that is “optional.” For example, I have a Spotify membership, an Xbox Live membership, a gym membership that isn’t the cheapest one I could find, a 6 GB data plan, and so on. These are expenses that bring me entertainment, health, or comfort, usually on a daily basis, so I choose to keep them around. But the key is, if I came home tomorrow unemployed, I’d know right off the bat the areas I can cut down to make things easier while I’m overcoming that new obstacle. So be sure to analyze your expenses.

The third tactic is to set budgets! There are great tools out there like youneedabudget.com and the Mint app that can help set and track your progress against these budgets. Some prefer to do this manually via spreadsheets which is an option as well – pick whatever suits you. I personally track my accounts in Mint, but have heard great things about “youneedabudget” (YNAB) for those who require a little more discipline and structure to how they assign budgets to different spending categories each month.

The last tactic to employ to prevent lifestyle inflation is to simply know what your expenses look like, and never making large increases to that no matter what, even when you get a raise or a promotion. If your annual expenses are $35,000 a year and you join a new company and this increases your post-tax income from $40,000 to $55,000, but you keep your expenses exactly the same, your savings amount went up from $5,000 to $20,000, but even more importantly this takes your savings rate from 12.5% to 36.4% – you essentially tripled your savings rate, which in a pretty literal sense triples the speed at which you become able to retire, pay for emergencies when they arise, and so on.
The rat race especially does a particularly good job of roping people into this way of life. That’s why phrases like “golden handcuffs” and “keeping up with the Joneses” exist. Focus on what you’re doing and what your goals and priorities are, rather than on what others are doing. It’s easier said than done, without a doubt, but with a few tweaks, you can make it that much easier to avoid lifestyle creep. Your future self, and your family and future family, will thank you profusely.

As always feel free to share your thoughts, your praise, your criticism, anything constructive as it all serves to make the show better.