Limerick financial adviser offers tips on how best to avoid ‘lifestyle creep’

I RECEIVED an email from an individual recently who reached out to me about a year ago looking to connect and have a financial review carried out for him and his wife. And he said that between one thing and another they couldn’t follow through and meet me at the time and that was fine - sometimes life just gets in the way.

The good news was that now they had more time and they were finally ready for me to put a plan together for them. So, I sent them a new questionnaire to complete because the one I had on file was a year old and I wanted it updated. And the questionnaire is a request for information which gives me a high-level picture of what their financial life is like.

And they returned it to me with a note saying that nothing much had changed since last year other than the very good news that both of their incomes had increased, so they thought they were in a better position than they were last year. Great to hear.

In advance of our meeting I began my own preparation by looking at the questionnaire they sent me last year so I could compare it against the new one, and yes some things had improved i.e. their mortgage had reduced, his pension fund was up and yes their monthly income had increased and by a substantial amount at that. His increased by c. €610 and hers by about €505 per month.

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But there was something on their new questionnaire that they hadn’t told me about and it wasn’t there last year either, and that was two car loans. And the new monthly repayments on each were €398 and €438.

I instinctively thought that perhaps their previous cars had to be changed but that wasn’t the case because I could see from my notes from the initial meeting we had a year ago, that they had two cars with no loan on either and the cars were registered in 2018 and 2020.

Anyway, the scores on the doors so to speak was that their income had collectively increased by a net 16% each month which was excellent but when you factor in their two new car loan repayments, the increase was really only 4%.

I thought for such a big increase i.e. €1,115, to be left over with only €279 was a bit disappointing and I wondered, were they really making best use of this new money? I didn’t know but I thought probably not.

Because when you get a raise and theirs was a significant one, when you use the majority to finance two cars, it was just putting them in more or less the same position they were in before they got their raises. In fairness they probably had two nicer cars to show for themselves but they had two nice loan repayments as well.

And if they asked me before they purchased the two cars, how much they should set aside for monthly repayments?
In total, I would have said €444 and not €836. If they followed an income increase rule which says that if you get a raise, the percentage you are allowed to spend is twice your years to retirement, they would have arrived at this €444 figure.

And the spend twice your years to retirement rule means that if for example you had 20 years to retirement, you are allowed to spend 40% of your raise and save the rest. If you had 25 years to retirement you can spend 50% and save the rest and so on. If they followed this rule it would have left them with a healthy €671 or 60% of their raise which could have been applied to other areas of their finances.

And if they thought the €392 they were paying more on the car loans than they should have been, would make much of a difference then they should think again because:

If they used €292 of it as an overpayment on their mortgage it would have reduced the term by five years and one month and

If they used the other €100 and made an AVC contribution to her pension fund it would have increased the value of her fund at retirement age by €95,353

It was a pity they didn’t speak with me before they bought and financed those two new cars of theirs because what happened to them was textbook lifestyle creep which is also known as lifestyle inflation. And very simply this occurs when a person starts spending more money when they start earning more money.

So, as your income increases so do your outgoings and in many cases at a higher rate than your new salary.
The new cash gets spent as fast, if not faster than when it comes in. And it doesn’t have to happen just from increases in salary, it can happen when a previous loan you were paying comes to an end and rather than continuing to put that money away into say a savings account, it's spent instead.

And you might think that an increase in salary will mean you'll have more money in your bank account, but this isn't always the case. In fact, lifestyle creep can make it so that you have less money. And it happens because as your income changes, you sort of give yourself permission to spend more.

The problem with doing this is that after a couple of months you can’t readily identify where that new money is now going and you begin to wonder how you ever survived before your raise. But if you analyse what you spend your money on, you’ll find it easily enough.

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It’s likely to be going on higher debt repayments, more nights out, more expensive clothes, work on your house, more deliveries from Amazon Prime etc.

That couple I was talking about were probably perfectly happy with their ‘18 and ’20 reg cars a week before their raise, but when their new salaries hit their account, suddenly the two cars looked a lot more run down in their eyes. And it’s easy to get caught up in spending your newfound income without giving it much thought.

It could have been a long time coming and hard earned and people typically don’t know what the ideal percentage of their new income they should be spending or saving anyway, so I get how this could easily happen.

And lifestyle creep does exactly what it says it does, it creeps up on us but the signs are there for all to see. For example, if your savings rate has remained stagnant even after a few years of raises and bonuses, that’s a sure sign that you are a victim of lifestyle creep. Or if you notice that you're spending more money in general because you feel like you can, but you don’t have to, that’s another sign of lifestyle creep.

Or you look at savings and see they’re reducing and your credit card balance is increasing and all of this after an income increase. Lots of signs and wanting to improve your standard of living isn't a bad thing either, as long as you're mindful of the consequences and the potential impact it has on other areas of your finances. The good news is that there are some things you can do to counteract the threat of lifestyle creep and I believe the following would help:

And there are three methods to consider and the first I spoke about already i.e. spend twice your years to retirement. The second is save your age as a percentage of your raise, so if you are 45 then spend 45% of your raise. And the third number to consider is save at least 33% of your raise. All three are good numbers to follow, but the spend twice your years to retirement creates the biggest outcome.

A monthly budget as boring as it sounds and it is, is the antidote to lifestyle creep. Making and keeping a budget is important because it will help keep your spending in check. And being able to see where you’re spending your money each month will help identify areas you are spending more than you thought or should be.

Getting a raise has a way of forcing you to re-focus on your financial goals. If you do, it will remind you what’s important and you can then make sure you are spending this extra money on things that really matter to you.

If that couple I met had a goal of being mortgage free as fast as possible or retiring early or increasing their savings, then perhaps had they known the impact some of that extra money would have had in each instance, they would have used the money differently rather than spending it on debt repayments on two cars.

And if you don’t have any clear plans about what you would like to achieve financially, then now is the time to consider some because if you don’t and if you don’t have any clear objectives for what you want to happen for you and/or your family, you could end up spending that extra cash on things that don’t bring you closer to what’s important to you.

If you go from making say €3,000 to €3,500 per month, you need to make sure you are ready with a plan with what you are going to do with that extra €500. Leaving it sit in your account means it’s practically begging you to spend it.

Avoiding lifestyle creep doesn't mean you have to save every extra penny you earn either, of course it doesn't. Part of the point in getting a raise in the first place is to use some of it to afford things that might have previously been out of reach. You work hard and you deserve to enjoy some of that extra money now but finding that balance is important as well, so you can spend some of it now and some of it when you’re older.

So, without going on and on, when your income increases it should really put you ahead, but if it doesn’t and making more money means you are in exactly the same position as before, then you are just working harder without living better and that's not what you want.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie