Be sure you don't fall victim to 'lifestyle creep'

Liam Croke

Reporter:

Liam Croke

Be sure you don't fall victim to 'lifestyle creep'

Just because you've got a raise, doesn't mean you should suddenly start spending all around you

Did you ever get a pay rise? Or seen your take home pay increased because of some action implemented in the budget? You may have though, great, those extra funds will relieve a bit of pressure each month.

But, three or four months on, your bank account looks just like it did before the increase and you can’t figure out why this is the case. You begin to wonder how you ever got by before your income increased.

If this ever happened to you, you have fallen victim to what is known as lifestyle creep.

A term originally coined by Michael Kitces, lifestyle creep occurs when your outgoings increase in proportion to your income. The changes in your outgoings may be subtle from year to year, so much so you don’t even realise it’s happening; thus the lifestyle changes just “creep” up on you.

There are two reasons people don’t notice this happening.

First, they incorporate small little treats into their daily routine that they hardly notice.

Interestingly these small little treats may once have been seen as luxuries i.e. the weekly latte now becomes the every second day.

The other reason is because now we have more disposable income to use, our mind-set and thinking changes almost immediately.

Suddenly the car you were perfectly happy with a week before your raise, looks more run down. You think your phone needs to be upgraded, so you change it and go on a better plan. In some cases people will even look at up-grading their house, and suddenly their mortgage repayments have become bigger.

All of this is understandable. You may have more breathing room in your budget now that your income has increased and you want to fill your lungs so to speak, so you loosen the purse strings and begin to reward yourself and who can blame you? We all have been through some difficult times in recent years, but you need to be careful nonetheless.

To forestall lifestyle creep, here are some suggestions you can apply it to and improve your finances.

Increase your savings by applying the percentage you are saving to your new salary.

Let me explain, if your previous monthly income for example was €3,000 and you were saving €150, that is 5% of your salary. If your new salary is €3,200 then you should be saving €160 (€3,200 x 5%) or better still increase your savings rate by 1% and save 6% of your new salary, which would be €192 per month.

Consider increasing your pension contributions by 1%. Using the above ratio if you increased your contribution by 1% i.e. an extra €42 per month, you would see your salary reduce by only €27.50 per month after tax relief.

If you have debt, consider increasing the amount you are paying by using some of your extra income. Overpaying a €250,000, 25-year, variable rate mortgage by €50 each month will take 18 months off the term of your mortgage, saving you about €9,962 in interest payments.

By applying the above to a €200 pay increase each month, you are achieving quite a bit and you still have €80.50 left over to spend on whatever you like.

The key to following through and making these things happen is setting up the extra savings or payments automatically from your account or, better still, direct from your salary, because what you don’t have, you won’t miss it. Some people might put off saving that extra money now because they are in their 20s, 30s or 40s, and tell themselves that when they are older, they will begin to save more and catch up on their pension contributions etc.

But that is assuming they will see consistent earnings growth throughout their career. There is evidence, however, which challenges this assumption. Two recent studies show our assumption that income will continue to grow throughout our adulthood is not true. Most earnings growth occurs in 20s and 30s, slows down in 40s and turns negative in our 50s.

This information is not to be underestimated and is very important to know. Yes, the temptation is strong to put off saving until later, and enjoy living in the moment on our new higher salary. However if our income begins to decline in our 50s, when we had planned to play catch up, after years of self-inflicted lifestyle creep, you could be squeezed into having to save more to reach your financial goals while your income is declining, and that is a tough ask.

Another way of avoiding lifestyle creep is by re-visiting your financial goals. Changing jobs or getting a raise has a way of forcing you to re-focus on your financial goals. If you do it will remind you what is important to you, and you can then make sure, that is exactly what you are spending your extra money on.

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, without having any clear objectives for what you want to happen for you and your family, you could end up spending that extra cash on things that don’t bring you closer to what’s important to you.

So, sit down with your spouse and talk about where you want to be financially in two, five, or even ten years’ time. Redefining your goals and sketching out a plan can reveal where that extra money needs to go.

In short, you’re less likely to experience lifestyle creep if you stay focused on your goals and understand how this extra money can help you achieve them.

Liam Croke is MD of Harmonics Financial Ltd,

based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie