DANGER! Lifestyle Inflation!

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What’s up everybody!

For those who do not know me – I am Mr.FN. I am new to the blogging game and enjoying it immensely. For me, it’s a new creative outlet (guitar, singing, and bass being my others). It’s something I’ve thought about for a little while now, and am extremely glad I took the plunge.

Thought I’d share that small personal update. But enough ’bout me.

We’ve all seen it. It has taken friends, family, and perhaps even ourselves. Dragging us off into the depths of its’ lair and covering us in mounds of debt. This is the ever dangerous beast known as Lifestyle Inflation.

What is Lifestyle Inflation Mr. FN?

Well, you know those raises you’ve been getting at work? Lifestyle inflation is when you take that raise and apply it to your cost of living. It’s “Big Shot-itis”. What is the long-term impact of doing this?

  1. It makes it harder and harder to climb out of existing debt;
  2. It makes people feel like it is totally acceptable to continually escalate their lifestyle choices, whether they can financially support it or not. This usually leads to more high interest debt which continually beats you down so that you cannot escape the clutches of Lifestyle Inflation.
  3. It makes it extremely difficult to exit the rat race earlier than when we have been told is an acceptable age to leave.

I just got a sweet raise at work! Hmm…what should I do with it? I could treat myself and all my close friends to a special meal, maybe go and buy a nice luxury car, some clothes?

Whoa whoa whoa! What did I just mention? I know there’s a certain appeal to splurging but let’s hold on a second. We’ve all wanted to feel like Oprah giving away free cars because of how well we are performing at our day jobs:

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But let’s face it – we’re not doing anywhere near as well as Oprah. So let’s stop pretending.

Let’s say, as crazy as it sounds, that instead of spending the raises from work, we save them? Sock away that extra cash and let it compound over time to help you achieve Financial Independence.

Human beings seem to have this inner voice telling them to spend as much of their hard earned financial capital as soon as they receive it. Socially acceptable? Sadly yes. But these folks need to gain perspective and understand the long term implications of their decisions.

Time for a beneficial Math exercise!

Assumptions:

  • Single person, age 25 making $40K a year;
  • Let’s assume they want to retire when they are 45 (20 years from now);
  • Over the course of their 20 year career they will receive, on average, 2% above inflation in raises per year;
  • Average annual return of 7%, net of inflation, in the stock market;

So let’s say this person can currently live off $25K a year living a rather modest version of frugal.

Scenario 1: Subject to Lifestyle Inflation. They continue socking away $15K a year earning 7% interest over 20 years. They end up with $615K in savings at their retirement date. Now based on the 4% rule*, the $615K could give this person about $25K a year in perpetuity for living expenses. This would have been enough if they had not been dragged off into the woods by the Lifestyle Inflation beast and eaten alive.

Scenario 2: They continue living a modest but rewarding lifestyle, riding their bike to work, getting in-season fruits/vegetables, making their own coffee, etc. However, they are able to sock away the 2% raise every year. They will put away an extra $267K by their retirement date!!

That boosts their savings at retirement from $615K to $882K, or a 43% increase!! That is the power of compounding and discipline.

Under scenario 2 (and the 4% rule*), this person can now generate $35K a year, way more than the $25K they live off! So in theory…

  1. This person could have retired earlier if they wanted;
  2. This person could have socked away the MAJORITY of their raises and left a little bit left over to enjoy some additional joys along the journey to Financial Independence;
  3. Or they can now enjoy an extra $10K buffer on expenses, maybe take some trips during early retirement and explore the unknown parts of the World.

Whatever tickles this person’s fancy.

You can see from the above example that limiting Lifestyle Inflation not only boosts your savings, but it also reduces the amount you need to live on. It’s a double whammy in your favour (or against – your choice).

So beware of Lifestyle Inflation. Stay frugal my friends.

3 thoughts on “DANGER! Lifestyle Inflation!

  1. Pingback: Booked: Think and Grow Rich | The Frugal North

  2. Pingback: Study Up On: Building Wealth | The Frugal North

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