Disclaimer: The statements made in this post are the opinion of the author. They should not be viewed as financial advice. Please consult with a financial specialist before making any financial decisions.
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Have you ever gotten a raise and thought to yourself, “Awesome, let’s go out to eat to celebrate then buy that TV we’ve been looking at!” If you have, you are not alone. In fact, this seems to be human nature, although I’m not convinced it isn’t just commercialized nature. The problem with this mentality is that it is the surest way to be broke your entire life.
The thought process I’ve described above is called Life Style Creep. Simply put, it means that you increase your expenses exactly as much as your income increases (if not more). For most people this is imperceptible, that’s what makes it so dangerous. You use your three percent raise to go out to eat just a bit more, get that brand new 4K TV, or upgrade your car. It seems like the natural thing to do, but the problem is that people can’t actual afford this, but they do it anyway because they have access to credit.
Robert Kiyosaki, the Author of Rich Dad, Poor Dad (affiliate link, but also an awesome book I’d recommend to anyone), said that the biggest trap in finance are these words: “no money down, low monthly payments” (that is a paraphrase). The basic idea here has two pieces. First, we assume that because we have more money we can spend more. Second, we buy things we want on credit instead of saving for them because we “can afford the monthly payment”. Then, as interest piles up, we get into debt and we get stuck barely holding on waiting for the next raise to be able to cover our payments. We get the raise, we have more money, and then we start all over again.
The Psychological Problem
The issue here is that people can’t help themselves. When we get a raise, we feel like we’ve worked hard to get it, so we deserve to be able to spend it. In fact, the most compelling argument that this behavior is not only acceptable but makes sense is: “If you’re going to make more money, why not enjoy it?” I completely see where you’re coming from if that is what you are thinking. Setting aside that the debt is actually causing you mental stress so you are not enjoying it, let’s look at a simple solution that will help you start building wealth AND enjoy yourself more.
A Simple Solution
To handle the desire to have more fun when you get more money AND the need to spend less than you earn, may I suggest that you apply the 50% rule. Since you are already tracking your spending, you can intentionally spend more on certain categories (such a entertainment or eating out). The 50% rule means that you intentionally (even automatically) put 50% of your raise into savings so that you don’t even get a chance to touch it–that can either be into a retirement account or a bank account depending on what you are currently working towards. The other 50% can then be intentionally used to have more fun.
For example, let’s say that you make $30,000 a year. At the end of the year you get the semi-regular 3% cost of living increase. So the next year you’ll make $30,900. Half of 900 is 450. So you will immediately add $37-38 to your monthly retirement contribution (37.5 X 12 = 450) or into a savings account. Then you have another $37-38 a month to put put towards fun (going out to eat, watching a movie, or saving for that TV you want).
A slightly more advanced golden nugget of this strategy is that if you put that 50% into a tax advantaged retirement account that defers taxes (so NOT a ROTH account), then you will feel even richer because with less taxable income you have a lower monthly tax bill. Try it. Increase your contribution by $10 next month, then compare that to how much your paycheck drops (hint, it will be less than $10).
If you want to keep more money and not just make more money then you need to beware of life style creep. Don’t increase how much you spend every time you increase how much you earn. If you can’t avoid increasing how much you spend then try the 50% rule. You’ll be surprised by how much you can save with this simple strategy.
What ways can you think of to avoid life style creep? What was your experience with the 50% rule? Tell me about it in the comments below.
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Life Style Creep: Also called Life Style Inflation, it means that you increase your expenses exactly as much as your income increases (if not more), this is usually gradual or unnoticeable with each small raise and it gets people into debt or at least living paycheck to paycheck.
Credit: Using someone else’s money to make a purchase (like getting a mortgage on a home, financing on a car, or using a credit card) that then charges interest on top of the amount borrowed.
50% Rule: Putting 50% of each raise towards savings (whether in a bank or a retirement account) and 50% of each raise towards things you enjoy. This allows you to have fun with your raise but also contribute to your overall wealth.
Tax Advantaged Retirement Account: Any retirement account that that either allows you to be taxed on your contributions later after they’ve grown, upfront so they grow tax free, or–in rare instances–not be taxed at all.
ROTH Account: Any retirement account that is labelled a ROTH account (e.g. ROTH 401K or ROTH IRA, etc.) is a tax advantaged account that taxes your contribution upfront but NOT later when the money is pulled out (unlike a traditional account which is the opposite).