A situation where people’s lifestyle or standard of living improves as their discretionary income rises either through an increase in income or decrease in costs. As lifestyle creep occurs, and more money is spent on lifestyle, former luxuries are now considered necessities. https://www.investopedia.com/terms/l/lifestyle-creep.asp#ixzz58ETIu2pV
Lifestyle creep can derail your financial plan. It’s completely normal to want to upgrade the car or house when you get a raise or big bonus but the problem occurs when that big payday doesn’t continue. That’s why it’s important to upgrade a little bit but not all the way to the top!
Let me be more clear–you should definitely treat yourself and family when you experience financial success.But everything needs to be within reason. You should always have some cushion between income and expenses.
Many people close to retirement don’t even know they are creeping and will be in for a rude awakening when they want to stop working. If they kept their savings level but increased their lifestyle they will fall short big time. Falling short in retirement, means running out of money!
I do not think that is what you want to do….
That is why we always recommend to save at least 50% of the bonus or raise. In the perfect world we would love for people to save 100% of it and only live on a base salary, but we understand that is not always possible. But a cushion of 50% should keep you in check.
A more dramatic example is:
Someone I know, after having a banner year at work and receiving a big bonus, decided he wanted to buy a new house. He didn’t settle on a house just big enough for his family, he went over the top with spare bedrooms, huge backyard, pool, etc. He could only afford this house if he continued to get big bonuses. His base salary alone wasn’t big enough to cover a traditional mortgage with a principal and interest payment so he went with an interest only loan. The plan was to make up the principal payment every year with the big bonus check. His lifestyle had creeped to the danger zone.
I’m sure you can guess where this is going.
A few years later the big bonus didn’t come and then it didn’t come again. His industry had changed and it was doubtful the bonuses would ever come again….and now the house is choking him and giving him unneeded stress in his life. The plan is to sell and start over. Looking back he regrets buying the house.
Going forward
A simple solution to this problem is to only take on expenses that your base salary can handle. The bonuses should be used to increase savings or on things like vacations–1 x events. Not recurring bills like a mortgage payment.
If your income is driven by annual raises, you should save 50% of the increase.
Always maintain a cushion and stop creepin!
-Jared
