Lifestyle Creep refers to the phenomenon where your living expenses slowly (in a creeping manner) become higher over time. Due to this, even earning a higher income may not help you set aside significantly more in savings. Usually this happens in a way that you don’t notice – you may buy a better car when you get promoted; then start buying more expensive brands of clothes or shoes to keep up with the car and then start going to more expensive restaurants or vacations. Before you know it, you have begun spending all of the extra income you got due to your promotion.
Let’s understand with an example – Amit earns Rs 1 lakh every month and has Rs 70,000 as expenses. He receives a 10% increment every year for the next five years – he likes to upgrade his lifestyle with his earnings, so he spends 70% of his total income each year. His friend Bindu also works in the same company earning the same salary. In the first year, she also has monthly expenses of Rs.70,000 like Amit but in later years she grows her expenses at only 5% annually, by spending higher only on a few things that are important to her. The chart below shows the comparison between their wealth over time, assuming they invest their savings at an 8% rate of return.
At the end of year 1, they have the same wealth. After 5 years, Bindu is 21% richer than Amit and after 10 years, Bindu is 44% richer than Amit. Over a 30-year working career, these two individuals would have vastly different wealth profiles – Bindu will retire with nearly 2.1 times the money as Amit. Put differently, she can retire 5-6 years before Amit with the same amount of money as him.
How to avoid Lifestyle Inflation?
The answer to this problem is not to completely eliminate upgrading your lifestyle – it is a normal human desire to see progress in your living standards over time. The important thing is to ensure that your living expenses grow at a lower rate than your income. One trick you can use is to reward yourself with better things in some areas you are passionate about (say a better car) but maintain the same standards in the others (say the type of restaurants or vacations you go on). Another may be to set aside a high portion (say 80%) of any increase in income for savings and to allow yourself to spend the rest. Automating your investments directly from your salary account will also help you avoid unnecessary expenses.
