How to Avoid Lifestyle Creep When Your Income Increases: Try this 50/50 Rule for Saving & Spending



So You Got a Raise (or Promotion or Job Offer): Now What?


I’ve had clients ask me what they should do when they’re rewarded for their hard work with a nice bonus, a raise or a job offer. They wonder if it’s time to break open the bubbly and celebrate with a lifestyle upgrade, or whether they should buckle down and save it.

First off, let me define the term lifestyle creep.

  • It’s what happens when you spend more money as you earn more money.

  • Think buying a bigger house or a more expensive car or spending more on things like vacations, clothes or eating out.

  • Simply put, it’s means living paycheck-to-paycheck; if not beyond your means.

Let’s pretend you received a positive annual performance review that includes a bonus and some newly vested stock options that total $15,000 in cold hard cash. Should you spend it all on that fancy two-week Hawaiian beach vacation you’ve been daydreaming about?


Or let’s say you apply for and receive a promotion at your company that comes with a 10% salary increase. Should you put your townhouse on the market and move into a larger house in a new housing development with a yard?


Here's what I notice often happens in these types of spending situations which I'd define as lifestyle creep. After returning from the vacation or moving into the new home, people experience feelings of guilt or even buyer’s remorse because the extra money is all at once gone.


Now on the other hand, you could save all the extra money because you know that’s what you’re “supposed” to do to get ahead in life. But this leaves you feeling like the event that led to that extra income was anticlimactic. What's the point of working so hard without feeling rewarded by it today?


Neither of these are great options because they leave you feeling less than satisfied. And there’s nothing wrong with improving your lifestyle over time. So, what if the right decision is a little bit of both?


This Nice-to-Have Decision to Make is Why I Recommend Following This Simple 50/50 Rule


Here’s how it works:

  • You save and invest 50% of any extra income you earn.

  • Then, you spend the other 50% without guilt.

For your extra savings, you could take half of your percentage increase and bump up your 401k contribution. Or you could invest half of your monthly dollar increase in a Roth IRA or investment account.


To find satisfaction from how you’re spending, you might consider taking a more affordable beach vacation to Florida. Or upgrade the kitchen in your townhome or buy a more reasonably priced house with a yard that needs a little TLC.


I know this rule might sound a little basic, so I’m going to explain why I believe it works.


We’re Only Human, Especially When it Comes to Our Money


We all know we’re supposed to save today to build wealth for tomorrow, but the fact is we humans like instant gratification. A lot. Especially when we work so. darn. hard.


It comes down to simple psychology. Once our basic needs are met so we’re living comfortably, our money decisions are often based on our past. This includes what our parents or relatives taught us and said (or didn’t say) about money. This is especially true when it comes to our spending decisions.


Spending money provides an immediate rush and sense of control, while saving it feels more abstract. And whatever feelings one experiences from their spending decisions are usually short-lived, whether they're good or bad.


Having a set rule to follow puts you in control and allows you to take action. From that action you get to experience the shorter-term sense of gratification that comes from spending, while also getting a longer-term sense of satisfaction from saving something towards your future.


Why the 50% Saving Rule Can Lead to Success Over the Long-Term


The potential success of the 50% savings rule is due to the power of compound interest.


Here’s an example:

  • You earn $120,000/year and receive a job offer for a 10% increase of $12,000/year.

  • You decide to save half by increasing your 401k contribution by 5% or adding $500/month to an investment account.

  • You receive a 7% average return for 30 years.

  • Which leads to a balance of more than $600,000! *

This rule is something my husband and I started following several years ago, and I’m happy to report we no longer feel guilty for having some fun, nor do we feel like we’re making a big sacrifice.


By investing half of any increase in your future self, you can still reward your current self who just wants to hear “great job, you earned this.”


Other Areas You Apply the 50/50 Rule


There are other areas to which you can apply this rule beyond salary increases or bonuses.

  • Tax refund: Did you overpay and receive a tax refund from the IRA? Spend half of it and use the other half to build your wealth.

  • Reduced childcare costs: Is your kids (or more than one) heading off to full-day kindergarten in a public school? Take what you were paying towards a nanny or daycare center and use it for something fun like a vacation fund or dinners out, and save or invest the rest.

  • Paying off non-credit-card debt: Follow the 50/50 rule when you pay off debts like student loans, auto loans or a home equity loan.

  • A large inheritance: If you lose somebody you love but are lucky enough to receive a large inheritance, you should probably consider seeing a financial planner first. 😉 There may be tax implications and other complexities to work through. And if you’re fortunate, you may be able to save and invest more than 50% of the windfall.

Applying the 50/50 Rule to Your Life


The main goal is following this rule is to build up your nest egg over time, even if it feels like you’re still living paycheck-to-paycheck. The rule also allows you to enjoy the rewards of your hard work and improve your lifestyle.


 

Source

*SEC's Compound Interest Calculator


Important Disclosures


Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made will be profitable or equal any performance noted on this site.