“Some of the Worst Projects Have the Largest Budgets” – The Financial Engineer
As I started off into the real world, fresh out of Purdue, I worked on large projects. I worked with a seasoned coworker who told me: “Some of the worst projects have the largest budgets.” At the time, I was not aware of what that truly meant.
It has been about 6 years since that statement was made, and at the time it was said, I was not aware that it would be more than a statement. I consider it an opinion that was not intended to be advice; however, I consider it one of the best pieces of advice I never received.
This makes complete sense to numerous aspects in life and business. For most, salaries will increase as we progress in our careers. The savvy will find other income streams, or start businesses. Either way, income will increase for individuals over time. More income will ultimately increase the potential for spending. Another term for this is known as life-style creep.
Huh, Frivolous Spending Caused by the Largest Budgets?
Most are asking, what do you really mean by this FE? Well, you have read numerous stories of lottery winners who are broke within a year after winning. It is due to their spending habits developed through their new found wealth. They squander their money in ignorant liability purchases, such as cars and fancy homes. This is an extreme example, but has the same basis as why most people let life-inflation get the better of them.
I define life-style creep as the thought of un-necessary wants being perceived as necessities. In other words, frivolous spending caused by large budgets. It typically occurs when an individual’s income increases. What was once thought as frivolous spending now becomes viewed as a necessity.
It can also occur when there is a decrease in costs. For example, if someone was to pay off their student loans they no longer have to pay that bill. The money that was once budgeted to pay the loans can now be used to pay for something new. An individual could fall into a mindset of using the extra monthly funds to purchase a new item that could require financing.
When Does Frivolous Spending Typically Occur?
Lifestyle creep opportunities can come in numerous forms throughout life. I believe it will occur at 3 different stages in life. Some of these have occurred in my life already.
1. Recent College or Tech School Graduates
I have encountered it when I accepted my first well-paying job. As a recent graduate, I accepted a position that provided an average Civil Engineering entry level salary. This was the first well paying position I had. Although my spending habits didn’t change too much, I started paying off my student loan debts and started investing. I also had $400 monthly rent with utilities to cover. Yes, $400 a month without roommates (to be elaborated on in the future). These were new expenses I did not previously have.
2. After a Promotion or Raise
Frivolous spending seems to creep into a person’s life when raises or promotions are achieved. You get a raise, so the first thought is what to purchase with the new funds? A mindset of, I worked hard for this achievement, so why not reward myself?
Make It Rain!!!
I could purchase a bigger house or a newer car. The added costs to gain more will make most fall victim to lifestyle inflation. This mindset can be a dangerous one. What if a black swan event occurs, say a global pandemic, and you lose your high earning job?
3. Right Before Retirement
Lifestyle inflation can rear it’s ugly head right before retirement as well. People who are within 5 years of retirement, are typically empty-nesters. They no longer have child-related costs. They have paid off their mortgages or are close to doing so. This rush of reduction in expenses can escalate into an affinity for extravagant goods. The goal of retirement is to maintain the lifestyle someone had in the years prior to entering it. If their current lifestyle is altered into a frivolous one, a retiree will require more funds to support their newly acquired spending habits. Unfortunately, their income resources will decrease in retirement. Their funds cannot maintain the new accustomed spending, which could have consequences in the later years of retirement.
Next, I will discuss my plan to prevent it.
How to Prevent Frivolous Spending as Budgets Increase
Each stage of life has it’s own complications. As such, each stage should be evaluated separately. First, I will share ways on how I tried to reduce lifestyle creep as a young individual.
1. Recent College or Tech School Graduates
As a young individual, I thought about what I wanted out of life. I evaluated both professional and financial goals that I wanted to achieve. After the goals were established, it was important to plan the path to achieve those goals through a budget. I knew I wanted to invest in a family home. It would be important to consider a family size. Where and when you want to retire.
Essentially, an individual needs to ask themselves what the future could hold and their associated costs. This will keep you on track to achieve those goals. It is important to stay away from the idea that you can’t save or invest now because you’re just starting your career or profession. This is the wrong mindset that will deter you from the benefits of compound interest. It will also prevent you from achieving financial goals, like purchasing a home with 20% down.
I lived as frugal as I could out of school. My budget did not include a high monthly payment for a new car. I had a used car with minimal car payment. My apartment rent was $450 a month! Yes, $450 in Minneapolis, MN. It was the best thing I could have done for myself. There was no need to live in a fancy apartment, and I did not have a roommate.
Next, I will discuss how to prevent life-inflation after being promoted.
2. After a Promotion or Raise
Receiving a promotion is an exciting time. A lot of hard work went into achieving the success. It would be easy to reward yourself with a new car or expensive purse. Why would you continue to spend hard earned money on a liability and/or a depreciating asset? Instead, look to invest the wage increase to allow your money to work for you. Don’t just spend the money on new purchases that will put you further into debt. Doing this would only increase stress, and prolong the financial goals.
I have always increased my 401k contribution, IRA contribution, or invested in real estate for short-term rentals upon salary increases. I find it to be a great way to reduce my adjusted gross income, which reduces my tax obligation at the end of the year as well.
Lastly, I will discuss how to prevent splurge spending just before retirement.
3. Right Before Retirement
The Financial Independence goal is in site! This is an exciting time that is more than likely at the peak of a person’s income. The empty-nester is now looking at lower expenses and high income. Feelings of euphoria could set in and change the mindset to splurge a little more on yourself. This could create havoc on the retirement savings in the long run.
Frivolous Spending Before the Golden Years
Instead of spending on new items, consider throwing fuel on the retirement fire. Consider placing it into your IRA, or 401k. According to Investopedia, you can increase your max contribution by $6,500 in 2020. This will enable an individual to maintain their standard of living while entering retirement. It is important to know that a typical retirement will see a decrease in income. Always keep in mind that the account’s you have need to last you the entire time.
Additional Thoughts
Be aware of down times in life that could create subtle opportunity to spend irresponsibly. Whenever boredom lurks find ways to keep yourself busy. Find ways to keep yourself stimulated and engaged. This will prevent window shopping, or scrolling through your phone.
One way is to keep yourself productive. Make a list of tasks you need to get caught up on, and start working towards completing each one. This could as simple as making a list to clean the house. Look into a workout routine during down points in your day to keep yourself away from the browsing on shops.
Develop hobbies or new skills that will prevent you from spending. Start researching each hobby through books. Creating a list to accomplish those hobbies will keep you focused. Read books to add to your knowledge of the hobby or skill
If considering a purchase, wait a couple of days to think about whether you really need to purchase the item. I only consider purchasing an item after 2 days of thinking about it. This seems to be an adequate amount of time to reduce the chance of spending money due to numerous triggers. Such triggers to be aware of are buyer’s high, emotional purchases, panic buys, or leisure/boredom acquisitions. After the 2 day timeframe I have realized that this may warrant the need for the smaller purchases ($100 or less).
In Summary
A slippery slope is created when a frugal mindset is replaced by a spending one. It can change slowly with small purchases or instantaneously. Being self aware of typical stages in life when this can occur will enable you to be proactive. Minimize self-reward purchases to prevent the slow creep of frivolous spending, especially after receiving raises. Use financial goals and hold yourself accountable.
Always think about the purchase two days after your first initial urge to buy. I find this is adequate amount of time in order to minimize emotional buying. Staying busy will keep yourself from boredom buys.
What are some of your strategies to prevent life-inflation? How do you keep from frivolous spending?