Liam Gibson, Wealth of Geeks
Sixty-nine percent of American adults report losing sleep over job security worries, and three-quarters are concerned the country is headed for a recession.
Despite a strong economy and many workers earning higher wages, 2023 has left many Americans tossing and turning over their finances, according to a recent report by the American Academy of Sleep Medicine (AASM).
Trying to keep up with the Joneses appears partly to blame.
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Paycheck to paycheck
About 64% of American consumers are “just getting by,” according to a LendingClub survey that included 4,000 respondents. Surprisingly, those who have slipped into survival mode are well-heeled. A whopping 86 percent of consumers who have joined those living paycheck to paycheck earn a six-figure salary.
Conventional wisdom suggests workers who earn more can save more. With the median household income hovering around $70,000, those who make more than $100,000 should have an easier time investing more and retiring sooner. Yet, that’s not necessarily the case.
“Studies have shown time after time that living paycheck to paycheck has very little to do with income levels but rather with spending levels,” says Bobbi Rebell, founder of Financial Wellness Strategies.
“Anyone who spends everything they earn will find themselves in this position.”
Yet, don’t those who work hard to increase their income and net worth deserve to spend a little more on themselves? Finding a balance between optimizing and enjoying your life and preparing for what lies ahead is challenging, especially in the current economic environment.
Runaway lifestyle inflation will eat up every penny of added earnings. However, if people cover their bases by first saving for emergencies and retirement, some increase in discretionary spending seems only natural.
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Earnings up, costs down
Lifestyle creep is an increase in spending after receiving a raise or paying off a loan that undermines one’s financial plan. On the surface, earning more should raise your wealth, but it can backfire with nasty ramifications.
For instance, someone who lands a new job that pays $30,000 more in annual income but then buys a boat for $50,000 will have more debt than before their job change.
The “ hedonic treadmill “ is a psychological trick humans easily succumb to. The more we spend to increase our lifestyle, the more we need to gratify our new desires, and satisfaction eludes us. By gradually getting used to luxuries we previously couldn’t afford, the bar for spending notches higher, undercutting one’s savings rate. If it goes unchecked, it can lead to a downward spiral.
It doesn’t help that inflation has been chewing a hole in people’s pockets, making everything more expensive, even if the products and services one buys remain constant.
According to Bankrate, the gap between inflation and wages isn’t likely to fully close until the fourth quarter of 2024. Until the current inflationary period is well and truly in the rearview mirror, Americans will have to be extra vigilant to ensure their spending doesn’t go out of control. This may be an ideal time to take stock of one’s financial direction and get proactive in planning with the help of a financial advisor.
“I ask clients if there are changes they would consider now to provide a more secure future,” says David Edmisten, CFP and Founder of Next Phase Financial Planning. “I’ll help them review their spending categories and offer ideas where they may be able to consolidate items or reduce spending, and we’ll talk through how they can make that happen.”
Other advisors simply need to let the numbers do the talking.
“We don’t need to tell our clients what lifestyle creep does to them, we just show them on paper,” says Spiros Vassilakos, CEO and Chief Advisor at Athenian Private Client Group.
“Higher spending habits can delay retirement and undermine financial success.”
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Generation gap
Although all consumers are prone to overspending, younger generations seem particularly sensitive to the effects of lifestyle creep.
According to an Intuit Credit Karma survey, about 36% of Gen Z and millennials have a friend who encourages them to overspend.
About 36% of millennials say they would consider ending a friendship due to their friends’ spending habits. In comparison, 29% of millennials felt it’s important that their friends earn as much as they do.
With most millennials now in their 30s, they are likely to be experiencing some of life’s transitions, be it job promotions, weddings, or babies. According to financial therapist Amanda Clayman, these milestones are exciting but can also trigger money-based tension between friends.
Economically speaking, millennials have had a hard time dealing with these changes. Many are burdened by hefty student debt, have lived through two recessions and are relatively poorer than their parents.
The pandemic’s “ K-shaped recovery “ exacerbated the gap between rich and poor millennials, intensifying pressure on the have-nots to spend to keep pace with the haves. With a gloomy economic outlook on the horizon, some may see overspending as an escape from harsh economic realities.
“When you are younger, you want the latest and greatest car, phone, and computer,” says Vassilakos. “But it is important that we help educate Gen Z and millennials how unnecessary purchases affect future lifestyle options.”
“Our clients that are over 50 love to travel, give to charitable causes or start a new business… the later you begin to save, the less passion projects they would be able to accomplish,” he warns.
Vassilakos’ words highlight how objectives shift as we age. Ultimately, finance is highly personal, and one’s budget needs to reflect what feels right for the person today without jeopardizing their financial freedom tomorrow.
“Everyone’s lifestyle is different, some may benefit from an inheritance in the future, or others may have had a head start in life due to generational wealth,” says Vassilakos. “It is important clients stick to the roadmap we create with them and motivate them to push on toward financial independence.”
By mapping out a long-term financial strategy and constantly checking their progress, consumers can ideally strike a balance between spending to enjoy themselves today and saving enough for the future and retirement.
Consumers will do well to watch out for lifestyle creep and ensure this insidious phenomenon doesn’t sneak up and throw their financial life plan off course.
