Impact of Lifestyle Inflation on Financial Freedom

I was driving home from work the other day and ended up behind one of my all-time favorite cars—a sleek and beautiful late model Porsche 911 Turbo, a genuine mid-life crisis car.

As I sat there admiring the wonders of German automotive engineering, I started to feel some resentment bubble up.

What's wrong with me?

I have a high-income job, a decent net worth, and the kind of cash flow that allows me to snatch one of those babies from a dealer every year. Why do I deny myself such pleasures in life? Don't I deserve to treat myself for all that hard work?

THAT…ladies and gentlemen is lifestyle inflation at its worst!

The example I just used is perhaps an extreme version of lifestyle inflation. But I can assure you there is no shortage of examples, regardless of someone's income level.

That type of thinking is the quickest way to sabotage your financial freedom goals.

A Tale of Two Lifestyles

One of the advantages of being transparent with my finances on this blog is that it allows me to use my household as a real-life case study. To drive the point of lifestyle inflation home, I'm going to do a retrospective analysis of my finances.

I'll compare my current financial situation and progress towards financial freedom, to an alternate fictitious, yet frighteningly realistic path. The alternate route will embrace lifestyle inflation in all its consuming glory.

Path # 1:  The Real Max Household Journey

Let's have a look at the past 16 years of income for the “real-life” Max Household…

Over that period, we managed to earn about $3M in Gross Income. Almost half of which was made just in the past five years. After you take away taxes, insurance, and 401(k) contributions, we ended up with about $2M in Net Income.

If you take away all our Expenses of $855K over those years, excluding debt pay-offs, we end up with about $1,160K in Discretionary Income.

This is the amount of money we got to pocket after all the dust settled. You'll also notice that I called out 401(k) contributions in the chart above, which added up to $225K of personal contributions over the years.

If you include those contributions, we basically saved close to $1.4M over 16 years. That's a 47% savings rate on a gross income basis, and 70% on a net income basis.

Positioned for Financial Freedom

There's no doubt we could have been more frugal during our early years, but we didn't have our financial awakening until later in our journey. We may have been able to squeeze out another $200K or so from our expenses, but that would have been at the expense of some fun along the way.

If you've been following my Net Worth journey, you'll notice that my net worth during that period is about 15% higher than the $1.4M. That's mainly due to investment appreciation and some increase in home value.

So where did all this extra (discretionary) income of $1.4M go!?

I distributed it across three main buckets over the years, in line with my Net Worth Allocation Strategy:

Bucket #1:  Home Bucket / $475K / Paid-off Mortgage and remodeling costs

Bucket #2:  Traditional Retirement Fund / $225K / Just my 401(k) Contributions

Bucket #3:  FIRE Fund / $500K / Funds set aside for various potential investments

The remaining amount of about $200K was used to pay off student loan debt and other debt such as car loans.

This strategy positions us well for financial freedom in less than five years. Curbing lifestyle inflation helped to fill the right buckets.

Path #2:  The Play it Loose Max Household

As our income has grown over the years, we could have easily spent the discretionary (extra) funds in other ways. It actually wouldn't have been that hard to let lifestyle inflation creep upon us. Let me demonstrate…

Since we're living in the moment and not concerned with saving for the future, we're going to pass on any 401(k) contributions and just pocket the money. This means that the $225K we could have contributed tax-free is now ours for just $155K after taxes. Add that to the $1,160K in discretionary income, and we have a total of $1.3M to blow.

McMansion Here we Come!

If I use our average income over the period, and apply “conventional advice” on home affordability, we could have easily ended up in a home that cost twice as much as our current one.

Here's a snapshot from a popular online calculator on home affordability…

We're now proud owners of a $1M house!

lifestyle inflation home

Same neighborhood, same community amenities, and just a few blocks from our current home. Our new house is twice as big and uses up twice the utilities and resources to maintain. But I bet the Joneses are green with envy!

Check out Those Sweet Wheels!

No self-respecting McMansion owner would drive around in a vehicle that's older than three years. And it better has a German automobile symbol emblazoned on the hood. Better yet, make that two vehicles!

That works out to a total of 6 cars over 16 years. A mid-size luxury sedan averages about $55,000, according to KBB. That's a total of $330,000 spent on just cars. Now to be fair, we'll assume a 50% depreciation every time a vehicle is traded in for the next, which means the true total cost is $165,000 for cars.

Throw in Some Upgrades!

Eating out at the local pizza shop was fine for date night, but that raise deserves some sushi!

Intimate birthday parties for little Max? Forget that! Let's invite the whole class to a 2-hour extravaganza and throw in some ponies!

The latest $1K iPhone X as a stocking stuffer sounds like a great idea! Make that two!

Pretty soon, that left-over $135K disappears in a flurry of frivolous consumption. Who knows, maybe we'll even tap into some credit cards to keep the party going.

It's All Good, Right ?!

So where did all this extra (discretionary) income of $1.3M go in the end!?

If we look at the three main buckets mentioned earlier:

Bucket #1:  Home Bucket / $1M / Let's assume all paid-off for consistency

Bucket #2:  Traditional Retirement Fund / $0K / Cars were more important

Bucket #3:  FIRE Fund / $0K / What the hell is a FIRE fund!?

The remaining $300K was spent on cars and living it up. But who cares!? In this alternate reality, we can still claim a $1M net worth.

We awaken from this nightmare of an alternate journey after 16 years. Suddenly financial freedom doesn't sound so bad. Unfortunately, we're shocked to realize that our $1M net worth is virtually worthless in that respect.

We would need to severely alter our lifestyle to have any chance of gaining financial freedom and certainly couldn't claim it in 5 years.

Closing Thoughts

Don't get too hung up on the absolute dollars used in these examples. That's not the point. Buying a $1M house may seem crazy to many, but going from a $100K to a $200K home is no different. Adjusting for income, you still get comparable lifestyle inflation.

The alternate reality could have taken multiple forms. We could have blown the money on all sorts of different things, instead of upgrading to a more expensive house. Again, that's not the point.

When I step back and look at the past 16 years, I'm genuinely shocked at how easy it would have been to stray from our current path. The discipline takes to pass up on unnecessary consumption when your finances afford you the luxury of indulging is quite a feat.

Hundreds of choices had to be made during that 16-year journey concerning spending. We chose to prioritize our financial freedom, above all else. Looking back, I don't feel like we deprived ourselves of any major experiences (Porsche 911 notwithstanding).

It's possible to keep a balanced life to reach financial freedom, but it's not easy.

Focusing only on a final net worth figure does a disservice to the battles fought along the way against lifestyle inflation

I also believe that once someone reaches their financial freedom goal, any spending that does not jeopardize their financial stability is fair game. That's another way of saying that you don't need to deprive yourself of any experiences once you've graduated to true financial freedom.

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