Over the last few years, I have worked with a lot of young families to plan how they will save for retirement and fund education costs for their children. Their problem was simple: they knew they needed to save more but they didn’t know where to trim their budget. Or their budget was already trimmed if a spouse was staying home to raise children and they lived on one income. They didn’t know how to get started.
One solution that I brought up was to earmark the majority of any future raises (or future income from the spouse not currently working) to be directed into savings (college, retirement, other). On paper and in concept, it makes a lot of sense. This post shares the experience of someone who carried out the same kind of strategy for many years.
The problem that ends up holding many people back from reaching their goal with this kind of strategy is a concept called Lifestyle Creep or Lifestyle Inflation. This occurs when someone receives a raise and instead of immediately increasing their 401(k) contribution amount, they put it toward something to make their life more enjoyable. It could be an improvement to the house, an extra vacation, a new car, or just eating out more frequently. The “needs” of today end up outweighing the “needs” of tomorrow.
Turns out, there is an evolutionary reason for this mindset. In the early days of our existence, it was feast or famine. Our ancestors adapted to their reality by consuming as much food as possible when it was available so they could survive when food was scarce. Unfortunately, we have not yet evolved to shed that mindset from our thinking. Short article here helps explain the concept.
The solution to this evolutionary crutch is to systematically and regularly increase savings rates. I work with some clients where we are increasing the rate at which they save two or three times a year. Mentally, it is easier to increase your savings rate by an extra $100/mo every few months rather than increasing the savings rate by $400/mo every year.
But even then, that solution doesn’t make up for good-old-fashion discipline.