Do you increase your savings over time?
Photo by Timo Stern on Unsplash
I have been opposed to the FIRE movement (Financial Independence, Retire Early) for a while. My basic premise was that those with high incomes and extremely high savings rates looking to retire in their 30’s are chasing the wrong solutions. Whatever issues they are dealing with in their life can probably more effectively be solved with other, less drastic solutions, like finding a different job under a manager who supports you. If you can find a job that provides fulfillment and allows you to pursue a happier life, this may be more helpful than cutting back all discretionary expenses, living in your parent’s basement, and trying to be financially independent by 35.
But after a good discussion with my colleague, Trishul Patel, I learned the difference between Lean FIRE described above and Fat FIRE. Fat FIRE still pursues aggressive savings and keeping expenses low, but maybe not a hyper-aggressive savings and extremely low expenses. The end result being that it takes longer to achieve Fat FIRE, but when you achieve financial independence, you probably have more assets saved up to support a more expensive lifestyle. While I still wouldn’t consider myself a supporter of the FIRE movement, the labeling of a philosophy that considers the interplay between savings and spending has some benefit. Because it is this balancing dynamic between saving and spending that becomes important to track throughout your working career.
There are many people who made good incomes and were saving sufficiently in their 30’s to be on track to achieve financial independence around 55-60, but by the time they get to 50, they are no longer on track. They are now on track to achieve financial independence at 65.
So what happened in their late 30’s and 40’s to take them off track?
Sometimes it is some form of bad luck. If you turned 40 in 2000, the tech crash and financial crisis would likely have impacted your investment returns pretty significantly. The flip side (which is kind of how reversion to the mean works) is that you kept saving diligently that entire time and stayed invested appropriately so that the huge bull market this decade probably doubled your money in 5-7 years and you ended up where you wanted to be anyways.
Or if there was a medical or health issue that you could not foresee. Which is where having appropriate health, disability, and life insurance comes in. But in these situations your lifestyle changes so dramatically, that even after you get through it and adjust to a new baseline, your original goals are no longer your current future goals.
But these bad luck scenarios just didn’t come up that often with my clients. Most of the time, it was because there was not enough diligence when it came to tracking the interplay between saving and spending. When they got a raise or promotion, they finally felt like they got a little breathing room financially. Things were a little easier and they could now afford those few extras they had been looking at for a while. This was fine until things started to feel just a little tighter. Then they were looking forward to that next raise to help ease things a little bit. Expenses and spending were going up faster than inflation, they were going up right along with the increased income. The best phrase I’ve seen describing this phenomenon is “lifestyle creep”.
Lifestyle creep could be moving to a bigger house with a larger rent or mortgage payment, where the real unplanned effect was the additional homeowner’s insurance and property taxes, and furnishings and other material items to fill the space. Adding subscriptions without turning others off. [Some day I’ll actually cancel my Sports Illustrated subscription.] Humans have a pretty incredible capacity to fill their available living space with stuff and to increase their spending to match their income.
Even if you were using a financial planning software or retirement calculator to figure out how much you need for retirement based on your current lifestyle, one of the important, basic assumptions is that your expenses grow with inflation. But if your expenses grow greater than inflation like your income, then the goal you were targeting in your 30’s and 40’s is no longer sufficient to support the lifestyle you actually have in your 50’s and NOBODY wants to go back. SO instead of being financially independent at 55, you decide to take advantage of your peak earning years and keep saving and push your goal back to be financially independent at 65.
And there’s nothing wrong with this. It’s a pretty common retirement plan. But it wasn’t what you set out to do. Not tracking your spending and saving over time forced you to make an unintentional, required adjustment to your goals. This is where the Fat FIRE philosophy or working with a financial planner can come in. It’s not cutting back your expenses. It’s taking a brief look every year to identify any changes that are pretty easy in the moment, but are necessary to stay on track.
The easiest method stay on track relative to your savings and expenses is to increase your savings every time you receive a raise. If you get a 5% raise, try to increase your savings rate into your 401k by 2-3% at that moment. You will still take home a slightly bigger paycheck, but you have put yourself in an even stronger position by saving a larger percentage of a slightly larger income. If you do this over a few years, you can get relatively easily get to the point where you are maxing out your 401k contribution.
In general, it’s this mentality of “paying yourself first” that will most effectively help you grow your savings and manage your spending. Every time you get a raise, look to increase your savings. If you are already contributing the maximum to your 401k, focus on your overall savings rate and figure out how much you need to manually increase your monthly systematic savings to maintain an appropriate savings rate.
By focusing on increasing your savings, you are also directly mitigating lifestyle creep without having to feel like you are cutting back any expenses. There is a dual positive effect of having a larger savings base to draw from, but also, not needing as large a savings base in the first place to provide for your lifestyle.
Saving a percentage from your paycheck into your 401k tends to be the easiest way to effectively save for retirement. As your income goes up, that percentage at least keeps up rather than remaining flat. Making changes to your 401k contribution is relatively simple. The investment options are good enough. And your contribution is made before your take-home pay hits your checking account. This is the closest you can get to literally “paying yourself first.” The concern to keep in mind is that there is a contribution limit on the 401k, currently $19,000 in 2019. If you make $150k and max out your 401k, you are saving 12.67% of your income. If you are trying to save 15% for retirement, you will need set up a systematic savings outside your 401k, probably a monthly contribution and systematic purchase in an investment account. This is where the risk of not increasing your savings is most likely to come in. To reach your savings target, you set up an automatic transfer of $300/mo from your checking to the investment account. When you got a small raise the next year, your 401k contribution probably keeps up because the IRS usually increases the contribution limit each year (*depending on acts of Congress, not a safe assumption), but many people miss increasing their extra savings from $300/mo to $315 or $300/mo. They leave it at $300/mo and end up spending that extra $30 from their paycheck. This is where I see lifestyle creep impact people over time
Whether it’s following FIRE, working with a financial advisor, or developing the mentality to pay yourself first, focusing on managing spending by consistently increasing savings can be the most effective way to combat lifestyle creep.
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Aaron Agte, CFP®, founder of Graystone Advisor, is a fee-only Financial Planner located in Foster City, CA, serving clients virtually in the Bay Area and across the country. He specializes in helping couples with stock options, RSUs, and other equity compensation.
@AaronAgteCFP