There’s a simple reason you always spend your pay rises – there’s also a way to save them.
A pay rise is a wonderful thing. That extra money will solve your financial woes and get you on track to buy that dream house or boost your retirement savings, won’t it?
But a year later you’re back at your boss’s desk; you’ve spent the last pay rise by upgrading your lifestyle with a bigger house, a better car, a fancier holiday. You need another pay rise, just to break even.
If this sounds like you, you’re suffering a condition known as “lifestyle inflation”: the tendency to increase your spending as your income goes up.
Cashed up but saving less
There is surprisingly little research on the extent of lifestyle inflation, but it seems to be getting worse in Australia. Our average weekly earnings have risen almost 27 per cent in the past seven years, according to the Australian Bureau of Statistics. But our household saving rate has slumped from about 12 per cent to just over 6 per cent. As we’ve become richer, we’re saving less.
Dr Brad Klonz, one of the world’s foremost experts on our minds and money and Associate Professor in psychology at Creighton University in Omaha, Nebraska, told Mercer there is an underlying reason we tend to spend more money when we get more.
Put simply, we believe we have earned that money by working longer, harder or better.
That creates an attitude, Klonz says, where we think, “haven’t I also earned a higher quality of life? Of course I have! Better food, nicer clothes, a newer car, a bigger house, etc.”
This cycle is never ending. You get a pay rise and replace your current wheels with something more impressive or reliable like a new Subaru, or perhaps a Mercedes or maybe even a Porsche. Yet chances are you’re no happier.
In the late 1990s, British psychologist Michael Eysenck coined the term “hedonic treadmill”. When something good happens, such as a pay rise, we get a short-term boost to happiness. But then we return to our usual level of happiness. We hop on a treadmill, chasing the next happiness hit – more money and better things.
The hidden costs of earning more intensify lifestyle inflation. You might have to work longer hours, which means greater childcare costs and the need to outsource basic household chores. Exhausted, you need better, more expensive holidays to recuperate.
The effect can be demoralising: harder work with nothing to show for it.
Plan your pay rises
So how do we prevent lifestyle inflation? Rather than trying to defeat our natural tendencies, we need to plan for them.
First, we need to measure your net worth – your assets minus debts and money we owe to others – not your income. Rather than thinking in terms of rising income, you need to focus on increasing your net worth.
Secondly, you need to implement a system to capture pay increases and put them to work in the service of longer-term goals, such as retirement savings.
The key is to put the system in place before you get an increase in income, Klonz says.
“You might dedicate a portion to your retirement savings, a portion to servicing debt, a portion for saving for other goals, such as a car or home, and a portion you can use to raise your current standard of living,” he says.
Mercer financial adviser Sean Cummins says pre-paying private school fees can save you in the long run, assuming you’ve paid off other debts including your mortgage as well as personal and car loans.
“The key benefit of prepaying fees years in advance is that you miss the annual increase in fee rises which is generally around 5%,” Cummins says. “It also eliminates future fees as a financial pressure point.
“If your children have already finished school and you no longer have that school fee burden, always consider putting part of your bonus towards retirement savings – contribution caps permitting.
“You should also spend part of it on yourself – you can’t be sensible all the time.”