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Increase Your Income

Beware Of Lifestyle Creep

Lifestyle creep, also known as lifestyle inflation, refers to the tendency for individuals to gradually increase their spending as their income increases. This can occur over time as people receive pay raises or promotions, or as they receive windfalls such as bonuses or inheritances.

Beware Of Lifestyle Creep

Lifestyle creep can be a natural and inevitable part of financial planning, as people may want to upgrade their living standards as their income increases. However, it can also be a potential financial trap, as individuals may end up spending more than they can afford and accumulating debt as a result.

To avoid lifestyle creep, individuals can try to be mindful of their spending and make a conscious effort to save and invest a portion of their income, rather than simply spending it on higher-priced items or activities. Setting financial goals, creating a budget, and tracking spending can all be helpful tools for avoiding lifestyle creep and maintaining financial stability.

There are several strategies that individuals can use to avoid lifestyle creep and maintain financial stability as their income increases:

  1. Set financial goals: Identifying specific financial goals, such as saving for a down payment on a house or paying off debt, can help individuals stay focused on their financial priorities and resist the temptation to spend unnecessarily.
  2. Create a budget: Creating a budget can help individuals track their spending and identify areas where they may be able to cut back. By allocating a certain amount of money to different categories, such as housing, transportation, and entertainment, individuals can better understand their spending habits and make more informed financial decisions.
  3. Track spending: Keeping track of spending can help individuals identify patterns and areas where they may be overspending. This can be done manually by keeping receipts and recording expenses in a ledger, or through the use of budgeting apps or software.
  4. Save and invest: Rather than simply spending any extra income on higher-priced items or activities, individuals can make a conscious effort to save and invest a portion of their income. This can help them build financial security and achieve their long-term financial goals.
  5. Be mindful of advertising: Advertising can often create a sense of desire for products or services that individuals may not actually need. Being mindful of this and avoiding impulse purchases can help individuals avoid lifestyle creep.

By adopting these strategies, individuals can avoid lifestyle creep and maintain financial stability as their income increases. It is important to remember that everyone’s financial situation is unique, and it may be helpful to consult with a financial advisor to develop a personalized plan that meets individual financial needs and goals.

Setting Financial Goals

Setting financial goals can be an effective way to stay focused on your financial priorities and avoid lifestyle creep. Here are some steps to consider when setting financial goals:

  1. Identify your priorities: What is most important to you financially? Do you want to save for a down payment on a house, pay off debt, or save for retirement? Identifying your financial priorities can help you focus on what matters most to you.
  2. Determine your current financial situation: Take a detailed look at your current financial situation, including your income, expenses, debts, and assets. This can help you understand your financial starting point and identify any areas where you may be able to cut back or save more.
  3. Set specific, measurable, achievable, relevant, and time-bound (SMART) goals: To be effective, financial goals should be specific, measurable, achievable, relevant, and time-bound. For example, rather than setting a goal to “save more money,” a SMART goal might be “save $500 per month for a down payment on a house by the end of the year.”
  4. Create a plan: Once you have identified your financial goals and understand your current financial situation, create a plan to help you reach your goals. This may include setting a budget, creating a savings plan, and making a debt repayment plan.
  5. Monitor your progress: Regularly review your financial goals and progress to make sure you are on track. Make adjustments as needed to help you stay on track and achieve your goals.

By setting financial goals and creating a plan to achieve them, individuals can stay focused on their financial priorities and avoid lifestyle creep. It is important to remember that financial goals may change over time, and it may be helpful to revisit and update them as needed.

Create a budget

A budget is a financial plan that helps individuals track their income and expenses in order to manage their money more effectively. Here are some steps to consider when creating a budget:

  1. Determine your income: Start by identifying all sources of income, including salary, bonuses, investments, and any other sources of income.
  2. Identify your expenses: Next, identify all of your fixed expenses, such as rent or mortgage payments, insurance premiums, and loan payments. Then, list your variable expenses, such as groceries, entertainment, and transportation. Be as detailed as possible to get a complete picture of your spending.
  3. Track your spending: Use a budgeting app, spreadsheet, or pen and paper to track your spending for a month or two to get a better understanding of your spending habits. This will help you identify areas where you may be able to cut back.
  4. Set a budget: Based on your income and expenses, set a budget by allocating a certain amount of money to different categories, such as housing, transportation, and entertainment. Make sure to allow for some flexibility, as unexpected expenses may arise.
  5. Monitor and adjust your budget: Regularly review your budget to make sure you are staying on track. If you find that you are overspending in a particular category, consider cutting back or finding ways to save in that area.

By creating and following a budget, individuals can gain a better understanding of their spending habits and make more informed financial decisions. It is important to be realistic and to allow for some flexibility in your budget, as unexpected expenses may arise. It may also be helpful to consult with a financial advisor to develop a budget that meets your individual needs and goals.

Track spending

Tracking spending is an important step in managing your money and avoiding lifestyle creep. Here are some ways to track your spending:

  1. Use a budgeting app or software: There are many budgeting apps and software programs available that can help you track your spending. These tools often allow you to connect your bank and credit card accounts, making it easy to see all of your spending in one place. Some popular budgeting apps include Mint, You Need a Budget (YNAB), and Personal Capital.
  2. Use a spreadsheet: You can also track your spending using a spreadsheet, such as Microsoft Excel or Google Sheets. Simply create a list of your expenses, including the amount and the category, and update it regularly.
  3. Use a ledger: If you prefer a more manual approach, you can track your spending using a ledger. Simply record your expenses in a notebook or on a piece of paper as you incur them, including the amount, the date, and the category.
  4. Use receipts: Keep all of your receipts and record your expenses in your budgeting app, spreadsheet, or ledger. This can help you get a more accurate picture of your spending.

By tracking your spending regularly, you can gain a better understanding of your spending habits and identify areas where you may be able to cut back. It is important to be consistent and to record all of your expenses, including small purchases, in order to get a complete picture of your spending.

Save and invest

Saving and investing can be an important way to build financial security and achieve long-term financial goals. Here are some steps to consider when saving and investing:

  1. Set financial goals: Identify your financial goals, such as saving for a down payment on a house or saving for retirement. This will help you determine how much you need to save and invest in order to achieve your goals.
  2. Determine your risk tolerance: Consider your risk tolerance, or the amount of risk you are willing to take on in your investments. This will help you determine the types of investments that are most appropriate for you.
  3. Create an emergency fund: Consider setting aside a portion of your income in an emergency fund to cover unexpected expenses. A good rule of thumb is to save three to six months’ worth of living expenses in a liquid, easily accessible account.
  4. Choose the right investment accounts: Choose the investment accounts that are most appropriate for your financial goals and risk tolerance. This may include a 401(k) or IRA for retirement savings, or a taxable brokerage account for more short-term goals.
  5. Diversify your portfolio: Diversify your portfolio by investing in a variety of asset classes, such as stocks, bonds, real estate and cash. This can help spread risk and potentially improve your chances of achieving your financial goals.
  6. Monitor and adjust your investments: Regularly review your investments to make sure they are aligned with your financial goals and risk tolerance. Make adjustments as needed to help you stay on track and achieve your goals.

By saving and investing a portion of your income, you can build financial security and achieve your long-term financial goals. It is important to be consistent and to consider your financial goals, risk tolerance, and investment choices carefully. It may also be helpful to consult with a financial advisor to develop a personalized investment plan that meets your individual needs and goals.

Be mindful of advertising

Advertising can often create a sense of desire for products or services that individuals may not actually need. Being mindful of advertising and avoiding impulse purchases can help individuals avoid lifestyle creep and maintain financial stability. Here are some strategies to consider:

  1. Be aware of advertising techniques: Advertisers use various techniques to try to persuade consumers to buy their products. Understanding these techniques can help you be more aware of the ways in which you are being marketed to and avoid falling victim to them.
  2. Don’t rush into purchases: Take the time to think about whether you really need or want a product or service before making a purchase. Consider whether the product or service will add value to your life and whether you have the financial resources to afford it.
  3. Shop around: Don’t be afraid to shop around and compare prices before making a purchase. This can help you get the best deal and avoid overspending.
  4. Don’t be swayed by emotional appeals: Advertisers often use emotional appeals to try to persuade consumers to buy their products. Be aware of this and try to make purchasing decisions based on logical, rather than emotional, considerations.

By being mindful of advertising and avoiding impulse purchases, individuals can avoid lifestyle creep and maintain financial stability.

Categories
Financial Literacy

Buying vs Renting a Home

There is often a hard held belief that no matter what, you should always buy the place you live in, because after all when you rent you just throw money out of the window or rather to your landlord that you’ll never see again. While when buying a home, you always pay part of the mortgage towards the principal so you increase your equity, so you increase your assets.

Buying vs Renting a Home

Housing Is Your Biggest Expense

For most households, the money spent on the place we live in is the number one budget, taking roughly 30% of the annual expenses. It’s therefore extremely important to spend wisely on housing and it’s often where a lot of money can be saved.

As seen here, regardless of whether you are buying or renting, the place you live in is never an asset and always is a liability, short of house hacking (more on that in another post). A home takes money out of your pocket, so it’s a liability from a cash flow perspective.

That said, while the place you live in is always a liability, the game is to reduce such liability, to save as much money as you can.

And in reality the answer to the buying vs renting argument, is always: it depends.

It depends how much the home cost versus how much you would pay to rent a similar home.

Let’s look at the usual associated costs in each case:

Renting Costs

The renting costs are usually straightforward: the rent you pay to your landlord.

Buying Costs

When buying a home, there are several expenses associated with owning a home also known as unrecoverable costs:

  • The closing costs when buying a home
  • The mortgage payment
  • The home insurance
  • The property taxes
  • Miscellaneous maintenance expenses

So to figure out whether you should buy or rent you need to figure out if the buying costs or higher or lower than what it would cost to rent a similar home in the same area, for the time period you expect to live there.

There are plenty of calculators out there to help you estimate whether you should buy or rent, but the rule of thumb is: if in your area real estate is very expensive (e.g. the San Francisco Bay Area circa 2020 where a 1200 sq. ft home is worth +$1,000,000), it will usually be more advantageous to rent. Conversely if real estate is much cheaper (e.g. in Memphis, TN circa 2020 where a 1200 sq. ft home is usually worth around $90,000), it will usually be more advantageous to buy.

Now there are always exceptions: you may be able to find a cheap house in an expensive area or find an extremely cheap rental in an area where real estate is cheap. That’s why you should always run the numbers, but hopefully that gives you the feel and the basics on how you should allocate your housing costs, which is for most households the biggest budget expense.

The 5% Rule

If you want a quick and easy rule of thumb to figure out whether you should buy or rent, Benjamin Felix at PWL Capital came up with the 5% rule, which estimates that homeowners usually spend 5% of the house price annually, between taxes, maintenance, opportunity cost.

Therefore if the annual rent is less than 5% of what the house would cost, it’s usually preferable to rent.

If the annual rent is more than 5% of what the house would cost, it’s usually preferable to buy.

For example, let’s take a house that would cost $100,000 and the monthly rent is $700. The 5% rule says, the rent should not be more than 5% x $100,000 = $5,000 annually. The rent annually is: 12 x $700 = $8,400. Hence in this case it would be interesting to buy the house rather than renting, according to the 5% rule.

Now let’s take a house that would cost $1,000,000 and the monthly rent is $3,000. The 5% rule says, the rent should not be more than 5% x $1,000,000 = $50,000 annually. The rent annually is: 12 x $3,000 = $36,000. Hence in this case it would be interesting to rent the house rather than buying, according to the 5% rule.

Of course the 5% rule is an oversimplification and it’s just a quick guideline to get a back of the envelope estimate. As mentioned above it’s important to get the actual numbers (as taxes may be different based on where you live, the financing cost may be different…) to have a more accurate estimate on whether it’s financially more advantageous to buy or rent.

Categories
Financial Literacy

Defining Asset vs Liability

Money is just another problem that needs to be solved. And to understand a problem it is critical to define it properly. Albert Einstein famously said: “If I had an hour to solve a problem I’d spend 55 minutes thinking about the problem and five minutes thinking about solutions.”

And at the core of every problem definition lies the vocabulary and the true meaning of words. One of the greatest tragedy in modern age is not being able to properly define asset and liability.

So let’s keep this simple:

  • an Asset puts money in your pocket
  • a Liability takes money out of your pocket

Now if you’ve ever applied for a loan to buy a home, you may have stumbled upon a banker lauding how great of an asset your home is. Spoiler alert: it’s not. Or more precisely not for you.

Let me explain, to enjoy your home you’ll probably have to pay your mortgage, which takes money out of your pocket. You also have to pay property taxes which also takes money out of your pocket. You’ll need a home insurance, which again takes money out of your pocket. You’ll also need to cover expenses associated with maintaining your home, which yet again takes money out of you pocket. How much money does your home put in your pocket? $0. So from your perspective, your home is a liability not an asset.

Now looking at it from your banker’s perspective, the mortgage interests you pay on your loan brings money in your banker’s pocket. Therefore from your banker’s point of view, your home is an asset.

And with this comes an important corollary around assets and liabilities: the nature of a given resource usually does not define whether it is an asset or not. Instead the usage of such resource defines whether it’s an asset or not.

As seen with your home: it is a liability for you, but the exact same home is an asset for your banker.

Similarly if you own a rental property, which is just another home, and you make a profit after paying your mortgage and the associated expenses, then the rental property is an asset, because it puts money in your pocket.

Note that by integrating an investment component to your housing, you can limit or even sometimes eliminate the liability. And since the housing cost is usually the biggest household income for most people it’s well worth taking a hard look at it. See what house hacking can do for you.