And why it’s more than you think
IT WAS JANUARY 4, 1877 and the world’s richest man had just died. Cornelius “The Commodore” Vanderbilt had amassed a fortune of over $100 million over the course of his lifetime as a railroad and transportation pioneer.
The Commodore was of the belief that splitting the family fortune would lead to ruin, so he left a majority of his wealth ($95 million) to his son William H. Vanderbilt. At the time of this bequest, $95 million was more money than was held in the entire U.S. Treasury.
The Commodore’s decision not to split his empire proved right. Over the next nine years, William H. doubled his father’s fortune to nearly $200 million through proper management of their railroad business. After adjusting for inflation, the $200 million Vanderbilt fortune would be worth roughly $5 billion in 2017 dollars.
However, William H.’s death in late 1885 would cultivate the seeds of folly that would lead to the fall of the House of Vanderbilt. Within 20 years no Vanderbilt would be among the richest people in America. In fact, “when 120 of the Commodore’s descendants gathered at Vanderbilt University in 1973 for the first family reunion, there was not a millionaire among them.”29
What caused the Vanderbilts’ financial ruin? Lifestyle creep and lots of it.
Lifestyle creep is when someone increases their spending after experiencing an increase in income or as a way of keeping up with their peers.
For the Vanderbilts this meant dining on horseback, smoking cigarettes wrapped in $100 bills, and living in the most opulent mansions in New York City—all just to keep up with other Manhattan socialites. While your tastes may not be as extravagant as the Vanderbilts’, their story illustrates how easy it is to increase your spending over time, especially after you’ve experienced an increase in income.
For example, imagine that you just received a raise at work and now you want to go out and celebrate. After all, you’ve worked hard and you deserve something nice, right? Maybe you want a new car, a better place to live, or you just want to dine out more often. No matter what you decide to do with your newfound cash, you’ve just fallen victim to lifestyle creep.
While many personal finance experts will tell you to avoid lifestyle creep at all costs, I am not one of them. In fact, I believe that some lifestyle creep can be very satisfying. After all, what’s the point of working so hard if you can’t enjoy the fruits of your labor?
But, where is that limit? How much lifestyle creep can you afford? Technically it varies based on your savings rate, but for most people the answer is around 50%.
Once you spend more than 50% of your future raises, then you start delaying your retirement.
It might seem odd that earning extra money without saving enough of it can force you to delay your retirement, but I will demonstrate why this is true. In fact, people with higher savings rates have to save a larger percentage of their future raises (if they want to retire on the same schedule) than people who have lower savings rates.
Once you understand why this is the case, then the 50% limit above will make a lot more sense.
Why High Savers Need to Save More of Their Raises
To start, imagine two different investors: Annie and Bobby. Both of them earn the same after-tax income of $100,000 a year. However, they save different amounts annually. Annie saves 50% of her after-tax income ($50,000) each year, while Bobby only saves 10% ($10,000). By definition, this means that Annie spends $50,000 and Bobby spends $90,000 a year.
If we assume that Annie and Bobby both want to spend the same amount of money in retirement as they did while working (lifestyle maintenance), then Annie will require less money to retire than Bobby because she lives on less money.
If we also assume that each investor needs 25x of their annual spending to retire comfortably, then Annie requires $1.25 million, while Bobby will require $2.25 million to retire. In chapter 9 we will discuss why a savings goal of 25x annual spending can lead to a comfortable retirement.
With a 4% real rate of return and no changes in their income/savings rates over time, Annie will be able to retire in 18 years while Bobby will take 59 years. Note that Bobby’s retirement timeline of 59 years is unrealistic for most people, so he will probably have to increase his savings rate if he wants to retire on a more reasonable schedule.
Now, let’s go 10 years into the future. After 10 years of saving (with a 4% inflation-adjusted return), Annie will have accumulated $600,305, while Bobby will have $120,061. They are both still on track to retire on their original schedules (i.e., Annie in eight years and Bobby in 49 years).
But, now let’s say they both get a raise of $100,000 a year to increase their earnings to $200,000 annually (after tax). How much of this raise should Annie and Bobby save if they want to retire on their original schedule?
You might think, “Just save at their original savings rate,” right? But if Annie saves 50% of her raise and Bobby saves 10% of his raise, this would actually delay their retirements.
Why? Because their retirement goal hasn’t accounted for their increase in spending as a result of their raise.
If Annie is now making $200,000 a year and saving 50% of it ($100,000), by definition, she is spending the other 50% of it ($100,000) each year. Since her spending doubled from $50,000 to $100,000 after her raise, her spending in retirement must also double if Annie wants to maintain her new lifestyle.
This means that Annie now requires $2.5 million to retire instead of her original $1.25 million. However, because Annie saved for the prior ten years as if she only needed $1.25 million for retirement, she has to work longer to make up for this lower level of savings in her past.
With $600,305 invested and annual post-raise savings of $100,000 (at a 4% rate of return), Annie would reach her $2.5 million retirement goal over 12 years from now, instead of her original plan to retire eight years from now. Her lifestyle creep pushed back her retirement date. This is why too much lifestyle creep can be dangerous. It’s the impact on your lifetime spending that matters.
If Annie wanted to retire on her original schedule, she would have to spend less than $100,000 a year. This implies that she has to save more than 50% of her raise. In fact, Annie would need to save 74% of her raise ($74,000) in order to retire on schedule in eight years. Therefore, Annie needs to save $124,000 a year in total ($50,000 original savings + $74,000 from the raise) until retirement.
And since Annie is saving $124,000 a year, it follows that she gets to spend $76,000 a year for the rest of her life. At this level of spending, Annie’s retirement target would be $1.9 million instead of $2.5 million.
And what about Bobby? If he wanted to retire on schedule in 49 years’ time after getting a $100,000 raise, he would need to save an additional $14,800 a year or 14.8% of his raise to do so. This gives him annual spending of $175,200 and a retirement target of $4.38 million, but still requires another 49 years for him to reach retirement.
As I mentioned above, saving for a total of 59 years isn’t realistic. As a result, Bobby should save 50% of his raise (or more) if he wants to retire within a more reasonable timeframe. I will explain why this is true in the following section.
More importantly, this thought experiment demonstrates why higher savers have to save an even larger percentage of their raises (compared to lower savers) if they want to keep their retirement date constant. This is why Annie (the high saver) has to save 74% of her raise while Bobby (the low saver) only has to save 14.8% of his raise to stay on schedule for retirement.
While this thought experiment is useful in this regard, it isn’t useful for determining exactly how much of your raise you should save. Since most people tend to get many small raises throughout their career (instead of one big raise), we should simulate the impact of many small raises if we want to be more precise.
The next section does this and provides an exact measure of how much of your raise you should save.
How Much of Your Raise Should You Save?
After running the numbers, the most important factor in determining how much of your raise you need to save (to keep the same retirement date) is your current savings rate.
Differences in annual rate of return, income level, and income growth rate matter far less for this discussion. After testing all of these things, I found that savings rate was the most important.
Therefore, I have created the following table showing how much of your raise you need to save to have the same retirement date based on your current savings rate. This analysis assumes that you require 25 times your annual spending to retire, you get an annual raise of 3%, and your portfolio grows at 4% a year (all in inflation-adjusted terms).
Initial Savings Rate |
How Much of Your Raise You Need to Save |
5% |
27% |
10% |
36% |
15% |
43% |
20% |
48% |
25% |
53% |
30% |
59% |
35% |
63% |
40% |
66% |
45% |
70% |
50% |
76% |
55% |
77% |
60% |
79% |
For example, if you save 10% a year now and get a raise, then you need to save 36% of that raise (and each subsequent raise) in order to retire on the same timetable. If you save 20% now, then you need to save 48% of your future raises. If you save 30% now, then you need to save 59% of your future raises, and so forth.
What this really shows is that some lifestyle creep is okay! For the person saving 20% of their income now, they are allowed to spend half of their future raises without altering their retirement timeline. Of course, if they spend less than half of their future raises, they can retire sooner, but that is up to them.
Counter-intuitively, the lower your current savings rate, the more your lifestyle can creep without affecting your current retirement plan. Why? Because those people who save less, by definition, spend more (for the same level of income).
Therefore, when these low savers get a raise and decide to spend a portion of it, it changes their total spending (on a percentage basis) less than a higher saver who got the same raise and spends the same percentage of it. It is the impact of a raise on spending that disproportionately affects higher savers more than lower savers.
Why You Should Save 50% of Your Raises
Despite all the complicated theory, assumptions, and analysis shown above, I suggest that you save 50% of your raises simply because this is what will work for most people most of the time.
If we assume that the vast majority of savers have savings rates in the 10%–25% range, then the 50% limit is the correct solution based on my simulated data (see table above). And if your savings rate is currently below 10%, I can only assume that saving 50% (or more) of your future raises would be helpful to build your wealth.
More importantly, saving 50% of your raises is easy to implement and remember. Half is for you and half is for future you (in retirement).
Coincidentally, this idea is similar to The 2x Rule I wrote about in the prior chapter when discussing how to spend money without feeling guilty.
As a quick refresher, The 2x Rule states that before you buy something expensive, you should set aside a similar amount of money to buy income-producing assets. So, spending $400 on a pair of nice dress shoes means that you would also need to invest $400 into an index fund (or other income-producing assets).
This is the equivalent of a 50% marginal savings rate and just so happens to perfectly fit with the 50% limit on lifestyle creep highlighted above. So, go out and enjoy your raises—but remember, only half.
So far, we’ve been talking about spending money that you have. However, some purchases may require spending money that you don’t have.
Let’s now discuss whether you should ever go into debt.
29 Vanderbilt, Arthur T, Fortune’s Children: The Fall of the House of Vanderbilt (New York, NY: Morrow, 1989).