Can Your Lifestyle Inflation Keep Up With Investment Inflation?
Ensuring that lifestyle inflation doesn’t surpass income and wealth inflation is crucial in personal finance. We aim to increase the gap between income and expenses to achieve financial freedom. But what happens when you’re already living freely, or your investments are so successful you might end up with more money than you can use in your lifetime? It’s just as problematic as not having enough for retirement.
For disciplined investors, it’s worth examining if your lifestyle inflation can match your investment inflation, especially since many people are now pondering how to effectively spend their accumulated wealth.
Tether Your Lifestyle Inflation to Your Investment Inflation
If you’re taking investment risks, you should enjoy the rewards. Don’t let the overly cautious dissuade you. Just as you wouldn’t let someone who didn’t help cook a meal dictate your portion, you shouldn’t let fear dictate your enjoyment of financial gains.
Consider this scenario: You spend $100,000 annually and have a $2 million investment portfolio. Traditionally, for every dollar earned after taxes, you might spend 20 cents. However, after a profitable year, perhaps you decide to live it up, matching your spending increase to your portfolio’s performance. If your portfolio increases by 10% to $2,200,000, you raise your spending by 10% to $110,000. Even after a 25% tax on your $200,000 gain, leaving $150,000, and spending an extra $10,000, you still have $140,000 in net gains. Thus, even with increased spending, your wealth continues to grow faster than your expenses.
Managing Lifestyle Inflation for Investors
Most aggressive savers and investors find it hard to spend more as their wealth grows, accustomed to frugality and always mindful of opportunity costs. The notion of doubling unspent money in 7-10 years based on historical returns is enticing but consider the diminishing returns of overly conservative financial strategies as you age.
Here’s an example of extreme frugality: Joseph, a reader, has a $250K income and an IRA worth $20 million. He’s concerned about potential punitive taxes on his retirement funds. Yet, his situation highlights an opportunity—spend or give more away. Despite a significant net worth, he spends only a fraction of his income, emphasizing that many fulfilling activities are free or low-cost.
Why Not Spend More?
Spending doesn’t always correlate with happiness, but holding too much can seem wasteful. If you’re financially secure, consider allocating a substantial portion of your investment gains to enrich your life or others. For instance, setting up educational funds or supporting charities are meaningful ways to use excess wealth.
Strategies to Match Lifestyle and Investment Inflation
For those financially independent or nearly there, consider these methods:
– If optimistic about the market, spend 50% to 100% of your net investment gains annually.
– If cautious, limit spending to about a quarter of these gains, saving the rest as a buffer.
– Maintain or slightly increase spending annually, adjusting based on actual returns to avoid depleting your wealth prematurely.
Final Thoughts
Annually review your net worth against your spending. If your investments continue to outpace your expenses, consider donating a portion of the surplus to charity. Balancing wealth accumulation with fulfilling spending can enhance your life and those around you without the risk of outliving your resources.
Readers, how do you adjust your spending as your wealth grows? Do you struggle with the idea of spending down your assets, or do you find ways to enjoy your financial success responsibly? Your strategies and thoughts are invaluable as we navigate the complex balance between saving and spending.
