Way of life inflation after the primary massive paycheck
Earning a high income creates what I call the great dilemma caused by lifestyle inflation. This has puzzled high earners for years.
Today’s classic is being republished by The doctor philosopher. You can see the original Here.
Every year I give a lecture with my residents called “Investing 101”. You probably expect to sit down and learn the difference between stocks and bonds. Or how to define a putt, call, or mutual fund. Instead, the first fifteen minutes are devoted to a completely different topic. When the rubber hits the road, investment talks are not very helpful when there is no money to invest. You see, doctors don’t have an investment problem, they have a spending problem and a lifestyle inflation problem. This is the big dilemma: lifestyle inflation.
My last Resident Paycheck & First Attending Paycheck
One of the “hooks” I can use to help my residents understand this issue is to show them my most recent Residential Paycheck first, which was about $ 3,500 per month to take away. I then show them my first paycheck which resulted in a monthly take home of about $ 16,500.
Then i wait.
Eyes start to open, the “ooh’s & ahh’s” come out as the residents take care of that number, which is actually higher when I hit the social security wage base every year.
Then finally someone says, “I can’t even imagine making that much money in a single month. That’s five or six months’ wages for us. “
The big dilemma: lifestyle inflation
Unfortunately, residents can only enjoy this amazement for a moment as I then spend some time shattering their dreams of buying the big house, buying the new car, private school for their kids, and the like.
Why? Because this started as an investment talk. You need to save money first if you still want to invest money. Otherwise the conversation is pointless.
First, I’ll show them what it will be like if they don’t intentionally save and spend the money they want when they’re done training.
Here is a general example that I am using. If they want to retire $ 4 million by the age of 60, which allows them to spend around $ 160,000 annually on retirement under the 4% rule, they need to save about $ 4,500 per month ( provided they have a degree around the age of 32). .
This may not be possible after massive lifestyle inflation.
The following big elements devour the sizeable paycheck you just saw. Let’s see how much we would have left if we had deducted all of the following from that $ 16,500 paycheck:
- Mortgage payment of $ 4,000 ($ 750,000 at 4.5% – 30 year fixed)
- $ 3,000 student loan payment (disbursed in ten years as no student loan refinance ladder was used)
- $ 2,000 for daycare or private schools for children
- $ 1,200 car payments
- $ 1,650 for tithe / charity
- $ 500 for disability / life insurance
Notice that I didn’t mention anything about vacation, travel, gasoline, groceries, utilities, cell phones, etc. This is all in addition to the previous fixed costs. Guess what their takeaway salary is after making these big lifestyle choices?
Just $ 4,150
And we just said that if we start saving at 32, we need to save about $ 4,500 a month to retire at age 60. With this kind of lifestyle inflation, we’re not going to make it.
Even without tithing / charity donations, the takeout would be $ 5,800. I don’t know too many doctors who can save $ 4,500 a month and live on $ 1,300 a month on gasoline, groceries, cell phones, restaurants, and vacations.
Remember, as a resident, they lived on $ 3,500 a month.
This, my friends, is the great dilemma. It is caused by lifestyle inflation.
Lifestyle inflation suppresses any chance of financial success. You just can’t do it after you finish exercising and hope to retire at an age that is acceptable to you.
Can it be otherwise? Yes it can.
It just requires that residents / fellows who have completed the training make deliberate decisions based on their desires. They need to find out their monthly savings needs and how fast they want to pay off their debts FIRST.
Then they need to develop a lifestyle that will enable them to achieve those goals.
How much do I have to save?
How does this work?
By following the formula below, we can figure out how much you should save each month based on your individual goals. Ideally, this should be done before the training is finished.
- Determine the age at which you want to retire. Use the children’s questions if you haven’t already figured out.
- Then determine how much you want to spend annually in retirement. (This assumes, of course, that you are out of debt – hopefully by refinancing your student loan). When you are out of debt, retirement expenses should only include travel, food, time off, utilities, taxes, health care, and so on.
- Multiply the annual spending of number 2 by 25 for a typical retirement between the ages of 60 and 65. Multiply by 30 for early retirement (to be conservative).
- You can then create fun Excel spreadsheets using the future values feature explained below. Enter your projected monthly savings rate to see how close you are to the number you need to retire when you want to.
The cold hard math: formula for future functions
- Plug this into Excel -> = FV (6% / 12, N, [pmt],[pv], 1)
- For “N”, enter the number of months you are away from your expected retirement age, which you set in number 1 above.
- [PMT] is the amount of monthly savings. For Excel to make sense, it has to be negative. So if you are saving $ 5,000 a month, you need to enter -5,000.
- [PV] is the present value of your savings accounts. Insert a negative number again. If you see savings of $ 50,000, enter that as “-50,000”.
Here is an example. Let’s say we find that you can save $ 5,500
Let’s further assume you believe your employer can save $ 5,500 a month, including your employer’s 401K match and the Roth IRA contribution for the back door.
How much would you have in 28 years (336 months) if you hadn’t saved anything and received 6% compound interest? Well, if you put that in Excel it would look like this:
= FV (6% / 12, 336, -5500,0,1) = $ 4,801,343
That is more than enough! What if you wanted to retire at 55 years old (23 years or 276 months)?
= FV (6% / 12, 276, -5500,0,1) = $ 3,273,669
Now they don’t quite make it. That number would only allow for $ 120,000 in annual spending. So if you are going to retire at 55 and want to spend $ 160,000 on retirement, you need to save more every month.
The point is this. The paycheck present seems pretty big until we inflate our lifestyles to the point where we can no longer save or pay off debts.
Rather than being a typical American and letting lifestyle inflation drive our savings rate, let’s hope we have enough left over to save for retirement after that point – we should be doing just the opposite. First, use a backward budget to determine the savings rate required to retire after the desired age.
Then build a lifestyle with what is left. Pay your future self first and last your current self.
Did you do the math before making lifestyle choices? Or were you just hoping there would be enough when you wanted to retire? Leave a comment below.