Your Brain on Stocks

The Fundamental Law of Lifestyle Inflation

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From 2008 to 2011, the Katy Freeway in Houston underwent a $2.8 billion makeover with one goal: reduce traffic. Upon completion, its widest stretch of roadway had been expanded to contain 26 lanes. But as many other metropolitan areas can attest to, one more lane rarely does the trick (see LA below). In the battle of Another Lane vs. Rush Hour Traffic, Rush Hour Traffic is the undisputed champion.

According to a 2009 NBER research paper, the fundamental law of road congestion is that new roads create new drivers. This means trying to outbuild congestion is largely an exercise in futility. We can build as many lanes as we want, but the traffic problem is Sisyphean.

Induced demand is the economic term to describe this phenomenon, and it’s also something that Biggie Smalls had a grip on when he proclaimed: Mo Money Mo Problems.

As Biggie knew, the same induced demand that underlies the fundamental law of road congestion rings true in personal finance, as well. We call this lifestyle inflation, and it is the silent-killer of financial plans everywhere.

Lifestyle inflation refers to the tendency of our living expenses to adjust upwards with pay over time.

It’s very easy to allow an increase in pay to justify additional expenses we may not have otherwise taken on. This often happens subconsciously, which is why I recommend intentionally allocating pay raises.

Left untended, the extra money netted from a raise can quickly transform into a higher standard of living we become accustomed to. It is far more difficult to walk back a lifestyle than it is to corral its expansion in the first place.

Approached intentionally, choosing how to allocate raises is an opportunity to kill two birds with one stone. Savings is the preferred destination for any raises, assuming cash flow was previously positive. The first reason is obvious: more saving means more money for later. But the second reason is equally important: living happily on less now also means needing less to live happily in the future. Both outcomes are a dream come true for any retirement plan – more resources, more flexibility, less stress.

In addition to concurrently receiving raises and increasing your savings rate, automation is the name of the game. As Michael Batnick recently wrote, “You spend 100% of the money you don’t save”. Once you decide how much to increase your savings by, automate it and get out of the way.

If the fundamental law of road congestion is that new roads create new drivers, then the fundamental law of lifestyle inflation is that more money creates more desire. But as Morgan Housel once shared, “Wealth is what you don’t see. It’s the cars not purchased. The diamonds not bought. The renovations postponed, the clothes forgone and the first-class upgrade declined. It’s assets in the bank that haven’t yet been converted into the stuff you see.”

Be intentional with your cash flow, and don’t let lifestyle inflation self-destruct your financial plan.

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