Here Is the Easiest Path to Build Wealth
Photo by Stephen Leonardi on Unsplash
The best financial advice is what you will actually follow through on.
There’s often a huge gap between how you should manage your money and how you will manage your money.
Most people don’t like change.
Even if someone is deeply unhappy, they are resistant to making major changes to their day-to-day lives. Never underestimate the power of inertia — it’s part of human nature.
In this post, I explain one of the most undiscussed topics in personal finance; treating new money like it doesn’t exist, aka “reverse lifestyle inflation.”
Read also: 10 ways to radically improve your finances in 2023 ( check this out)
The fastest way to save a lot of money (that most people won’t do)
Let’s get back to that gap between the right money move “on paper” and why that is often unrealistic for most people.
The easiest way to save more money is to address your two big fixed expenses.
I’ve written 4,000-word book chapters on how you can reduce your spending on housing and transportation.
Many people responded in a big way to that chapter of The Financial Freedom Equation because they know how much of their paycheck gets eaten up by fixed costs. They agree with most of my advice on reducing those fixed costs, but very few make any changes.
Because changing where you live and how you get around town will dramatically change their day-to-day lives. People are resistant to change — especially when it comes to big changes like where they live.
Reverse lifestyle inflation
The fastest way to improve your finances is to make big, life-altering decisions. But there is another way. It’s slower, painless, and doesn’t require immediate or even big changes to your daily life.
Here are seven words that can change the trajectory of your financial life:
Treat new money like it doesn’t exist.
If you just got a promotion that will clear an extra $500 per paycheck, call your bank and set up an automatic transfer of $500 from your checking account to your savings/investing account every payday.
Next year, you get a cost of living adjustment that nets you an extra $50 per paycheck; call up your bank and bump up your automatic savings by $50.
Treat new money like it doesn’t exist.
You may have heard of the term “lifestyle inflation,” which refers to the phenomenon where the amount of money you spend rises as your income increases — making it impossible to build a high savings rate. The impacts of lifestyle inflation are subtle and seem harmless at first — but left unchecked can kill your odds of reaching financial independence because you’ll need more and more money to maintain your standard of living.
Think of this strategy of treating new money like it doesn’t exist as “reverse lifestyle inflation.” It won’t feel like a big deal immediately, and that’s the whole point. It’s not painful, so you are more likely to stick with it.
Remember, the essence of reverse lifestyle inflation is to treat new money like it does not exist and redirect it to savings and investments. Let’s dive into some examples of how reverse lifestyle inflation works and how it can help you increase your savings rate and build wealth.
First, I’ll create some hypothetical numbers so that I can illustrate the power of reverse lifestyle inflation:
You make $50,000
You currently save $0 per year
You get a 3% annual raise
You save 100% of your annual raise
Your savings/investments earn a 5% annual return
Now, let’s run through some scenarios where you build wealth by treating new money like it does not exist.
What to do when you get a pay raise
If you redirect your annual raise to savings, you can go from a 0% savings rate to a 26% savings rate in 10 years. By year 28, you would be saving 56% of your income.
That savings rate combined with compounding returns eventually adds up to a serious investment portfolio.
After 10 years, you’d have $105,000. After 28 years, you’d have $1.28 million.
That is a life-changing amount of money without having to make drastic changes to your lifestyle.
To be clear, you will need to cut back on your spending, at least in “real” or “after inflation” dollars. If inflation is 2% per year, what I am advocating for here would effectively cut your spending by 2% per year. You will need to make adjustments to your lifestyle, but they are so small and gradual that almost everyone could begin following through right now.
This math looks promising, but there are even more opportunities to boost your savings rate and the size of your portfolio. Let’s review two more scenarios where you can treat new money like it doesn’t exist.
What to do when you pay off a loan
If you’re in debt and have a plan to pay it off, I have some good news; you are in a prime position to practice reverse lifestyle inflation.
The longer it takes for you to repay your debt, the more you get used to making debt payments. If you pay $300 per month to a student loan for 10 years, your spending habits adapt to the fact that you can’t spend that $300 per month. The day you pay off the student loan is a fantastic opportunity to embrace lifestyle inflation. Rather than absorbing that $300 payment into your budget, treat that money like it does not exist and redirect it to saving and investing.
If you redirect pay raises and the amount you used to spend on debt repayment, you can supercharge your savings rate and build wealth much faster.
Let’s add a few more numbers to our previous example.
You have a $250 monthly credit card payment that will be paid off in three years.
You have a $400 monthly payment to a line of credit that will be paid off in four years.
You have a $350 monthly student loan payment that will be paid off in six years.
If you continue redirecting your annual raises to investing and invest your previous monthly payment once each loan is paid off, after 10 years, you’d have a 35% savings rate, and by year 28, you’d be saving 62% of your income.
After 10 years, you’d have $191,000 saved and $1.9 million after 28 years.
What to do when money falls in your lap
Let’s discuss one more scenario where new money comes your way, and that’s when you receive a sudden financial windfall. This could be expected like when your year-end bonus comes in, or unexpected, like when your rich uncle dies and leaves you an inheritance.
Let’s continue this exercise and assume you redirect all your pay raises and former debt payments to investing but add in the assumption that 12 years into this process, your rich uncle dies and leaves you $30,000, which you immediately invest.
After 28 years, you would have over $2 million by simply treating new money like it doesn’t exist and redirecting it to a portfolio of low-cost index funds.
Reverse lifestyle inflation in real life
I started this post by saying, “the best financial advice is what you will actually follow through on”. Is it realistic to expect you never to spend any salary raises or financial windfalls for the rest of your working life?
Of course not.
What I presented here was an extreme, oversimplified example. This example serves only to show you the power of setting aside and investing a portion of new money that comes your way. In this example, you would have saved 100% of your new income, which you almost certainly won’t be able to do — at least not for too long.
What you need to do is adjust the concept of reverse lifestyle inflation and create a rules-based system. The rules should have you saving aggressively early on as you build up your savings rate and then relax once you hit certain thresholds.
Read also: How to build multiple streams of income by using this system
Here’s an example of a rules-based system to practice reverse lifestyle inflation.
Save 100% of new money until you reach a 10% savings rate.
Save 75% of new money until you reach a 25% savings rate.
Save 50% of new money after you clear a 25% savings rate until you are financially independent — then celebrate!
New money is easier to save than old money because you have not gotten used to spending it. Redirecting a portion of that new money to a portfolio of low-cost index funds will make your financial life easier over time. Eventually, you’ll put yourself in a position where a bit of good luck, like a promotion or an inheritance, can meaningfully change your financial life.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
Contributed by Ben Le Fort
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