31 Days to Financial Independence (Day 22): Using “the Gap” and Avoiding Lifestyle Inflation

“31 Days to Financial Independence” is an ongoing series that appears every Thursday on The Simple Dollar. You might want to start this series from the beginning!

Last time, we finished up our series of discussions on strategies for increasing your income with a look at starting a side business and dabbling in entrepreneurship. Today, we’re going to step back from that perspective and see how an increase in income intersects smartly with frugality.

Let’s assume that you’re a person who is essentially living paycheck to paycheck. You make $50,000 a year and you spend $50,000 a year. You’re not building anything for the future.

Over the course of this series, we’ve covered a ton of strategies for cutting spending. Let’s say you used just some of them and managed to cut your spending by 10%. You’re now making $50,000 a year and you’re spending $45,000 a year.

Now, let’s say you used some of the money-making strategies we’ve discussed in the most recent portion of this series and managed to improve your income by 10%. You’re now making $55,000 per year and spending $45,000 per year.

That difference between income and spending – $10,000, in this case – is a number that I like to call “the gap.” It’s the gap between your spending and your income level. In general, any activity that causes a noticeable increase in the size of your gap, whether it’s cutting spending or earning more money, without adding misery to your life is a good thing.

Financial success boils down to building up a gap through frugality and hard work and then doing smart things with that gap. In other words, once you’ve managed to create that $10,000 gap in the example above, you then use $10,000 a year on top of your normal bills to eliminate debts, save for retirement, save for your children’s education, and invest in yourself.

The big enemy of the gap is lifestyle inflation. Many people will adopt frugal strategies to get more bang for their buck, but then they’ll spend the money they save on different stuff. Many people will also see a raise at work or some other bump in their income as a reason to start spending more.

They’ll start buying nicer cars. They might move to a nice place or move to a bigger house. That sounds great, but the fundamental problem is that you’re still stuck on the same treadmill, just with shinier baubles.

The entire purpose of the journey to financial independence is to get off that treadmill entirely, giving you time and energy and freedom to do almost anything with your life. That’s the big goal. If you use the gap to build your personal wealth rather than nicer stuff, you become less and less controlled by things like the whims of your boss, the negativity of a bad workplace, work that doesn’t fulfill you, and so on.

Exercise #22 – Using “The Gap”

What follows are several strategies for ensuring that the “gap” that you’ve built up is used to give yourself the maximum number of options in terms of how to use your time and energy in the future, as well as many strategies for avoiding lifestyle inflation.

As your “gap” grows, adjust slowly. When you first start seeing an increase in your “gap,” either due to an increase in income or a decrease in expenses, don’t immediately make any changes at all to your life. Instead, put that money into a savings account or use it to make extra debt payments and give it some time to sink in.

The key here is to make sure that every change you make to your life as a result of your improved frugal choices and your improved income is done in a smart and thoughtful way, and the best way to encourage smart and thoughtful money decisions is to take them slowly.

So, if you find yourself starting to build up a little “gap” between your income and your spending, take the changes slowly. Do smart things with the money and don’t immediately give into temptations to spend it before you’ve given yourself time to consider the new options that are now before you.

Be conscious and aware of lifestyle inflation. It is very easy to simply not think about lifestyle inflation when you’re making purchasing decisions. If you’ve managed to build up a “gap” through some sustainable frugality strategies and/or an increase in income, it is incredibly easy to convince yourself that you can afford a new “treat,” and then that treat turns into a routine that raises your expenses. That treat might be a nicer car than you would have bought before or an expensive coffee in the morning or something else entirely.

Whenever you start to think about buying yourself a “treat,” think seriously about whether you would have bought this thing before you had a “gap” and whether that treat is really better than what you will gain from using your gap smartly. Sometimes you might decide to go with the treat anyway, and that’s fine, but by simply thinking about that question, you’ll find yourself preserving the gap and making good long term decisions regularly.

Give yourself a monthly “splurge budget” and cap it tightly. One great way to avoid lifestyle inflation but give yourself some breathing room to buy things spontaneously and have a little fun is to give yourself a monthly “hobby/splurge/entertainment” budget, from which you can spend however you like. Use it for a morning coffee at the coffee shop or a new book or a new board game or a night out on the town.

However, when you hit that cap each month, stop spending. Don’t spend frivolously until the start of the next month.

What this does is it allows you to enjoy some treats and splurges, but it keeps them firmly in the department of treats and splurges rather than letting them grow into routines. It lets you indulge in hobbies, but keeps those hobbies from turning into endless funnels of money. It lets you be spontaneous, but still keeps your big financial goals in mind.

Remember that every non-essential purchase comes right out of your long-term goals. Thinking about buying a pair of $300 shoes? Maybe a $500 video game console? Those things come right out of your long term plans, whatever it might be. It means you’re going to be working just a little longer.

It’s often hard to “feel” that impact, so what I like to do is calculate my true hourly wage, something we talked about earlier in this series. Your true hourly wage is simply the amount you earn in a year minus all work-related expenses (like wardrobe, workplace socializing, lunches eaten out, etc.) divided number of hours you devote to work, meaning your work hours plus your commute plus any time spent on professional activities outside of work.

That hourly wage is a very powerful tool. You can use it to examine the cost of a splurge and translate it directly into the number of working hours you’re going to have to add to your life just to have that treat. If your true hourly wage is $10 and you want a $500 item, are you really willing to add 50 hours of work to your life? That’s what the true cost of that video game console is. Is it really worth that? Would you be willing to sacrifice fifty hours of freedom and fun and instead work during that time in order to have that $500 item?

That simple thought experiment talks me out of purchases all the time. It’s a powerful thing when you really sit down and think about it. It would be great to be able to always work on my terms, or to simply not work at all and spend days reading or working in the garden or playing a game or volunteering. I’m giving up a lot of that time in order to have an expensive item.

Use your “gap” only as extra debt payments, not for minimum payments. One of the smartest strategies for using one’s gap is to eliminate debt as fast as possible. If you can throw your “gap” money straight into debt repayment, you’re going to burn through that debt nice and fast (if you’ve put in the work to build up a nice gap, that is).

However, it’s a good idea to continue to budget for the minimum payment out of your normal expenses rather than just buying fully into the idea that your “gap” is taking care of all debt payments. Your “gap’ should be treated as a bonus. For example, imagine if, instead, your goal was to save for retirement with your “gap” money. You wouldn’t even have it available for things like making bill payments.

I highly, highly recommend making minimum payments on your debts just like you normally would, then drawing extra debt payments out of your “gap” money. This will cause your debts to go down even faster than before and it will also leave you in the right place for determining what your true expenses are in the event of a life change.

Go small, not big, with your housing. Regardless of whether you choose to rent or buy, the bigger your living quarters, the more expensive it’s going to be. That money comes straight out of your savings for the future.

The truth is that when you buy a large home, it’s mostly just empty space that you’ll eventually fill with stuff. The smartest thing you can ever do regarding your living space is to minimize the space that’s there just for storing stuff. If you want to have a big room for entertaining guests, that’s great, but don’t spend valuable housing money on having more closets or bedrooms you won’t use. Minimize the extra space.

Not only will minimizing the extra space save you in terms of the cost of your living quarters, it will also force you to spend less on the simple accumulation of stuff. You’ll have to think more carefully about acquiring possessions simply due to space, which means you’ll approach purchasing decisions with a more discriminating eye. (There’s also the issue of moving, which is substantially more expensive and time consuming if you’re moving out of a large home with a lot of accumulated stuff.)

Make cooking at home the norm in your life. Yes, this is a tip that came up earlier in this series in the section on trimming your food spending, but I’m mentioning it again here because it’s so important in terms of maintaining lifestyle control. Get in the habit of preparing food at home and make that the normal routine. Make eating out the rare exception to your plans.

This can be intimidating for a lot of people, but it need not be. Cooking at home really isn’t hard at all. It just takes breaking through to a strong familiarity with what’s in your kitchen, and that’s really only done by cooking a lot, starting with simple meals.

So make yourself spaghetti. Make some mac and cheese from scratch. Fry some eggs and some chicken breasts. Make a soup in a slow cooker. Repeat all of those things several times until you can do them almost in your sleep. When you’re at that point, most recipes won’t seem intimidating and simple meals seem easier to prepare than dealing with restaurant hassles and waiting and mixed-up orders, let alone all of the extra expense of it.

Don’t engage in a cycle of brand new cars. One common element of lifestyle inflation is the shiny new car that many people often talk themselves into buying. Then, when that car gets a little older, they replace it, and replace that one, and that one.

Regardless of whether you’re taking out a loan or paying in cash or even leasing, that’s a very expensive cycle. As was discussed in the earlier section on trimming your transportation costs, the most cost-effective strategy for buying and selling cars is to buy a late model used car from a reliable company, drive it into the ground (doing proper maintenance along the way to extend the lifespan), and then replace it.

Rather than diving into buying a sequence of brand new cars, instead use your “gap” money to move yourself away from using car loans to finance cars and pay for them out of pocket instead. This will save you a ton on interest.

Automate your investments and other financial moves. If you’ve decided to use your gap money for investing, make it automatic. Set up automatic transfers to take some amount of money directly out of your checking and into your investment accounts on a regular basis.

Automating investments is actually very easy. Almost every investment firm makes it possible to fill out an online form that will give them permission to automatically withdraw whatever amount you designate from your checking account in whatever pattern you wish and have that money put into your investments. You never have to lift a finger again except to turn it off.

The reason for this is simple: it takes the decision to save or invest each month out of your hands. It’s already happening. You won’t have to think about it. You don’t have a window to talk yourself out of it. You won’t be able to tell yourself that you can invest next month but this month you want a treat. The investment just happens.

This is the equivalent of “paying yourself first,” a personal finance maxim that you’ll hear repeated all the time. When you “pay yourself first,” what you’re really doing is investing before you worry about all of your other ordinary expenses so that you know that money will be there for you down the road. Using your gap in that way is a very smart move.

Splurge with time, not with money. One of the most powerful techniques that I’ve ever found with keeping lifestyle inflation at bay is to simply teach myself to splurge with time rather than with money. The reason is this: there is almost nothing I can buy that is as valuable to me as an uninterrupted block of time to devote to a hobby I enjoy or to quality time with someone I care about.

So, rather than spending my time looking forward to a future purchase, I spend my time looking forward to a Sunday afternoon and evening spent with five of my best friends playing a board game around a big table. I spend my time looking forward to a Thursday evening curled up with a book I’m really excited to read.

I find those blocks of time by scheduling them in advance and also by not wasting time on things that are low value. I simply don’t spend time channel surfing or web surfing (at least not very much). If I’m doing something, there’s purpose behind it, and if I don’t have enough energy to do anything with purpose, I go to bed so that I can rest up and do things with purpose the next day.

I get far more value out of a “time splurge” than I get out of almost anything else.

Build and maintain friendships with people who have similar values. If you fill your social life with people who find value in splurging with time rather than money and who make conscious choices about their spending, you’re going to find it far easier to do that yourself. Seek out those people in your life and build up friendships with them.

Most of our social life involves potluck dinner parties, game nights, and volunteer events. It’s a rich and engaging social life. Many of the people who come to our dinner parties and game nights are financially stable and spend money in a responsible way. We’re all living in relatively modest homes, drive relatively modest cars, and don’t spend money extravagantly.

Because of that, our social cues are all about not spending excessively. They’re centered around not inflating our lifestyle and instead working toward big lifelong goals.

To paraphrase Jim Rohn, you are the average of your five closest friends. Are your friends also committed to avoiding lifestyle inflation? Do they have big, lifelong financial goals? If they don’t, try to develop new friendships with people who do share those values.

Next time, we’ll take a look at specific strategies for investing for retirement.

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