Mind The Gap: Income Inflation Plus Lifestyle Deflation Equals Freedom

The year was 2009. The stock market had crashed in 2008, and was just beginning its slow march to recovery. Even though the market was doing poorly, real estate was crashing, and the company I worked for had received a TARP bailout (by buying a small bank so they would be eligible), our personal financial situation was fine. My husband and I both had full-time jobs, with him working second shift while I worked full time during the day. We had a lovely house we had bought in 2006, which we were able to afford on a 30 year mortgage. I bought a new car over the summer, after my husband was in a bad accident in my old (1997 Dodge Stratus) car. I had the cash to buy the car outright but chose to finance it, to preserve our cash. And I started an MBA program in the fall of 2009, going to UCONN evenings and weekends while family watched the boys.

Then, while I was sitting in my Statistics class, the rug was pulled out from under us.

My husband sent me a text message to let me know the factory he worked for was closing. This was very unexpected, and not something we had anticipated. This was not a good time to be out of work, with the economy crashing, investments going down, and real estate underwater. The next few years were rough as we coped with less income (although he did get unemployment for a long time, because of the bad economy), growing kids, working on that MBA, and paying those bills. I changed jobs during this time, getting into a better company long-term but taking a hit on the school front. My company was reimbursing me for my MBA, and when I switched my classes for two semesters weren’t covered. I had to take a loan out to cover part of school, and some other expenses. We were treading water, draining savings during the year and replenishing them with my bonus/our tax refund only to drain them again.

Then the bottom fell out totally when my husband had a surgery gone wrong, where he almost died of septic shock.  Then his unemployment stopped, our expenses shot up with needing daycare/after school care/vacation care, and not to mention the medical bills.

We had let lifestyle inflation creep up on us. We were “doing well”, things were “going well”, and letting a bit of debt into our lives/loosening the spending belt seemed natural. But then that belt got tighter, and tighter, but our spending habits were hard to change. We had increased our fixed costs and our variable costs, right when our income took several hits. Not good.

If you’ve been following me for a while, you know how that story ends. After the near-death experience, we got out of debt (see Part 1 and Part 2 of that story) by slashing expenses to the bone. By the time 2013 ended, we had turned around the financial ship. My husband still wasn’t earning an income (and would never work full time again), but there wasn’t the huge childcare expenses we once had. My MBA was over, those student loans paid back before the interest capitalized. There was no more car loan, and all future cars (of which there has been one) would be purchased in cash. No more credit card debt, and all purchases other than online and vacation were put on the debit card. The mortgage payment was unchanged but we were in a 15 year instead of a 30 year. And the financial future was brighter, or at least not as dark as it once was.

The key to that turnaround, and our financial success since, has been income inflation and lifestyle deflation. As they say in London, “Mind The Gap”. In this case it’s the gap between your income and your expenses.

Growing Income and Assets

Our income has grown, although not exponentially, since 2009. It hasn’t quite doubled but it’s getting close. I started receiving some longer-term incentives from my job, which I couldn’t tap until I had been at the company for four years. Since I joined when the stock market was down significantly, the growth since then has led to an appreciation in the value of those shares. I’ve gotten several promotions with moderate salary increases, relatively typical raises, and bonuses every year. My income had more than quintupled between 1999 when I started my first full-time job and 2009 when my husband lost his job, so the days of that kind of exponential growth are over, but I’m fine with more moderate increases adding up over time.

Income inflation will usually happen over your working lifetime

The value of our assets has grown, due to our saving and investing both regular income and windfalls, and due to the market increases. Fortunately even with lifestyle inflation I had always been a saver and investor, and had a good nest egg coming out of the financial crisis. Additional savings/investments coupled with a solid financial foundation and a bull market all worked together to increase our asset base. Although this house value hasn’t gone up a dime since we bought it.

Lifestyle Deflation

This was really the key to not only surviving our personal financial crisis, but getting rid of debt and achieving a high savings rate.

As I mentioned, my income had quintupled from that first job I had when I moved out of my parents house, working full time while going to school full time nights/weekends, and 2009 when our financial crisis it. Although I always saved and invested, it was more around 15-20% of our income instead of the almost 50% it is now. So income went up, and so did expenses.

I bought a condo a few months after I turned 20, made $65k on it, and sold it to buy a house. We were buying at a high point in the market, meaning that everything we looked at was ridiculously overpriced. We looked at about fifty homes before buying this one, and used that condo profit for the down payment. Luckily this meant we were able to put 20% down, but it was still a stretch and required both our incomes to pay the mortgage. This created a high fixed cost in the mortgage/taxes/insurance, and a high number of other costs like heating oil, electricity, home repairs, etc.

• Looking back I would have preferred to get a less expensive home with a lower mortgage. However, the advantage of this house is it’s one we can-and plan to-live in forever. At 2200 square feet, on an acre and a half of mostly woods, and four bedrooms it comfortably fits our family of five. So even though we’ve gone from a three to a five person family since we bought it, we feel no need to move.

Also as I mentioned before there was that car I bought. This created a fixed payment in the form of a car loan. Our family grew from three people to four, and of course there were more expenses. Preschool for the oldest. Diapers for the baby. Lets not forget about that iPhone I got for my birthday, which came with a cell phone bill. And although I still did my part to try and keep some of the expenses down, they crept in one direction – up. Credit cards were used for everything, “for the cashback”, but sometimes the balance would creep up…

Until I decided to get serious about slashing everything to the bone. Nothing was spared. My goal was to lower all the fixed expenses as much as possible and reduce variable expenses where I could.

How did this work? Lets take a deeper look.

Reduce fixed expenses:

• Originally I was going to refi the mortgage into another 30 year, dropping the interest rate from 5.3 or so down to 3.5. This would have decreased our fixed costs a few hundred dollars a month. However, I decided instead to reduce the fixed expense of interest and keep the total payment the same, by going with a 15 year at 2.75%.
• Home phone – switched from an option through the phone company at about $50 per month to Ooma, at less than $5 per month. Find out why I still have a home phone
• Internet was changed to the slowest speed, even though we haven’t had cable in almost a decade now. Happy to report that streaming still works fine with the $40 per month plan.
• Speaking of cable, of course it was cut. If you’re looking to cut out cable, check out some tips here
• Cell phones were dropped to the lowest-cost plan, no unlimited texting/calls. My kids still don’t have their own cell phones.
• That car loan was paid off, and those student loans paid before they had a chance to become a fixed cost
• Shopped around for car and home insurance, and shopped around again whenever prices went up. I now pay $250 per month for both (2 cars & home), when I used to pay about twice that-or more.
• Had we had any subscriptions besides Netflix they would have been cut. We have cancelled Hulu more times than I can count because they were going to charge a fee that wasn’t worth it.
• My now-middle son started school, removing the need for preschool and daycare expenses
• My husband recovered and was able to start driving again, as well as watching the kids. This removed all the child-care expenses, as well as a huge burden on me/our families

Reduce Variable Expenses:

Reducing fixed expenses is huge. Once you either cut out or reduce a fixed expense, you realize those savings again and again every single month. A one-time action can save hundreds-or thousands-over the course of years. But you don’t want to ignore your variable expenses. These are the expenses that change every month, and can be harder to reduce because you need to make the decision to reduce it again and again for months (or years, or a lifetime).

• Electricity and heating oil, two big expenses, were reduced by watching our use of electricity and reducing the temperature in the house
• Food costs were reduced by using deal sites like Hip2Save, Krazy Coupon Lady, and various other deal sites. We also shopped more at warehouse clubs. More about my deal scoring strategy can be found here.
• We essentially stopped eating out, cooking food at home instead.
• Tag sales and thrift stores became our good friends
• Kids activities were free or reduced cost. Lots of time was spent at library activities, free events, free museums, and with Groupon/library passes.
• Clothing was handed down from oldest to youngest (now middle), as were toys. “New” clothing needs were satisfied from the kids consignment shop in the next town. For myself, I began shopping for clothes and shoes at an “upscale” consignment shop in my town. This led me to regret ever purchasing new clothes and shoes, as I could now get 5 or so items of higher quality for the price of one low-quality new item.

By doing everything I could to reduce variable and fixed costs, I was able to free up enough income to retire those loans quickly and ramp up savings and investing again. I also found that I was continuing to execute on money-saving strategies even once I didn’t “need to” anymore.

Today we eat out maybe 1-2 times per month, although I’d love to cut that out this year. I still get my clothes and shoes from consignment shops and thrift stores, and clothes for the little guy from the kids consignment shop. I don’t do as much couponing and deal chasing as I used to, but I do shop at warehouse clubs with coupons still. I’ve added in a few fixed costs (Hulu and HBO subscriptions for $20 per month), some have gone up on their own (internet is now $45 per month), but have reduced others (recently purchased pre-owned prior generation iPhones and switched plans to save about $30-$40 per month). I drive the same car now I did in 2009, and my husband’s new car (not SUV, small car) was purchased with cash when the old one was wrecked beyond repair.

Lifestyle Deflation – Without Deprivation

People mistakenly think that living a low-cost lifestyle is full of deprivation. That shopping at thrift stores and consignment shops is something you only do when you have to, driving old cars is a terrible drag, and not eating out is dull. This is only true if you think it is.

I prefer to live a low-cost lifestyle and have a high savings rate, for a number of reasons that are much more important to me than a bunch of expensive stuff. If anything were to happen to my husband again we would make it through OK. If I were to lose my job we could live at our current level of consumption for quite a while. Part of the drive to pay off my mortgage is to reduce those fixed expenses even further, giving us a lot more financial freedom every month. Driving down fixed costs means that you have a lot more to work with, for saving/investing or for spending. Or both.

What’s the secret to not feeling deprived? It’s changing the way you look at the situation. You can mope and feel sorry for yourself, and look forward to the next windfall so you can spend again. Or you can keep in mind higher goals than a new car and shiny new, current generation phone. Perhaps it’s greater financial security, the ability to give generously, or the ability to give your kids a debt-free start in life. Or all three. Instead of feeling deprived, you get excited about challenging yourself to see how long you can go without eating out. How long you can repair that coat for instead of getting new one, or how many complements you can get on your consignment shop outfits. You can feel energized about re-using things others would have tossed out, helping to reduce the amount of garbage in landfills and helping the environment.

The Final Word – On Financial Freedom

At the start I mentioned how income inflation coupled with lifestyle deflation leads to financial freedom, so I wanted to wrap up by talking about it for a moment. As your income goes up and your expenses go down, you’ll naturally have more of a gap for saving and investing. You’ll need to actually invest this for future goals, whatever those may be – a home down payment, a financial freedom fund, traditional retirement, early retirement, college savings, and the like. There’s really no secret to financial independence. It boils down to spending less than you earn. The less you spend, the less you need to cover your costs. Lets take a look using our friend the 4% rule.

• Expenses of $25k per year = $625k
• Expenses of $50k per year = $1.25 million
• Expenses of $75k per year = $1.875 million
• Expenses of $100k per year = $2.5 million

Even if you’re saving for a traditional retirement, this is important to note. There are lots of people who head into retirement with high fixed costs like mortgages – about a third of retirees. The higher your costs every month, the bigger the nest egg you need to cover them. The lower you can get your costs, the less you need.

What are your thoughts on income inflation and lifestyle deflation? How do you “mind the gap” in your financial life? Let me know in the comments!

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