Most people, books and programs will tell you that you should strive to save a specific percentage of your income each year. There is nothing wrong with this method and, if you have committed to consistently save 10% or more of your income, that’s great. There is another strategy for saving, however, which will build your financial resilience much faster: simply striving to keep your expenses constant (increasing only with inflation) as your income gradually increases with career experience.
Now the first thing I have to establish is that I am definitely not prescribing self-deprivation here. What I am effectively advocating is that you should strive to reach the point at which you have enough to live a comfortable life and then proceed to break the perceived link between money and happiness.
The choice between these two saving strategies is therefore a philosophical one. If you allow for an increase in living expenses with income while saving a fixed percentage monthly, you do this because of the perception that increased consumption will bring happiness. If you manage to fix your lifestyle at a comfortable level, on the other hand, you automatically eliminate a rather debilitating dependence on consumption to stimulate short-lived pleasurable feelings and free up your full capacity to pursue those things that bring true sustainable happiness (health, personal relationships and free creative expression).
In addition to potentially being psychologically much more rewarding, the fixed expenses saving strategy will also build your financial resilience at a much greater rate. Recall that financial resilience is the number of years that your accumulated financial wealth can sustain your current lifestyle. If your lifestyle keeps getting more and more expensive, therefore, increases in your financial resilience will be limited.
Let’s look at an example: Two well-educated people start off their careers with a good salary granting them a disposable income of $30000 per year. One decides on the fixed percentage saving strategy (saving 10% per year) and the other decides on the fixed expenses saving strategy (keeping living expenses fixed at $27000 per year). We will assume that both their incomes increase with 2% per year in real terms (adjusted for inflation). We will also assume that their investment strategies yield another 2% per year in real terms.
This definitely is a highly idealistic scenario because, as described in an earlier post, there are some major life events like buying a home and starting a family that will always have large impacts on financial resilience. However, the purpose of this simple example is only to illustrate the value of a solid commitment not to increase unnecessary consumption with rising income. The two graphs below give a clear illustration.
These graphs show that, at the end of their careers, the financial wealth of the person on the fixed expenses strategy is almost 4 times greater than that of the person on the fixed percentage strategy. The most important thing, however, is that her financial resilience is more than 8 times greater at the end of her career, implying that she will retire very comfortably.
Was the person who increased her expenses over time happier over her 40 year career? Well, that is of course a very subjective question, and your own subjective answer to this question will determine the strategy that is best for you.