“I know you’ve recommended that attending physicians should spend about 20% of their gross income on retirement. My husband and I have found this very difficult, both early on and now that we’re halfway through our careers. I’m a little embarrassed to say this, but I don’t see how we could spend much less than we do now without a dramatic change in our lifestyle. What should we do?”
The hedonic treadmill
Just as the time it takes to do a chore seems to expand into the time available, our expenses naturally increase until they consume our entire income. For most people, it takes a conscious and sometimes difficult effort to avoid this process. It’s also a truism in personal finance that reducing spending is much more psychologically painful than increasing spending is pleasurable. To make matters worse, many of us find ourselves on the “hedonic treadmill,” or “hedonic adaptation.”
As you earn more money, your expectations and desires rise simultaneously, resulting in no lasting gains in happiness. So you work harder and harder and spend more and more, and then you find that you’re no happier making and spending $500,000 a year than you are making and spending $100,000 a year. To make matters worse, the increasingly progressive tax burden on that extra income can further destabilize your finances.
More information here:
How to stop playing the game
Lifestyle inflation and its impact
Effects of Spending on Financial Independence
(Click for larger image)
Because you can always spend all of your income and then some, the secret to financial independence always lies primarily on the spending side of the equation. As a rule of thumb, financial independence means having a wealth level that is approximately 25 times your annual spending needs. The less you spend, the sooner you will become financially independent and the less you will have to save to get to that point – which also means you will have to take less risk with your investments. The easiest way to avoid the hedonic treadmill is to never get on it in the first place. However, for most of us, it takes a conscious effort to get off the treadmill or at least limit its effects on our financial lives.
Financial literacy can bring great benefits in this regard. If you’ve never heard of hedonic adaptation, chances are you’re already on the treadmill. Recognizing this completely natural tendency goes a long way in combating it. Understanding the consequences of a low savings rate (i.e. out-of-control spending) is also helpful. Saving more money each year not only increases the size of your savings pot, but also reduces the size of the savings pot needed to maintain the same lifestyle in retirement.
The math behind financial independence is surprisingly simple. You can make a graph with a savings interest rate of 0% on one side and a savings interest rate of 100% on the other side. Then, based on some simple basic assumptions (i.e. a real investment return of 5% and a real withdrawal rate of 4%) and ignoring the effects of pensions and Social Security, you can determine how long you need to work for a given savings rate.
For example, if you earn $200,000 a year and save 50% of your income, you only need your investments to produce $100,000 in income, and you can reach that point in about 16 years. But if you only save 10% of your income, you’ll need your investments to produce $180,000 in income, and it will take 50 years to get to that point. Obviously, everyone’s financial situation is different, and if someone inherits significant assets at a young age, he or she has the potential to become financially independent much sooner. But whether you start saving and investing at age 20 or 40, it still takes that long to achieve financial independence, and that amount of time depends most on your savings rate.
The graph above overstates the matter quite a bit, because most retirees will have some level of Social Security, while of course spending much less in retirement than they did earlier in life: mortgages are paid off, the tax burden decreases, children leave home and complete their education, work-related expenses disappear, and the need for life and disability insurance is eliminated. And if you work and save until you’re 80, your portfolio probably doesn’t need to last as long as an early retiree.
But the point of the graph remains the same: greater savings increase at the same time portfolio size and reduces the need for portfolio income.
More information here:
The Other Side of Hedonic Adaptation: When Life Knocks You Down
Hedonism vs. Eudaimonia
How to get off the hedonic treadmill
There are some practical steps which can be used to get off the hedonic treadmill. Everyone has heard how important it is to live on a budget. What they may not tell you is that living on a budget is actually a temporary process. A budget is a training tool, and once you’ve trained yourself to spend at a sensible level, you can essentially stop physical budgeting. Most financially successful people can usually get to that point with a few months or years of careful budgeting. Track your expenses by initially writing down every dollar you spend; then make sure you are actually spending your money in accordance with your values.
For example, if you find that you most value vacations with your kids and having a nice home, but you discover that you spend a large percentage of your money on education, dining out, and car payments, you need to align your spending with your values. As an average doctor, you can generally buy everything you want, but not everything you want. Spend your money on what makes you happiest.
Some people find it easiest to increase their savings rate by “saving their raises.” Every time their income increases, they simply continue to spend the same money they would on a lower income. However, this technique doesn’t work very well for most emergency physicians, who generally reach peak income relatively early in their careers.
Research has shown that spending cash is more psychologically painful than using a debit card, which in turn is more painful than using a credit card. This behavioral tendency, combined with the convenience of cards, means we generally spend more when we use credit cards. If you’re not saving as much as you’d like, consider going for a cash spending plan.
Psychological studies also show that our willpower is limited. We can only deny ourselves so many times before we give in to temptation. However, it turns out that it takes as much willpower to decide not to buy a BMW as it does to avoid buying a latte. Use your limited willpower where you can get the most bang for your buck: on the expensive items.
Recognizing the behavioral pitfalls that lead to out-of-control spending can keep you off the hedonic treadmill. Practicing emergency medicine is much more enjoyable when you don’t have to do it for financial reasons.
Have you found yourself on the hedonistic treadmill? Were you able to reverse it? How? How much do you save and why?
[This updated post was originally published in 2016 after first appearing on ACEP.]
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