Lifestyle changes. Trying to keep up with neighbors. Increasing expenses after an increase in income.
Whatever you call it, lifestyle changes are one of the most talked-about topics in personal finance, and there are plenty of financial experts (including me) warning about the dangers of them.
But are lifestyle changes really a concern for the majority of people, or is the issue being wildly exaggerated based on a small number of super-spenders?
For most of my writing, I haven’t been able to articulate the answer. But now I can. I have a data source that tracks my income and expenses. Same set Household changes over time. So instead of looking at a snapshot of income/expenses at one point in time, we can see how household income/expenses change over time. We can see how much US households increase (or decrease) their spending after an increase in income.
And what I found surprised me. Let’s take a closer look.
How much will expenses change as income increases?
In this analysis, we use the Panel Survey of Income Dynamics (PSID), which follows the same households over time. We have household income data as well as expenditure data from 1999 to 2021.
To analyze how spending changes after an income increase, we look at all households whose income increases over a 10-year period, excluding those who will be over 65 by the end of that period. After all, we don’t want to pick up on the changes in spending of people approaching retirement. The goal is to see what happens to the spending of working families whose incomes increase over a given decade.
Below is a plot of one such period, showing the inflation-adjusted absolute change in income (x-axis) and inflation-adjusted absolute change in spending (y-axis) for all households whose income changed positively between 1999 and 2009. I’ve also color-coded each household based on whether their spending decreased (“no lifestyle change”), whether their spending increased by less than 75% of their income (“some lifestyle change”), or whether their spending increased by more than 75% of their income increase (“serious lifestyle change”).
As you can see, there are a large number of households that have had “serious lifestyle changes” over this time period. There appear to be more households that have had “some” or “no” lifestyle changes, but there are a significant number of red dots. You might think this proves that lifestyle changes are a serious problem, but this is only a 10-year period in the data.
For example, if we plot the same graph for the period 2005-2015, we will come to a different conclusion.
Now we see that there are far fewer households with “serious” lifestyle changes. But neither of these graphs is more accurate or truer. Each graph has its own bias based on the period in question.
Either way, these charts don’t paint a complete picture of the financial behavior of American households. Why? The PSID data has weights for each household that adjust for sampling bias: some households are over-represented in the data and some are under-represented; the weights adjust for this.
Unfortunately, these weights cannot be easily visualized, but the weights can be used to calculate summary statistics across all periods in the data. So instead of focusing on one period or worrying about sampling bias, we can analyze all 10-year periods using household weights, which adjusts for time period and sampling bias.
For example, here are the summary changes in the 25th, 50th, and 75th percentiles of expenditures based on various changes in income across these households over a 10-year period:
Income Increase Change in Expenses (25th Percent) Change in Expenses (50th Percent) Change in Expenses (75th Percent) <$10k -$12,060 $1,022 $12,165 $10k-$25k -$7,402 $4,254 $20,981 $25k-$50k -$4,327 $8,864 $21,248 $50k-$100k -$9,890 $14,225 $32,977 Over $100k -$101 $24,139 $48,194
It shows how much spending has changed for the 25th percentile household, the median household (50th percentile), and the 75th percentile household for each income change bucket (e.g., under $10,000, $10,000 to $25,000, etc.) over a 10-year period.
For example, among households whose income increased between $10,000 and $25,000 over a 10-year period, 25% of households saw their expenses decrease by $7,402 or more. Half of these households saw their expenses increase by $4,254 or more. And 25% saw their expenses increase by $20,981 or more.
Overall, we see that spending is either falling or only slightly increasing for most income change brackets in the data. For some income brackets, spending is catching up with the overall change in income only at the 75th percentile. This indicates that very few households will significantly increase their spending as their income increases — a lifestyle change that I (and many others) have warned about. Thankfully, the fear of the lifestyle change seems to be more serious than the lifestyle change itself.
Why you shouldn’t be afraid of lifestyle changes
After examining the data, we can say that lifestyle change is not a big issue for most people. Generally, as a household’s income increases, overall spending decreases or spending increases slightly over time. Very few households experience truly “gradual” increases in spending. This does not mean that lifestyle change does not exist, just that concerns about it are greatly overblown.
Of course, lifestyle changes are certainly common, if you define a lifestyle change as an increase in spending that accompanies an increase in income, but I don’t think that’s the intent behind the lifestyle change warning. If you get a big raise and decide to add guacamole to your usual Chipotle order, that’s technically a lifestyle change, but I don’t think it’s the kind of thing that will put you in financial ruin.
No, the intent behind warnings against lifestyle changes is fear: the fear that as your income increases, your expenses will increase without limit. Fortunately, data shows that very few people behave this way. Make sure you don’t become one of them.
Believe me, I didn’t expect this result when I first saw it too. I’ve warned before about the dangers of making too many lifestyle changes. Thankfully, I now know that these dangers are based more in fantasy than reality.
If you disagree with me based on people you know or what you’ve seen in your work, that’s fine. Unfortunately, the aggregate data doesn’t agree with you, and unless another data source shows the opposite, your anecdote doesn’t compare to the best panel data we have on this topic.
We are born with a knack for remembering the exceptions in this world. If we didn’t, we would become prey for other animals. Luckily, we don’t live in that kind of world anymore, but our brains just haven’t evolved enough to see things differently.
Until then, enjoy making some small lifestyle changes – they’re not as big a deal as you might think.
thank you for reading.
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This is post 408. The code related to this post can be found here with the same number: https://github.com/nmaggiulli/of-dollars-and-data