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Personal lifestyle bubble can erode your ability to save

To start the 21st century, there was a technology/Internet bubble that drove stock prices to the point of irrational exuberance. Markets bounced off the tech crash bottom until the housing bubble ballooned to the point of implosion.

And now, with more than six years of recovery, U.S. stocks are hanging around all-time highs. Naturally, there is wonder about the existence of the next bubble. Could it be health care stocks that have gone too far this time and present a catalyst for the next bubble? The biotechnology sector gained 200 percent over the three years ended July 31.

But don’t burden yourself trying to predict the direction of investment markets. Whether or not there is any kind of stock bubble is less important for many people than a much more relevant complication — a personal lifestyle bubble.

With the economy growing, incomes rising, home values recovering and financial confidence following this same trajectory, many more people feel better about spending.

This willingness to increase standard of living along with net worth can lead personal balance sheets into the same troubled territory as overvalued investments.

LIFESTYLE CREEP

Standard of living can expand easily but often doesn’t reverse as easily when the underlying financial situation weakens.

Spending growth presents challenges of its own, but the largest problem isn’t the cost of goods or services purchased. It’s the opportunity cost. If that money spent on lifestyle were instead invested, its potential future growth represents the cost of the missed opportunity.

There’s no shortage of articles or savings calculators that will show you how fewer lattes or shoe purchases will make a difference in your finances. But while a tighter budget on more everyday spending is helpful, it’s the few larger-ticket items that have much higher opportunity cost.

For example, imagine you’re a 30-year-old DINK (double income no kids) couple. Your income has grown to the point that you can afford more discretionary spending. You like to have a new car every four years, so you lease. Your payments start at $500 per month and with each lease renewal the cost goes up 4 percent. You do this until retirement at 66. Over those 36 years you spend nearly $254,000 on vehicle payments.

Alternatively, you could put the same initial four years of lease payments into buying a vehicle that you keep for nine years (to be conveniently divisible by the 36 year period of the example). You repeat this purchase pattern with the cost of the vehicle increasing by 12 percent every nine years. The buy-and-hold vehicle owner purchases four vehicles over the 36 years and saves close to $140,000 in purchase costs/payments compared to the leaser. This amounts to $3,869 per year.

The savings is nice, but the real advantage comes in what you could do with that savings. This is the opportunity cost of choosing the more expensive route. Invest $3,869 per year for the 36 years at a modest 6 percent average annual return and you’ve got more than $460,000. If you’re eligible to make those contributions in a Roth IRA, that accumulated value is tax free.

Maybe cars aren’t your splurge, but at the same age 30 you spend an extra $25,000 on a house to reach the next best neighborhood. Aside from your taxes and insurance also being higher, that $25,000 could have been invested. Perhaps it would have been a good start to a college fund. At 6 percent annual returns it could grow past $70,000 in 18 years. Push it all the way until retirement and the value passes $200,000.

MONITOR YOUR OWN BUBBLE

These scenarios are more common than you might think. In addition to the large opportunity cost, the personal spending bubble can create unnecessary stress. It may mean working longer to reach a point of financial freedom. It may force you to invest the bit of money you do save more aggressively in search of a higher return. When investment markets are asked to replace the heavy lifting that could be done by saving, the associated risk can stretch your personal financial bubble to a fragile point.

If your ability to earn keeps growing, and you foresee stability in that growth, expanding your standard of living may be merited. But at the first sign of your spending growing faster than your income, you are entering a trajectory that is difficult to reverse. Once that mentality is embedded, it’s tough to remember that it’s not the money you make, it’s the money you keep that ultimately gives you the financial freedom you seek.

Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Tacoma. Reach him at bhjadvisors.com.

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