More money = more debt?

The following is the basic plan for achieving financial independence:

Get a job
Start to save
Get raises
Save as salary increases
Take advantage of dollar-cost averaging
Benefit from a bull market
Hit magic number
Retire

It sounds simple and straightforward on paper, but in reality, as this article will explain, earning a high income does not automatically translate into a high net worth.

Income and expenses

When most people are starting out, they rent a small apartment. Getting married or setting up a living arrangement with a significant other generally results in a higher income, but it is also likely to lead to the desire for more space - often at the cost of the desire to make maximum contributions to a pair of individual retirement accounts or 401(k) plans. The opportunity to increase savings takes a back seat as living accommodations are upgraded to a single family home.

After a decision is made to have children, buying a minivan, paying for clothes, toys, soccer, hockey, ballet, and other associated costs results in an increased outlay of cash, not only eliminating the ability to save more, but potentially resulting in a diminished savings rate.

Having children can also result in moving to a larger home in a better school district and,the decision to pay for tuition at a private school, and then a  college education. All of these things often take precedent over funding your own retirement savings.

Lifestyle

Lifestyle decisions also play can also negatively impact savings rates, even as income increases. Scrimping and saving simply isn't fun. If we can afford to take a luxurious vacation, buy that sports car, upgrade the wardrobe, spend a weekend at the spa, buy that place at the beach or chalet in the mountains, don't we deserve it for all the hard work we have done?

The desire to spend instead of save is also fostered by a quick look at the shenanigans on Wall Street and the poor investment returns in our portfolios. Anybody holding Enron, Worldcom or dozens of other failed firms in their portfolio aren't likely to be singing the praises of savings.

A look at most investment statements during a bear market also serves as a reminder that a 20 per cent loss is not recovered by a 20 per cent gain. If we're going to be cheated by the firms we invest in and watch our portfolios decline in value even when we diversify, it's easy to justify the purchase of something we will at least be able to enjoy in exchange for our money.

Geography

Geography can also work against the ability to save. In Silicon Valley, a modest ranch house can sell for $500,000. In New York City, private school tuition for three children can reach six figures and mortgage payments of $150,000 per year are not uncommon. Moving up in the world also places one in a different position on the socioeconomic scale.

If you are living the upscale lifestyle of an investment banker to the rich and famous, driving to a client meeting in a Ford Focus is out of the question. Similarly, if everyone in your social network has a housekeeper and vacations in the Hamptons, those items become an expected part of the lifestyle in order to maintain your social network and class.

The eye of the beholder

Although it might sound extravagant to those of us earning the 2007 national median of $50,233 (according to Census Bureau figures for 2008), having more money (even much more money), doesn't always put people farther ahead. In fact, those earning more almost always have a lifestyle that leaves them with more things to pay for.

That said, before class envy takes hold, those of us at the lower end are also not skipping our lattes, nights on the town, cable television, cell phones, cigarettes, alcohol, new cars, and other nice-to-have-but not-strictly-necessary expenses.

In the end, everybody wants whatever they can afford, and instant gratification is a whole lot more fun than watching a quarterly brokerage statement for 20 years or more. As a result, most of us end up financing our lifestyles with debt. If you manage to avoid this trap, you will be able to reap the benefits of an increasing income, and live comfortably for your entire life.

Conclusion

Sticking to the seemingly simple plan of earning more and saving more requires serious discipline and sacrifice. It means living below your means, regardless of the level of your means, and making savings a priority. If requires having a plan, saving and maximising the amount you invest in our 401(k) and other savings vehicles before spending on the extras.

It may not sound like fun, but years from now, when you look back at all the people who seemed to have it all but were really just getting by, you'll be the one laughing all the way to the bank.