How to Avoid Lifestyle Inflation

January 10th, 2020

It’s a fantastic feeling, isn’t it? That first pay raise. Suddenly, you’re earning more money, and the temptation to upgrade your life – a nicer car, a bigger apartment, fancier meals – is overwhelming. But beware! This urge to increase your spending proportionally to your income, known as lifestyle inflation, can quickly erode your hard-earned savings and hinder your financial goals.

Let's be honest, it's easy to fall into the trap. When your income increases, it’s natural to want to enjoy the fruits of your labor. However, if you’re not careful, that seemingly small increase in spending can snowball into a significant drain on your finances.

What is Lifestyle Inflation?

Lifestyle inflation happens when your spending habits increase as your income grows. Instead of saving a percentage of each paycheck, you start spending more on non-essential items, leading to a decreasing savings rate. For example, you might switch from a used car to a new one, or upgrade from a modest apartment to a luxury condo.

Why is it a Problem?

Slower Savings Growth: Even a small increase in spending can dramatically reduce your ability to save for long-term goals like retirement, a down payment on a house, or investments.
Increased Debt: Lifestyle inflation can lead to increased reliance on credit cards and loans to cover the rising costs.
Delayed Financial Goals: The longer you postpone saving for your goals, the harder they become to achieve.

How to Combat Lifestyle Inflation:

Here’s a breakdown of strategies to help you resist the urge and maintain your financial discipline:

Track Your Spending: The first step is understanding where your money is going. Use a budgeting app (Mint, YNAB, PocketGuard) or a spreadsheet to meticulously track every expense. This provides a clear picture of your current spending habits.
Calculate Your Savings Rate: Determine the percentage of your income you’re currently saving. Don’t just look at the amount you’re saving – the percentage is more important.
Establish a Rule of Thumb: A common guideline is the “50/30/20” rule: 50% of your income goes to needs, 30% to wants, and 20% to savings and debt repayment. Adjust this to your priorities, but keeping the savings component consistent is key. Another approach is the ‘10% Rule’ - for every pay rise, only spend 10% more.
Prioritize Savings: Make saving a non-negotiable part of your budget. Set up automatic transfers to your savings account as soon as you get paid. Treat it like a bill you have to pay.
Question Your Wants: Before making a discretionary purchase, ask yourself: "Is this something I truly need? Or is it just something I want?" Delay the purchase for a month or two to see if you still feel the need.
Focus on Experiences, Not Things: Instead of buying material possessions, invest in experiences – travel, concerts, or classes. Experiences often provide more lasting happiness than physical goods.
Don’t Compare Yourself to Others: It's easy to fall into the trap of keeping up with your friends or colleagues. Remember, everyone’s financial situation is unique. Focus on your own goals and priorities.

Conclusion:

Lifestyle inflation can be a silent financial killer. By being mindful of your spending habits, prioritizing savings, and resisting the urge to constantly upgrade your lifestyle, you can stay on track towards achieving your financial dreams.