Lifestyle Inflation – Could it be your biggest financial threat?

“There’s a new villain in town, and it’s attacking the lower, middle and upper classes. It’s called lifestyle inflation, and it doesn’t care how much money you make—it can still find you.”

David Ramsey

Lifestyle Inflation is a financial threat

As we embark on a new financial year, and set our goals for the 12 months ahead, our focus is on financial mindfulness. Lifestyle Inflation is a problem that we encounter on a regular basis – and nobody is exempt! The remedy begins with awareness – read on to learn more.

Most people will spend more money if they have more money to spend.

When your salary is $50,000 a year, it can be easy to spend as much as you earn pretty much every month. But what would happen if you end up earning twice as much in five years’ time? Unless you’re prepared to stick to a relatively modest lifestyle, chances are you won’t be saving any more when you’re on a six-figure salary than you do now.

Lifestyle Inflation occurs when your spending increases along with your earnings. It is a money mindset that can have you looking back and regretting how much you spent and how little you’ve saved. It is a stealthy threat, because although you might be able to pay all your bills and live well, you are limiting your ability to build wealth and secure your future.

Why Lifestyle Inflation Happens

People have a strong tendency to spend more if they have more. A couple factors are at work here.

One is the “keeping-up-with-the-Joneses” mentality. It’s not uncommon for people to feel like they have to keep up with their friends’ and business associates’ lifestyle habits. If everyone drives a BMW to the office, for example, you might feel compelled or pressured to buy one as well, even if your old Honda Accord gets the job done just fine.

Another contributing factor to lifestyle inflation is a sense of entitlement. You’ve worked hard for your money, so you feel justified in splurging and treating yourself to better things. While this is not always a bad thing, rewarding yourself too much for your hard work can be detrimental to your financial health now and in the future.

But what if spending more makes sense, sometimes?

There may be times when increasing your spending in certain areas makes sense. You may need to upgrade your wardrobe, for example, in order to be dressed appropriately at work following a recent promotion. Or, with the birth of a new baby, you may really need to move into a house with an additional bedroom so the grown-ups can get some sleep. Your situation will change over time – both professionally and personally – and you will likely have to spend more money on things you previously avoided altogether (like a car) or things you could skimp on (like your wardrobe). A certain amount of lifestyle inflation is to be expected as your work and family obligations evolve.

Spending a little extra to improve your quality of life might also make sense – as long as you can afford it. As you advance in your career, for example, you may not have time anymore to mow the lawn and clean the house – unless you use your one day off to take care of such chores. Even though it’s an added expense, it may be reasonable to spend the money and pay someone else to do it, so you can free up some time to spend with family, friends, or doing a hobby you enjoy. Being able to enjoy a bit of free time helps promote a healthy work-life balance and can make you more productive at work.

The important thing is to make decisions such as these mindfully, with due consideration and proper understanding of how the costs will impact your financial situation.

Avoiding Lifestyle Inflation

While some level of lifestyle inflation may be unavoidable, remember that every spending decision you make today affects your financial situation tomorrow. In other words, that $800 pair of Jimmy Choo heels you just bought is coming straight out of your retirement nest egg. Can you afford to spend that much on shoes? Even if you can, should you?

Even with a substantial pay increase, it’s possible (and quite easy) to end up living paycheck to paycheck, just like you did when you were making much less money. That’s because the increased spending that results from lifestyle inflation can quickly become a habit: the more you earn, the more you burn. You buy more things than you need just to maintain your new (inflated) standard of living.

Here are some mindful techniques that may help you to avoid lifestyle inflation:

Be conscious of lifestyle inflation

Awareness is the first step. Until you become conscious of lifestyle inflation, you won’t rein in your spending and think seriously about how to handle extra cash that comes your way. There’s a lot to be said for reminding yourself that a raise or bump in salary isn’t just “fun” money. If you spend it too fast, it won’t feel like much of a raise at all.

Make a budget

Budgeting is the key to getting on top of your finances! With a budget in place, you’ll know exactly how much you can spend while keeping lifestyle inflation at bay!

You might think a budget is restrictive, but it actually gives you permission to spend money – on those things you’ve already budgeted for, which means that they will be things you have considered mindfully, and are important to you. A budget helps you avoid impulse purchases, which are the worst kind for bringing on lifestyle inflation.

And what happens when you want to make a purchase that isn’t in the budget? Instead of relying on a credit card or loan to fund a splurge, stash away small amounts of cash over time. That way you can truly afford those lifestyle items you want. And you’ll be able to pay for them in cash!

Calculate real changes to your budget

After taxes and expenses, the effect of a raise is often less significant than you first think. Take the time to calculate the real change to your budget and determine how that extra money is going to affect your situation.

Calculating the real and final amount that lands in your bank account each month can provide a healthy dose of perspective. Once you’ve done the math, you might find that your raise doesn’t exactly merit a new car or shopping spree.

Separate needs and wants

While some purchases are necessary, it always pays to separate needs (things we have to have for survival, including shoes) from wants (things we would like to have but don’t need to survive, like the Jimmy Choos). Keeping needs and wants in mind – and making realistic, honest assessments about whether a potential purchase is a need or a want – can help you make better financial decisions and avoid excessive lifestyle inflation.

But be careful – watch out for that sense of entitlement that will have you perceiving your wants as needs! Feeling that you deserve to reward yourself for your hard work, or have the right to spend more in order to prove your success is tempting, and could have you blowing through that windfall before it makes a meaningful difference. Instead, stick to your plan and remember that your success shouldn’t be tied to material goods, but rather how you put your money to work for you and your long-term goals.

Don’t keep up with the Joneses

Just because your children’s friends are taking karate, art and horseback riding classes doesn’t mean your kids needs to do it too. Your neighbours might have gone on a two week European holiday, but that shouldn’t make your road trip or staycation any less enjoyable.

As if it isn’t hard enough to hear about these stories from neighbours, co-workers and friends, we now have a front-row seat to see it all too—thanks to social media. Scrolling through a news feed makes it easy to take a peek into someone else’s life and compare yourself to their highlight reel.

Don’t fall into the trap of letting the way others spend their money dictate the way you spend yours. The truth about the Joneses is that they’re probably broke and busy trying to keep up with someone else.

Don’t hang out with the big spenders

Feeling jealous about money and keeping up with the Joneses is part of human nature. For example, consider a night out: If your friends live an inflated lifestyle, you might be enticed to go to a pricier restaurant, order expensive drinks, or even pick up the tab. If your friends live more modestly, on the other hand, and you match your behaviour to theirs, you’re likely to spend less.

When you think you need something, give yourself a reality check by considering if your friends with more modest lifestyles manage without it, and if not having it seems to impact their happiness or quality of life.

Value experiences over things

If you start making more money, feel free to spend a little bit to improve your lifestyle. However, instead of going for a fancy new car, house, or expensive wardrobe additions, consider investing in experiences. Going on even a modest vacation or signing up for a class can create memories that give you a lasting satisfaction, making you less likely to keep spending. Contrast that to shopping for new clothes, which produces a short-lived high that needs to be replicated.

Talk to your friends and family

When you get that raise, sit down with the important people in your life, and talk about where you want to be in two, five, or even ten years. Whether you want to travel more, save for your kids’ college educations, pay off debt, or buy a home, redefining your goals and sketching out a game plan can reveal where that extra money needs to go. In short, you’re less likely to experience lifestyle inflation if you stay focused on your goals and get your family and friends on board.

Talk to your family about your new personal budget and why you prefer not to spend that extra cash on “things.” Set budget guidelines for gifts and occasions to control spending. Chances are they’re going to be supportive.

Avoid New Debt

Racking up credit card balances, financing a new car, or otherwise going into debt when you get a raise is step backward. Unfortunately, it’s a common move because folks often feel they can “afford” that new debt.

The simple truth is, there’s no such thing as being able to afford debt. All it does is spread your budget thinner, even when you’re earning more. When you factor in interest rates, the picture becomes even more bleak.

Instead, pay off any debts you currently have, starting with the smallest. Throw more than just the minimum payment at them if you want to make a real impact. Then, when everything is paid off, open savings accounts for things you eventually want, such as a car or home. This can help you put together a larger down payment and often get a lower interest rate when the time comes.

Be mindful of flow-on costs

It’s important to keep in mind that when you increase your lifestyle, you also increase your long-term expenditures. An expensive car might require a pricier mechanic, and a big house requires more upkeep. Don’t go from zero to one hundred in the first few weeks following your change in income. Celebrate modestly and pat yourself on the back. Then, plan your next move, remembering that small, incremental changes are much more sustainable than huge, life-altering decisions.

Automate savings

 “Do not save what is left after spending, but spend what is left after saving,” is one of the most famous personal finance quotes, by investing mastermind, Warren Buffett.

What it basically means is that you should always first reserve your savings out of your earnings, then plan your expenses from the balance that is left. Automating your savings is a genius strategy to help avoid lifestyle inflation and prioritise building wealth.

If you set up automatic processes to transfer a mindfully determined part of your earnings into your savings and investments first, and then spend what is left, it will help you manage your finances well and cut down on wasteful expenses. Since you won’t have as much to spend, you will automatically cut down on over-expenditure. Additionally, you can invest in tax-saving instruments that will fetch you high returns.

Save your pay raises

Whenever there is a bump in your income, it can feel really good to see that bigger paycheck. When you have that bigger paycheck, though, it can become really tempting to spend that extra money.

If you can manage on your pre-raise income, assess mindfully if you really need that extra income in your daily account. Could you set up an automatic transfer so that it just disappears into your savings? Let’s say you receive a 2% raise. Bump up your retirement savings by that same number – from2% to 4% – and your paycheck will barely change, but you’ll be doubling your retirement savings.

Track your progress and accelerate your financial freedom

Applying your extra income to your wealth generating plan will see you achieve financial freedom much sooner.

By regularly tracking your progress, you can see the impact of adding even small amounts of money to your investing, and plot your course on the road to financial freedom.

Greater income helps you achieve increasing financial goals as you advance through life, if you manage your lifestyle mindfully.

While an income boost is generally welcome, you can be just as broke and in debt whether you’re earning $20,000 or $200,000 a year – it depends on how you spend and save your money. Putting some of your good fortune to work through savings and investments and being mindful of the differences between needs and wants can help you manage lifestyle inflation – before it manages you.

If you choose to partner with Soundbridge on your mindful financial journey, you have the backing of a knowledgeable and experienced team of financial experts in your corner. We have a proud 40-year history of helping people to meet and exceed their financial goals, and enjoy life on their own terms. Speak to a financial adviser to find out how we can amplify your financial returns, make your money work as hard as you do, and secure your lifestyle well into the future.

Sources:

https://www.investopedia.com/articles/personal-finance/092313/how-manage-lifestyle-inflation.asp

https://www.moneycrashers.com/ways-avoid-lifestyle-inflation/

https://www.daveramsey.com/blog/lifestyle-inflation

https://www.thesimpledollar.com/save-money/six-ways-to-squash-lifestyle-inflation/

https://www.moneyandlife.com.au/financial-advice-planning/7-little-ways-better-money/

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