A while back, I had a short period of increased income. I thought, “Great, more savings!” But instead, I found myself dining out more and buying extra trailrunning gear. My spending rose with my income, a classic case of lifestyle inflation. Lifestyle inflation occurs when higher income leads to more spending on non-essential items. It often goes unnoticed, gradually eating away at savings and long-term financial goals.

The Causes of Lifestyle Inflation

• Increased Spending Capacity: More income makes it easier to justify spending on luxuries. For instance, a 20% raise might feel like a green light to upgrade to a more expensive car or start dining at upscale restaurants.
• Social Pressure: Keeping up with friends or societal expectations can lead to unnecessary upgrades, like buying a bigger house or the latest tech gadgets, even when they’re not needed.

The Impact of Lifestyle Inflation

The main problem with lifestyle inflation is that it can derail long-term financial goals by increasing fixed expenses, leaving less room for savings or investments. Opting for a bigger house or car can be particularly problematic, as it locks in higher monthly costs. These increased expenses can strain your budget, reduce the amount available for savings or investments, and create financial instability if your income fluctuates or unexpected expenses arise. Managing these expenses carefully is crucial to maintaining financial stability and achieving long-term goals.

Three Types Of People

Roughly speaking (very roughly!), there are three strategies to dealing with increased income. Understanding the different approaches people take towards lifestyle inflation can help you identify your tendencies and make better financial choices.

The Hardcore Saver

• Approach: Treats extra income as non-existent, funneling it into savings or investments.
• Goal: Achieve financial growth and independence, often aiming for Lean FIRE (Financial Independence, Retire Early).
• Characteristics: Highly disciplined, avoids luxuries, focuses on rapid wealth accumulation.

Example: Someone who receives a bonus and immediately invests it in their retirement fund.

The Calculated Spender

• Characteristics: Budget-conscious, balances spending and saving, enjoys occasional luxuries without compromising financial goals.
• Approach: Allocates a portion of the extra income for enjoyment while prioritizing savings and investments.
• Goal: Maintain financial stability without feeling deprived.

Example: An individual who upgrades their phone but ensures they also increase their monthly savings.

The Lavish Lifestyler

• Approach: Freely spends extra income, often without planning for savings.
• Goal: Immediate gratification and lifestyle enjoyment.
• Characteristics: Less concerned with long-term financial stability, often risks financial strain and debt.

Example: Someone who gets a raise and immediately spends it on a luxury vacation without saving any portion of the increased income.

While it’s tempting to indulge in newfound wealth, the Hardcore Saver and Calculated Spender approaches are more desirable for long-term financial health. It’s important to be mindful and deliberate about how you allocate extra income. Even if you enjoy some of the benefits of increased income, doing so thoughtfully ensures you maintain a balance between present enjoyment and future stability.

Plan For Managing Lifestyle Inflation

To combat lifestyle inflation and secure your financial future, consider these steps:

1. Set Clear Savings Goals:
   • Determine a specific percentage of your income to allocate to savings or investments, such as stocks or retirement accounts. This provides a clear target and helps you stay on track.
2. Pay Yourself First:
   • Transfer the designated savings amount into a separate account before spending on anything else. Automating this process can eliminate the temptation to spend the money instead. This strategy prioritizes your financial goals and ensures consistent savings.

Additionally, consider the “one-in-one-out” rule: for every new purchase, let go of an old item. This not only controls clutter but also encourages mindful spending and reduces impulse buys.

Conclusion

Managing lifestyle inflation is about making thoughtful financial choices. By being aware of spending habits, setting clear goals, and automating your savings, you can still enjoy the benefits of increased income without compromising your financial future. Share your strategies for managing increased income and staying financially stable in the comments below!

Sources

Melissa Houston on Forbes
Katherine McLaughlin on Business Insider