Have you ever seen a story about an athlete, celebrity, or even lottery winner that has made millions but are now in financial ruin? The obvious question comes to mind, “How is that possible”? The reality is, it’s frighteningly easy. In fact, millions of people fall in the same trap just on a smaller scale. These stories are a result of a common enemy across income tiers and wealth brackets known as lifestyle inflation.
What is Lifestyle Inflation?
In simple terms, lifestyle inflation is an increase in spending as your income increases. The biggest change in lifestyle usually occurs when someone leaves the minimum skill job market and enters into the higher skill market, whether it be a new job after finishing an apprenticeship, trade school, or college, or any other promotion from a minimum skill position.
Naturally, when someone goes from making less than $20,000 a year to something like $40,000 or more, new financial opportunities are available like:
- Moving from a cheap apartment into a nicer home
- Getting rid of their $1,000 car and upgrade to something more comfortable
- Improving their diet from ramen noodles and peanut butter and jelly
- Getting rid of their college clothes and upgrade to a more professional look
There is nothing wrong with upgrading your lifestyle within limits. After all, we produce wealth in order to consume it. While these choices make sense if not taken too far, for many, these upgrades continue their entire career. The house gets bigger or they buy in a more expensive neighborhood, the cars become more luxurious, spending on food and entertainment continues to climb. Each new increase in income is met with more spending.
Lifestyle inflation keeps millions in a perpetual state of ‘near poverty’, where they are usually just one or two paychecks away from financial ruin. It is typically accompanied by a mountain of debt, and keeps people trapped in the rat race in order to pay for this ever inflating lifestyle that costs far more than they realize. In short, it keeps financial independence just out of reach.
Why Does Lifestyle Inflation Happen?
The reason lifestyle inflation occurs is simple, humans are masters at adapting to their surroundings. Our financial conditions are no different. We get used to what we have and forget about what it is like to have less. The happiness of the ‘new thing’ wears off and we are right back to where we started before. This is also known as hedonic adaptation, or the hedonic treadmill.
For those who make minimum wage or similar, $40,000 a year seems like a fortune. That’s because you know what $15 – $20,000 a year provides, so doubling that would make you feel like shopping for a monocle and top hat. For someone who makes $100,000 a year and have allowed lifestyle inflation to creep up on them, they couldn’t imagine getting by on “just” $40,000 a year. The interesting thing is, the people making $20,000 and $100,000 respectively are often the same person just at different points in their life and career.
It matters very little how much money is in question, that is why it even happens to people who make millions of dollars. Everyone is capable of falling for the same trap. The most dangerous thinking regarding this or any other pitfall is believing that you are different, or above it.
8 Ways to Avoid Lifestyle Inflation
Controlling lifestyle inflation is a fundamental part of setting yourself up for financial success and avoiding this hazard that plagues so many. To be clear, warnings against lifestyle inflation don’t mean that you should maintain your poverty level standard of living well into your career, however, it does mean you should consciously limit the increase and look for ways to leverage your increase in pay during your career as a tool to accelerate you into financial independence.
1. Be Aware of Lifestyle Inflation
If you are reading this before your first big pay increase, lucky you, look around at others for examples of lifestyle inflation. It could be your parents, their friends, or even the celebrities and lottery winners mentioned above. Learn from their mistakes. If you are currently in your career, think back on your various levels of spending, and what you used to think was “a lot of money”. Be aware of how this has changed at various stages of your income levels. Most who fall into the trap of lifestyle inflation don’t realize it’s happening, so they don’t recognize it’s even a problem.
2. Develop a Budget and Stick To It
Let’s face it, developing a budget is really the easy part. The hard part is sticking to it. The sooner you develop a habit of controlling your spending and staying within a budget the better off you will be. When you get your raise, you will be much more in control. You will be able to see what it does to your finances more clearly and be able to maximize your chances of avoiding runaway lifestyle inflation.
3. Pay Yourself First and Pay Yourself More
There is a fairly common trick when it comes to budgeting and saving, that is to ‘pay yourself first’. This means to take a percentage of your income and allocate it to savings before you budget for anything else, we recommend 10% of gross income (gross is total income before taxes or other expenses). If you use a percentage, the amount you save will naturally increase as your income increases. For example: If your income increases from $40,000 to $45,000 a year, the amount you save before taxes would increase from $4,000 a year to $4,500 a year.
4. Set a Goal for Your Maximum Living Standard
As I mentioned before, it isn’t entirely bad to make increases to your standard of living, however, you will want to aim for a maximum. The lower you set it, the sooner you can start to snowball your wealth accumulation. Imagine if you decide that everything over $60,000 a year (minus taxes) will go toward savings in addition to your normal savings rate. This means that if you make $80,000 a year, you will live as if you are still only making $60,000 and budget accordingly. Imagine how quickly your savings and investments would grow, as opposed to allowing the new income to be simply consumed by a higher standard of living.
5. Find Contentment – Literally Stop to Smell the Roses
The most effective way to fight lifestyle inflation is to find contentment. Marcus Aurelius offers up a strategy for finding gratitude for what you have. This of course includes not just material things, but also loved ones and friends.
In addition, take in and appreciate the ‘free’ things in life. Nature itself is a wonder to behold. Take time to look up at the sky and appreciate the expansiveness and beauty of a blue sky, watch the clouds as they go by. Literally stop and smell roses, or any other flower for that matter. This is by no means an attempt to be trite or cheesy. Try it, you might be surprised by the beauty and wonder that is right in front of you.
By actively focusing on your current blessings, you don’t allow them to simply fade into the background of life. As Marcus prescribes, “thankfully remember how you would crave for them if they were not yours”.
6. Find and Appreciate the Variety of Life
This won’t just help fight off lifestyle inflation, this trick will help you re-kindle your appreciation for all things once longed for but now taken for granted. Break up your routine from time to time. Cook new foods, listen to a new musician, read a different kind of literature than you are used to. If you have a spouse, don’t let familiarity become complacency. Surprise each other with tokens of appreciation. Mix up your ‘date night’ rituals. Try new things. This will help fight off the trap of hedonic adaptation by keeping things new without necessarily having to spend more money to do it.
7. Take Small Steps to Scale Back
If you find yourself in a situation where you think you should scale back your standard of living, it is likely most effective to start small to maximize your chances of sticking to it. As I mentioned before, humans are masters of adapting to their surroundings. By slowly taking steps to reduce your expenses, you will give yourself the opportunity to adjust to them without “feeling” much of a loss. This maximizes the chance you will be able to stick to the changes and advance toward financial independence.
8. Surround Yourself With People Who Share Your Financial Goals
This isn’t a recommendation to end relationships with your spendthrift friends, but it can be very difficult to stick to your budget and goals if everyone around you is living an expensive lifestyle. It becomes very difficult not to eat out, go on expensive vacations, or engage in other activities on a regular basis if your entire social circle is doing it. A weekend doesn’t have to be expensive. A night in with friends cooking at home and playing games, or simply socializing can be a lot of fun and far less expensive than a night on the town with dining, drinks, and other costly entertainment. None of this is to say you can’t or shouldn’t occasionally treat yourself to these luxuries, but making a routine habit of them can ruin budgets.
You may have recognized a common theme in these strategies to control lifestyle inflation, you have to be proactive and get ahead of it. It is very difficult to scale back your standard of living once you increase it. Additionally, it is easier to control if you make a plan before your income increases, or you receive a windfall from something like an inheritance. It is all too common for people to think of this as free money and just blow it. However, if your goal is to achieve financial independence, being aware of lifestyle inflation, and planning ahead is the best way to avoid the dangers that come from it.