Becoming a victim of lifestyle inflation

3 Oct

This can happen gradually over time and can have both positive and negative implications on one's financial well-being. Lifestyle inflation is what causes people to get stuck in a cycle of living paycheck to paycheck where they have just enough money to pay the bills every month.

Example Of Lifestyle Inflation

Before Lifestyle Inflation

Alex starts their career with an entry-level job earning $40,000 per year.

He live in an affordable apartment with a roommate, paying $800 per month for their share of the rent. Alex drives a used car, which is fully paid off. They cook most of their meals at home, rarely dine out, and are diligent about sticking to a budget. Alex saves 20% of their income in a retirement account and an emergency fund.

After Lifestyle Inflation

A few years later, Alex receives a significant promotion, and their salary increases to $80,000 annually.

He decide to move to a more upscale apartment in a trendy neighborhood, now paying $1,500 per month for rent. He start dining out at expensive restaurants regularly and take more frequent and lavish vacations.

Alex reduces their savings rate to 10% of their income, thinking that they can afford to save less due to their higher earnings.

Warning Signs Of Lifestyle Creep

Spending To Project A Certain Image

Credit Card Debts

Sometimes we face a tough financial time and fall on credit card balance to pay just for the necessities like groceries and bills. But if you notice you’re consistently in credit card debt while still eating out multiple times a week or getting a new pair of shoes each month, then you’re probably becoming a victim of some lifestyle creep.

This is a very common sign that tells you that you are dragging yourself into the danger zone. To avoid spending too much money on items that are meant to glitter your status, you need to distinguish between the desire for something that brings you joy and wanting something that shows how well you’re doing.

For example - if few people in your office are wearing a new expensive watch, you may feel like you need the same one although your current watch is serving you well. You want the new watch just because you want to follow the trend and show people that you can buy an expensive watch. This is lifestyle creep. In contrast, if you are a technology freak and the latest features entice you and give you excitement, the purchase can bring you happiness.

Point to remember- You never know what’s going on in other people’s bank accounts that is giving you the lifestyle creep. I once had a prospective client who displayed his symbols of wealth- a luxury car, designer shoes, clothes, and so on but wasn’t able to meet the minimum requirement to invest in assets as “He was drowning in debt”. He literally looked like a million bucks on the outside but had nowhere near a million bucks.”

Reduced Saving With No Actual Assets

I hear people saying this a lot – “Where does my money go? Why is my bank account always empty? I am not being able to invest in any assets and so on. When we become a victim of lifestyle creep, it becomes challenging to save money and ultimately you cannot invest in anything fruitful. It takes us back to the example- do you want to buy things because it gives you happiness or because you want to build a certain image?

Strategies To Avoid Lifestyle Inflation

Make gradual and steady changes.

Once you have got a pay rise or your business has started doing well, don’t rush into upgrading so soon. You know that an expensive car requires an expensive mechanic, and a big house requires more budget to keep up. Refrain from making huge changes to your lifestyles in the first few months but instead celebrate modestly. Allow yourself some time to sync in with the change. Decisions that are made during this period are often regrettable in the future.

Make a budget plan.

Track where your money is going. If you create a budget plan and set a threshold on how much you can spend, you are halfway through the battle with lifestyle inflation. Your money is in your hands, and it will work under your authority. Before anything, set aside the money that you want to save, don’t keep it for the last. Whatever is now remaining is what you get to spend. Ideally, saving at least 30% of your income is recommended.

Manage your debt.

Create a comprehensive list of all your debts, including credit card balances, loans, and mortgages. Create a strategy for your credit card debt as well. You want to make at least the minimum payment each month, but the more you pay and the sooner you get rid of it, the better for your financial health. Ideally, you want to make a habit of never carrying a balance on your cards at all. Try to get rid of debts that are not your actual assets such as cars, and personal loans sooner.

Saving and Investment

The next two important things in the finance cycle are saving and investing. It is not advisable to just keep saving and do nothing with that. After you have kept some of that saved money for an emergency fund, it’s time to invest. You can find heaps of reading material on “How to invest your money” but always remember the basic principle. “Invest in income-producing assets”. Investing in real estate, investing in dividend-providing shares, and investing in mutual funds are a few examples. But of course, do your due diligence before investing.

Enjoy the rest.

Once you’ve set the guardrails and worked out your budget plan, you can enjoy the journey. The money you’re not putting toward essentials, debt, savings, and investments is yours to spend without fear and hesitation.