Careers tend to follow a general pattern. A person starts out at the bottom, making relatively little money. As they become more experienced and competent, promotions and higher pay follow. The increase in salary from an entry-level position can be dramatic. Many people find themselves making much more a few years into their careers than they did at first.
Making more money is, of course, a good thing. Virtually everyone would prefer a higher salary. However, it does come with certain challenges as well. Perhaps the greatest challenge is how to handle the extra money being taken home.
Unfortunately, many people act as if the extra money is burning a hole in their pocket. As they make more money, they spend more almost automatically — without necessarily gaining any greater utility from their increased spending. In essence, this is the problem of lifestyle inflation — the tendency to thoughtlessly and pointlessly increase spending simply because of a salary increase.
An example of lifestyle inflation is someone who begins dining out every evening once they are able to afford the habit. Other examples could include taking expensive vacations, buying costly wine, a few more shopping trips because you can, or getting a new car instead of an older model. Lifestyle inflation can be irrational, but it can also creep in without notice sometimes.
Of course, it’s not the case that all increases in spending accompanying an increase in salary are irrational. Some things are worth paying for. Buying a new home makes sense for a couple with children on the way. Upgrading from an older, less safe car is probably a great decision. What distinguishes lifestyle inflation, and makes it so noxious, is when the increase in spending doesn’t actually make life better in any appreciable way. The difference between a sensible expense and a foolish one is in the utility provided. People who fall into the lifestyle inflation trap increase their spending because they can, not because they need to.
Lifestyle inflation can have serious negative effects. Saving and investing money is one of the key aspects of a financially responsible lifestyle. Lifestyle inflation means that little money is being put aside in savings. This has both immediate and long-term negative consequences.
In the short-term, a lack of savings means having no money set aside for financial emergencies. No emergency fund means being unprepared to handle an unexpected expense, such as getting fired or a surprise medical procedure. In the long-term, someone who does not save will never achieve financial security and will not be adequately prepared for retirement.
So how does someone avoid lifestyle inflation? Fortunately, being aware of the problem is half the battle. Most of those who fall into the trap of lifestyle inflation do so unconsciously, not noticing how much their spending habits are changing. The problem is the lack of attention and knowledge.
After that, the biggest secret is discipline and self-control. Impulsive spending decisions are almost always foolish and wasteful. Planning and making a budget will help rein in mindless buying. A good strategy is to ask: will this purchase genuinely increase my quality of life? Or will going with the more economical choice be just as good? Asking simple questions like these will eliminate most needless increases in spending.
One plan of attack is to live as if you were still making a lower amount. In this scenario, someone who was making $60,000 and gets a raise to $70,000 would budget for $60,000 and still have the mindset that that’s their salary. This established rule ensures that the newfound $10,000 raise will go straight to investment or saving.
Lifestyle inflation can cause a lot of problems for those who aren’t aware of their newfound spending. Luckily, it’s not especially hard to avoid once you adopt a smart approach to personal finance.