Lifestyle inflation, spending more money as your income increases, might seem like a natural reaction to an increased income but it shouldn’t be. When you get a raise, what do you do with that additional income? What should you do? Do you use it to pay off debt? Put more away into savings? Or spend it? Lifestyle inflation can be an easy trap to fall into, but with one simple solution you can avoid it.
What Is Lifestyle Inflation?
For some, the response to a pay increase is to rent a bigger apartment, buy a new car, to go out to eat more often, and so on. In other words, they change their lifestyle because they are earning more. But this also means that some, or all, of that additional money they are earning is already spent every month. While their spending is increasing, their debt payments or savings stay the same. You need to consider, is it worth it to pay twice the rent to have a gym in the building (that you’ve only used once)? Or would it be better to put that money toward paying off your credit card bills or save it and finally get to travel like you’ve always wanted?
The goal should always be to live within your means. This means your income covers all your expenses. The money left over after paying for all your expenses should go toward paying down debt and accumulating savings. If you have debt, pay more than the minimum payment due. Set money aside for an emergency fund. Once you have that set aside, contribute to retirement savings and invest the remaining money. When your income increases, you have options on where to put that additional money. It can be tempting to spend it, upgrade from what you normally buy, figuring you might as well enjoy it a little. Or you can put it toward paying down debt and increasing savings. The former might be fun for now, but the latter will be more beneficial for you in the long run. By spending that money, you aren’t moving up. You’re holding yourself back. Debt will continue to tie you down. Lack of savings will limit you in what you can afford and keep you from reaching your financial goals.
The Simple Solution
The simple solution to avoiding lifestyle inflation is a two-part process. First, make saving automatic. Set up an automatic deduction from your paycheck to your retirement account. Set up another deduction to a secondary bank account for money that will only go towards savings or paying down debt. Second, make it a percentage. Make those automatic deductions a percentage, rather than a dollar amount, this is the key. By deducting a percentage, when your income increases, so does your deduction. If you get a raise, or you work overtime or you get a bonus, the amount that gets deducted will reflect that income increase.
Not So Scary Anymore
So with that simple solution, automatic deductions set at a percentage, you can avoid lifestyle inflation. It’s not to say you can never upgrade your living situation or your wardrobe, but instead, it’s about being intentional and seeing the big picture. Remember your long-term financial goals as you decide how to spend your money and use automatic deductions to help you when temptations come along.
Talk to your HR rep or bank to set up automatic deductions set at a percentage to avoid lifestyle inflation.