Lifestyle Inflation: The Silent Killer of Your Finances?

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Chances are, you want to make more money.

Most of us think that a higher income would improve matters in our financial lives.

But would more money really be useful to your long-term financial health?

It could potentially help — as long as you don’t let lifestyle inflation drain away your excess income.

The reality is that when most people earn more money, they spend more money.  If you aren’t careful, lifestyle inflation can destroy all of the benefits that come with a higher income.

You won’t get ahead if you don’t put that money to good use for your future.

What is Lifestyle Inflation?


lifestyle inflation: the silent killer of your finances
A recent article from The Atlantic does a great job breaking down household expenditures in America (America’s Weird, Enduring Love Affair With Cars and Houses).

The article takes a look at household spending data from the Bureau of Labor Statistics, and it finds that no matter how much money a household makes, it spends roughly the same percentage of its income in different categories.

On average, a household led by someone with a four-year degree makes twice as much as a household in which there is no college degree.

However, even though that college grad has twice the income, he or she isn’t spending a smaller percentage of his or her income.

The more education someone has, the more he or she is likely to make — and the more he or she is likely to spend.

According to the data presented in the article, spending on housing is between 30 percent and 35 percent of income, no matter how much education (and income) a household has.  Likewise, transportation spending is between 15 percent and 20 percent of income.

I was surprised at how similar the spending across various categories is, regardless of income.

When you consider the data, the indication is that many Americans aren’t saving money when they see an increase in income; instead, they are likely to spend it by purchasing bigger houses and nicer cars.

This is lifestyle inflation.

It’s the idea that you can boost your spending, since you have more money.

Often, lifestyle inflation manifests itself in eating out more, buying more things, and “upgrading” various belongings, from the furniture to the car to the types of clothes you wear.  Lifestyle inflation might also include experiences that you now feel that you can afford, from trips to the spa, to more expensive vacations, to costly gym memberships.

While it might be fun — and even worthwhile — to enjoy your higher income, it’s dangerous to your long-term financial health to let lifestyle inflation turn into regular obligations.

Some of the recurring expenses that can creep in due to lifestyle inflation include:

  • Higher mortgage payment on a bigger house
  • Higher car loan payments and insurance payments on a newer and nicer car
  • Increased monthly payment due to an “upgrade” to a premium cable package
  • Subscriptions to publications
  • More expensive cell phone plan

Lifestyle inflation usually comes with a feeling of entitlement.  You’ve worked hard to realize your improvement in income, so you “deserve” to treat yourself to a better lifestyle.

While it might not harm your long-term finances to celebrate a little when you get a bump in your salary, it’s important to watch out for the lifestyle inflation that becomes a regular fixture, since that is what will ultimately drain your wealth.

How Much Do You Save?

Every month, the Bureau of Economic Analysis releases a report on personal income, spending, and savings.

For February 2014, the BEA reported that personal saving as a percentage of disposable income was 4.3 percent.  That means that, on average, Americans spend more than 95 percent of their disposable income.

If you are “average,” the data indicates that it doesn’t matter how much you make.  You’ll spend a large portion of your income on housing, and, in the end, less than 5 percent of your income will be saved for the future.

The only way to break this trend in your life is to acknowledge the reality of lifestyle inflation and work to combat it.

One of the best ways to combat lifestyle inflation is to bank any increase in income that you get.

Even if you don’t save or invest 100 percent of your increase in earnings, you could set aside 80 percent or 90 percent of it.  That way, you still have room for a small amount of lifestyle inflation while putting most of your income increase toward the future.

What If You Saved Instead of Spent

When lifestyle inflation is part of your finances, you are doing more than just spending extra money.  You are also missing out on potential earnings over time.

Say you receive a raise of $400 per month.  If you decide to upgrade your lifestyle with that extra $400, you enjoy the short-term satisfaction that comes with whatever it is that is “improving” your life.

But what if you were to invest 75 percent of that raise in a tax-advantage retirement account?

That’s $300 a month going to work for you.

You’d still have an extra $100 each month to help you enjoy an occasional extra treat.  But over time, that $300 you invest can grow tax efficiently.  Using a compound interest calculator, you can determine how much you could benefit by banking your money instead of spending it.

If you saw annualized returns of 7 percent, after 20 years that $300 per month could grow into $157,189.62.  You’ll have made total deposits of $72,000, but your interest earned would be $85,189.62.

While lifestyle inflation would provide you with $72,000 in “value” over that 20 years, in terms of immediate gratification, you are leaving more than $85,000 on table.  Your money could be working on your behalf, adding to your retirement nest egg.

If you have already been saving, the compound effect of investing the bulk of any raise you receive during your career is even bigger.

Final Word on Lifestyle Inflation

Before you increase your spending when you see an increase in earning power, stop and think about what you might be leaving on the table.

Consider saving that money instead of letting lifestyle inflation suck away your wealth.

Glen Take: I’ve been guilty of lifestyle inflation, also known as lifestyle creep.  You know, you work hard controlling your spending and building your discipline to not impulse buy.  But when you get more money you feel like you need to let go a little, know what I mean?  So you treat yourself to a few things you couldn’t get before.  “Why shouldn’t I be happy,” you ask yourself.  And before you know it that increase in money you got is hurting you more than it’s helping you.

Huh?  Crazy right?  But it happens.

Miranda writes some great advice when she says to take a part of an increase and bank the rest.  This way you have a set amount you allow yourself as “play money.”  I’d go a little further and say that you should make sure the part you are saving is part of an automatic savings plan so the money gets put away before you even see it.  “Out of sight, out of mind” can go a long way in helping your finances!

Tell me your experience with lifestyle inflation.

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Published or updated May 5, 2014.

Comments

  1. Can’t agree more Miranda. Yes, with increasing income we tend to spend more that eats our income increase. In fact, I remember a real life experiences of one of my friends. We started our career almost at the same time. She was very sincere at work and moved up quickly on the corporate ladder. We met five years later and when we interacted on some financial aspect I found out to my amazement that her savings or investments were much less than what I did. She was living life as if there is no tomorrow and lived life to the fullest without thinking of the future, when she’ll not be able to work. I just wanted to share this experience as this was an eye opener for me and this blog post surely reminded me of that particular life experience.

    • Glen Craig says:

      It’s a big part of what makes finance ‘personal’ and what makes it difficult as well.

  2. It’s just crazy how across the board the spending goes, regardless of education level. It just goes to show you that just because you’re “educated” doesn’t guarantee you know what you’re doing with money. I think it can be inevitable on one level, but I love the approach you suggest and is one we do quite often. We have generally banked at least 75%, if not closer to 90%, of each raise so we can still enjoy some of the fruits of an increased income but still bank as much as we can for future needs.

    • I think it’s smart to bank increases in your salary, or at least most of them. I like your 75/25 split. Most of the increase goes towards your financial goals but you still get to enjoy the rewards of your hard work.

    • Glen Craig says:

      I think you’re right John that some lifestyle inflation is bound to happen. Look, most of us have gone through our Ramen noodle days in college or when we got our first jobs. So to upgrade your lifestyle when you start making more is bound to happen. But we have to remember to resist the temptation in going too far, which is hard. Banking the money before you have a chance to spend it is a great way to limit your spending.

  3. So true, Miranda! Unfortunately so many people see “success” in terms of their lifestyle. Their goal is a better lifestyle, not to save for the future or the unexpected. All the stress they endure in daily living builds a desire for less stress. That’s just natural. They think a more luxurious lifestyle will take away a lot of the stress, so they jump on the opportunity as soon as possible.

    As we know, it’s very easy to get used to a higher lifestyle and the thrill is gone pretty soon. We’re back to our stresses and maybe have added more stress by trying to pay for everything. We don’t learn very well that lasting happiness & satisfaction comes from relationships. And perhaps some relationships have soured that we thought we could count on. “Retail therapy” is very popular.

    I don’t know a solution that works for everyone, but working towards feeling satisfaction in living within our means and putting more focus on helping others is a good start. And don’t hang out with people who constantly put pressure on you to spend more money than you should.

    • Glen Craig says:

      Maggie, I think it’s a difference between external and internal happiness. All the latest gadgets, cars, etc… are all external. Like you say they make you feel better for a bit but it wears off once something newer comes out. If you can be happy with what you have and build up your savings for the future I think you have a better shot at long-term contentment.

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