What is Lifestyle Inflation?
Lifestyle inflation is common as a person advances through their career. Lifestyle inflation is when the money you have to spend after paying all your bills for necessities increases as your income increases. In other words, you have more money left over after you pay the mortgage or rent, make your car payment, buy groceries, pay your utility bills and such.
As you earn more money, you have more money to buy the things and services you want that you could not buy when you were earning less. This could be a boat or motorcycle, a foreign vacation, a new wardrobe or taking an exotic cruise.
Lifestyle inflation can put you behind the 8-ball for the rest of your life if you allow it. It will prevent you from getting out of debt, saving for retirement, paying for college for your kids or being able to meet other financial goals. It’s also one of the biggest reasons many people live paycheck to paycheck — regardless of how large your paycheck is.
Entertainment is a good example. If you make $5,000 a month and set aside 5% for entertainment, that’s $250 a month. If you earn a promotion at work and are now making $6,000 a month, that 5% now equates to $300 a month — or $3,600 a year.
Needs versus Wants
It’s normal to want to celebrate a promotion or a raise, but it’s important to make sure not to celebrate by buying something that will increase your monthly expenses to the point of making the increase in your income moot.
As an example, you get a raise that increases their income by $500 a month and then immediately trade in your car (that is paid for) for a newer, fancier car, which results in a $600 monthly car payment.
Not only is your increase in income spent, but the amount of money available for all other expenses each month is less than it was before you got the raise. Sure, you may have a new car that you are proud of, but your financial well-being is worse than it was before you got the raise.
How to Avoid Lifestyle Inflation
Frugally celebrate a promotion or raise
If you earn a raise, you should celebrate — especially if it’s higher than the average raise of 2.9%. But to outsmart lifestyle inflation, you need to resist the urge to run to the store for that expensive thing you’ve had your eye on for the last two months. Instead, consider a small way to congratulate yourself, like a special night out with friends.
Create a new budget
Since your income has changed, you need to create a new monthly budget. Just because you will have more money to spend doesn’t mean you can quit tracking your expenses and following a budget. Savvy savers will save or invest half of the increase in their wages.
Due to the COVID-19 pandemic, I think everyone has learned the lesson of needing an emergency fund equivalent to 3 – 6 months of your living expenses. It’s even better and smarter to have 3 – 6 months of your net (bring home) income. After all, you need money for more than your basic necessities.
Avoid new debt
This might seem like common sense, but you will never get out of debt if you keep adding new debt to the pile … especially credit card debt. It’s been proven that consumers are willing to spend more money using a credit card than they would with cash.
Stopping the use of credit cards is entirely possible. A generation or so ago, our parents and grandparents lived without credit cards. Modern credit cards weren’t introduced in the U.S. until around 1950, which means that Boomers and their parents were raised on the philosophy that if you can’t afford to pay for it in cash right now, you wait until you can.
Don’t succumb to peer pressure
Peer pressure from coworkers, friends and family is a powerful incentive, but the perceived wealth of these people can be a far cry from the reality of their finances. The truth is that 8 out of 10 working Americans are living paycheck-to-paycheck regardless of their income. That’s a dramatically different reality from the impression they want others to believe.
How to spend your increase in income
So, how exactly should you spend your extra money after a promotion or raise? Depositing more money into your retirement account, paying off debts, or just saving some extra dollars towards a specific savings goal are financially wise approaches to take.
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