What is lifestyle inflation? How to identify and reduce it

Unlike inflation, lifestyle inflation is entirely in your control. Here is more on life style inflation, symptoms and how to reduce it
Understanding lifestyle inflation, identifying and controlling it

It is normal for us to hope for positive growth in all areas of our life, primarily the money we earn every year. As we earn extra income, expenses too increase. Let’s look at Lifestyle inflation, it’s symptoms and how you can improve financial situation by avoiding lifestyle inflation altogether.

What is Lifestyle Inflation?

Now, you may remember the concept of inflation. In inflation, the value of money decreases over time. Likewise, with lifestyle inflation, your lifestyle and expenses that are required to maintain the quality of life inflates over time.

Most people can probably recall that as a student or perhaps at the very beginning of our working career we managed to live on almost no money at all. Life was pretty good and while sacrifices had to be made because of limited funds, life went on.

With increased income and more wealth, we are faced with increased spending, keeping up with the Joneses of our society and showing off our newly minted wealth.

Your Money or Your Life - the fulfillment curve

Acknowledging this behavior and taking actions to reign it in will be in your best interest. The graph above explains what you need for basics, comforts and Luxuries. Anything over that can be saved rather than spending further. You need a decent iPhone, what you don’t need is to buy the latest iPhone year after year when there are visibly no benefit except bragging rights.

Lifestyle creep with income increases

For most people, landing a full time job or getting their first major raise was a signal to get a new set of furniture or move into a bigger house. Maybe it justified taking a car loan out because “I need to be able to get to my new job!”, but almost invariably our spending increases as we have more income.

As part of our modern society it seems extremely normal to spend almost all of the money we have available. The baffling thing is that almost everyone has experienced a period in their life where they have been forced to cut back spending, perhaps through unemployment, the birth of a child, illness or an unexpected emergency.

We know how to be frugal. But we choose not to be.

There is not necessarily any need to return to the extremely austere life of a university student subsiding on noodles alone, but if we are to retire early and break out of the cycle of wasting our entire productive adulthood at work, we need to combat lifestyle inflation.

Signs that you are suffering from lifestyle inflation

If one or more of the following lifestyle inflation symptoms applies to you, you might need to consider whether your spending is holding you back from attaining an early retirement.

  1. If you receive a large windfall, you think immediately of something to buy with it
  2. You always hold a credit card balance
  3. You live paycheck to paycheck
  4. You feel the need to get the latest device or consumer product when the item it replaces is still working perfectly
  5. If you regularly suffer from ‘buyers remorse’ where you regret a purchase shortly after buying it
  6. You notice a number of items you buy are not being used at all and just gathers dust
  7. If you care about matching the spending of your colleagues or neighbours
  8. If you replace your car while your old one is still working
  9. If you take on debt to buy consumer products
  10. You associate spending with happiness, but normally don’t feel any lasting happiness after a purchase
  11. You worry about what is fashionable

FIRE and Lifestyle Inflation

Retiring early from work is not an easy task, and it’s made absolutely impossible if you suffer from any of the above. If you recognize any of the above symptoms and aspire to retire early then you need to consider whether the benefit you are getting out of your spending habits would exceed an entire adulthood of freedom from work.

For some people it might be, but for me, having the latest jeans that a celebrity is wearing or upgrading to a newer iPhone just because my neighbour got one is almost laughably unimportant when compared to financial independence. 

How to combat lifestyle inflation?

The first step is to identify a spending threshold above which you resolve to save every last penny in a long term investment account. I like to set this number as a percentage of net income (after tax and compulsory payments) based on how far away your planned early retirement is.

Track your income and savings rate

Start with understanding your income, expense and debt. Be aware of your personal finance goals, credit card debt, long term goals and your overall financial situation.

  • A 25% spending rate means that every year of spending a quarter of your salary you are saving 75%, or three years worth of living expenses at that spending rate.
  • A 50% spending rate means for every year of work you have earned a year of retirement.

Here are some of the effects on early retirement times if you achieve an extreme spending rate:

Spending only 10% of income = free in 3 years

Spending only 15% of income = free in 5 years

Spending only 20% of income = free in 7.5 years

Spending only 25% of income = free in 10 years

If you decide, like I have, that a 25% savings rate is achievable or is a good aspiration, then work out for you what that means in dollar terms and then plan out a proper budget. Then stick to it!

It normally requires reversing many of the problems I have identified above. Which is essentially making the realization that spending more isn’t linked to more happiness and that it is not possible to keep up with the spending of other people, and that it is OK to not have the latest gadgets. The concept of enough is discussed in detail in Your Money or Your Life and really is a must read book for anyone aspiring for an early retirement.

When you set a monthly target, try to set up a long term goal and investment buckets. Set up automated payments where you can. Automated payments timed to coincide with being paid are a very effective way of forcing you to be frugal. Pretend that the amount left is genuinely all you have left to spend, like back at college or back when you were in your first job.

Spending and Happiness

I genuinely believe that spending less doesn’t mean enjoying life less. Take a look at the changes you have made in your spending as your income has increased and genuinely ask yourself whether you have seen any increase in net happiness. If you haven’t, or the increase in happiness is not proportionate to the increase in spending, think about trying to do something about your lifestyle inflation.

Another option can be to allocate higher contributions towards retirement savings or Roth IRA (if you are in the US). Also don’t forget to ensure you have your emergency fund set up and fully funded, before locking your extra cash in other long term goal or retirement account.

Recognize that it’s standing in between you and a life of financial freedom, travel, of doing what you want, of helping others without worrying about money and of financial independence.

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