How To Avoid Lifestyle Inflation
You just got a pay rise and decided to move to a bigger flat in the city centre or join a more exclusive gym? It means you have just fallen into what I call "lifestyle inflation".
Lifestyle inflation is an increase in spending when a person's income increases. Lifestyle inflation tends to happen every time a person gets a raise and can make it difficult to eliminate debt, save for retirement, or meet other primary financial goals. Lifestyle inflation traps people in a cycle of living paycheck to paycheck and having just enough money to pay the bills.
Why Lifestyle Inflation Happens
Our desires increase as our salary increases
For our first home as an adult, we all had a more or less small apartment that we loved because this was the first time we ever had our own home. But, after a few months or years, this same apartment appeared much less pleasant than on the first day. You must wonder why? Because once we own an item, the joy it brings us declines progressively day after day as a machine that depreciates over time.
This phenomenon mainly justifies why people tend to buy the updated versions of phones - Why would you buy the iPhone 10, then the iPhone 11, then the iPhone 11 if the only applications you use daily are WhatsApp, Instagram, Messenger, LinkedIn and Google Chrome or Safari?
The marketing teams of retail companies are careful to sell items in different price ranges. They aim to entice high-income earners to buy "premium" products. It is what I call the "high-income trap". Indeed, if you compare the quality of entry-level and premium products, you will find that the difference is tiny - but in terms of packaging and price, you will find a real difference. All of this is to justify a higher price and to get more margin on high-income customers.
We are influenced by other people’s behaviour
One of the reasons why people spend more money when their income increases is because they want to show their social position and have the same financial habits as most people in their social circle including friends and colleagues.
Please find below a few real-life examples.
If all your colleagues wear a Rolex and £1,000 suits, you may feel as though you need to buy an expensive watch or suit, even if your current watch and clothes suit you perfectly.
Your current apartment is very nice and located in a nice neighbourhood 20 minutes away from downtown and 15 minutes from your workplace. But, all your colleagues live downtown and pay their rent +25% more for the same area. You may feel the need to move downtown.
The two above examples illustrate our “gregarious instinct” explaining why when most people act in a certain way, we feel the need to do the same.
How To Avoid Lifestyle Inflation
Now that we’ve answered what is lifestyle inflation and why it happens, we are now going to explore the 5 proven ways to avoid falling into this trap.
Track your spendings
First, look closely at your spending habits and determine where your money is going. Are there areas where you can make savings and adjustments? If you are spending too much money on clothes, you may need to cut back, or if you are spending too much money on eating out, you may want to consider cooking in bulk. Getting back on track does not mean giving up everything that makes you happy. It's all about being aware of your spending and deciding what your financial priorities are.
Create or review your budget
Next, create or review your budget. Creating a budget will help you keep track of your income and expenses to ensure that you are spending within your means. To get an overview of your spending, start by listing all your sources of income and expenses. Does your total income cover your spending leaving you with extra money? Or do you need a balance between what you earn and what you spend?
Set aside a percentage of your income for your desires
If you get a raise, decide how much you wish to spend on 'fun'. It will allow you to afford that good treatment, that luxurious lifestyle and that holiday. You deserve to treat yourself. Also, be honest with yourself and assess the impact of the amount you plan to spend on your long-term financial plan.
Set up automatic savings
Automating your savings is the easiest and most efficient way to save. First, you will only have to set up automatic transfers to your saving account and won’t have to make any saving decisions on a day-to-day basis. In a way, you will get paid each month your salary minus the savings you committed for.
Reach out to tax and financial advisors
Now, you managed to save some money but don’t really know where to put it. If you are facing an increase in spending due to an increase in income, one-on-one sessions with tax and financial advisors could help you save on tax and make smarter financial decisions regarding savings and investing.
Now, you have all the tools not to fall into the lifestyle inflation trap. Start implementing my advice to have more control over your finances!
I hope you found this article useful.
Have a great week!
Isaac
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