How to avoid the pitfalls of ‘lifestyle inflation’
Lifestyle inflation can be described as the habit of increasing your spending because of an increase in income. For example, when you receive a new job, promotion or raise and you take that extra money and immediately spend it as disposable income, this is known as lifestyle inflation. This habit can be a slippery slope. Not only are you spending your new money frivolously, but you’re also not doing yourself any favors. You aren’t paying off any debt, saving for retirement or making investments of any kind.
To avoid this practice, once you know about a pending new job or raise, put a plan together to put your money to good use. You’ll feel so much more fulfilled with your choices. Later in life, you’ll thank your younger self too. More money in retirement is a lot more valuable than that purse you’re never going to use again after a year.
Here are a few tips to avoid falling into the lifestyle inflation trap and make better choices.
Make saving automatic
The easiest way to save the increased money you’ll be receiving is by pretending it doesn’t exist. If you’ve been living comfortably off your current salary, there’s no need to go around spending money like a millionaire. Stay in your current comfort zone and automatically contribute a bulk of your extra money to your savings account. It will be like you never had it and you won’t even miss it. After a while, these savings can really add up and you can use the money to make bigger investments, buy a home or enjoy invaluable experiences like trips.
So you don’t feel completely deprived, if your new salary is increasing by $1,000 a month, for example, save $700 and keep the extra $300 back for an important upgrade such as a better living situation, a safer car, gym or fitness class membership, or experiences with loved ones. You’ll get more value out of items like these. If you have children, invest it in them. Education costs, travel, classes or college savings are always good places to start.
You can apply the same savings techniques to your retirement accounts. According to a Go Banking Rates survey, 42% of Americans will retire broke. Don’t be one of the 42%. Using that same $1,000 increase, you can automatically save $400 to your savings for a rainy day, and increase your retirement contributions by $400. That leaves you with $200 extra a month for other worthwhile purchases. This increase in your retirement accounts will pay off big time in the long run. Increasing your 401(K) contributions or investing in an IRA account are good starting off points.
Pay off your debt
The next most important thing you can do is pay off your debt. Going back to our $1,000 example, you could take $500 of that money and put it towards your debt pay off goals. You can use the remainder of the money for savings and retirement and that would still leave you $500 a month to help you chip away at your debt. Think about the fact that $500 a month is equal to $6,000 a year. It would feel pretty amazing to pay off an extra $6,000 a month off of your student loans, credit cards or mortgage.
Having less debt and a higher income means you’ll also be in a much stronger place financially. When you’re buying a home, renting an apartment or buying a car, lenders look at your debt to income ration very closely. This determines your interest rates and how reliable you are as a customer. Your credit score will also increase gradually putting you in a good spot for big purchases down the road.
Don’t keep up with your friends
Lastly, we’ve all heard the expression, keeping up with the Jones.’ Don’t be that guy. If you are always trying to one-up your friends and buy the latest and greatest thing, you’re just wasting your money. Let them make poor financial decisions and you will have the satisfaction of knowing you’re debt free, setting yourself up nicely for retirement and aren’t falling in the trap of material possessions.
Talk openly about your financial goals with your friends and family and ask that they encourage you and check in with you. When your friends and family know you’re saving for something important or are trying to reduce your debt, they’ll be more likely to offer up helpful alternatives to spending. On Friday night, for example, your friend might suggest he will bring over something to cook at your house rather than making a reservation at the most expensive restaurant in town.
You and your family can also align your goals together. With your spouse and children, this is critical. If one of you is looking to take your extra income and save it while the other is out there making lavish purchases, you aren’t on the same page. Have a talk with how you’d like to use the money and tell them your goals. When your goals are a stable retirement and education for your children, they will likely comply.
If your family is resistant, it’s also nice to have incentives for reaching a goal. Let’s say you’ve paid down the debt you wanted to and have reached your savings goal for the year. You can reward your family for participating by taking some of your savings and doing a meaningful experience together. You’ll have amazing memories and it’s something you’ll look back on versus spending the money on pricey dinners you won’t remember.