3 Steps to Avoid Lifestyle Inflation

Lifestyle inflation is when you upgrade your lifestyle as your income increases. Unfortunately, it can cause the best of us to live paycheck-to-paycheck. Why? Your income grows, but never your savings. 

It’s a common problem. According to CareerBuilder, 78% of Americans feel like they’re living paycheck to paycheck (even those making over $100K!). Here’s how you can effectively avoid lifestyle inflation in your own life. 

Key Takeaways:

• Lifestyle inflation damages your ability to save and invest.
• Upgrading your lifestyle increases happiness for about one month. Happiness then goes back to what it was.
• Increase your automatic saving deductions for every raise you get. 
• Contribute your raises to saving and investment accounts. 
• Avoid expenses that you can barely afford, such as a new house or car.
• Don’t compare yourself with peers or purchase things just to match the status quo. 

Example of lifestyle inflation

Let’s look at lifestyle inflation in action. 

Say hello to Katie. Katie is a marketing intern. She makes $25K per year. As such, she limits her expenses, living with several roommates and taking the bus to work. 

A year later, Katie gets a position as a Junior Marketing Manager. She makes $50K per year. Since her income went up, Katie decides to upgrade, renting a new apartment. She also buys a used, but nice vehicle. 

Three years later, Katie becomes a Senior Marketing Manager with a new salary of $90K. Excited by the increase, Katie immediately buys a 3-bedroom house. She also trades in her used car (even though it runs perfectly) for a luxury vehicle. Finally, she begins going out regularly for meals at fancy restaurants. 

Katie thought she’d be happier. After all, she’s making more money. But she’s stressed, living paycheck to paycheck as she struggles to cover a house and car payment every month.  

Katie learned something that many who receive a raise discover. As her income increased, so did her expenses. This means she has less money to save and invest. She’s also in debt. And interestingly, lifestyle inflation doesn’t increase Katie’s happiness over the long-term. In fact, upgrading your lifestyle increases happiness for about one month. Happiness then goes back to what it was. This is called the hedonic trend. 

Her story isn’t unusual. Lifestyle inflation is an easy trap to fall into. But it can be avoided by following the steps below. 

1. Increase your automatic saving deductions. 

Create guardrails that won’t allow you to increase your spending with every raise. One of the best ways to do this is to increase your automatic saving deductions for every raise you get. 

An automatic savings deduction is where money is automatically withdrawn from your paycheck (usually every month). This money is directed to a savings, retirement, or another investment account.

For example, if your income increases 5%, increase your savings by 5% and ensure that the money is automatically contributed to an account where it can grow. If your income increases by 10% a few years later, increase your savings by 10%. Pretend like this money doesn’t exist. 

Your net paycheck then stays the same, no matter how many raises you receive. 

By making these paycheck withdrawals automatic, you don’t even have to think about making progress. Your financial goals are being achieved behind the scenes. 

WHERE TO CONTRIBUTE RAISES

A great place to start with automatic deductions is your 401K. Use extra money to max out your contributions (this is especially important if your company offers a 401K match). Your retirement savings will then grow. 

And don’t stop there. You can also automatically direct money toward other accounts, such as a Roth IRA. Another option is investing through a brokerage account. A brokerage account (e.g., Vanguard or Fidelity) allows you to buy and sell different investments like stocks and bonds. This strategy can make you rich over time. 

Say that you receive a $6,000 annual raise or $500 extra per month (after tax). Every month, you automatically contribute this $500 into a brokerage account where you’ve already built a portfolio. At a 7% return, this money will grow to almost $90K in 10 years!

Compound Interest Calculator 

That’s the power of automatic saving deductions. 

Above all, make sure that your raises don’t go into your checking account. You don’t want the money to be easily accessible! Directing your money to a relatively non-accessible account protects you from impulse purchases. 

Note: Before investing, make sure you don’t have high-interest debt. Also, make sure you have an emergency fund and savings set aside. 

2. Avoid increasing expenses. 

Buying high-dollar items can make us feel good after we get a raise. We want a lifestyle upgrade, and it feels justified since we’re making more money. This can result in us buying a

• Luxury car
• Fancy home
• Expensive meals
• Brand clothing
• Phone upgrade

Treating yourself is okay now and then (as long as you budget for splurges). It keeps you motivated. But consistently upgrading your lifestyle after every raise can lead to expenses you can barely afford. This is especially true for two essential expenses: housing and transportation. 

According to the Bureau of Labor Statistics, housing and transportation make up around half of the average American’s household spending. These expenses are harder to decrease after you’ve upgraded and make it difficult to increase your savings.

In short, 

• Avoid upgrading your living situation if it’s unnecessary. Consider living with roommates or in a studio apartment instead of purchasing an expensive home. Or if you do want to purchase a home (maybe you plan on living in the area long-term), make sure the mortgage payment is well within your budget. 

• Steer clear of expensive cars. Select vehicles that offer bang for their buck (e.g., long life, low gas mileage) rather than ones that merely look cool. If you can purchase it in cash, do so! This will save you money on car payments and interest.

Another way to avoid increasing your expenses is to buy generic brand foods. Also, don’t feel the need to buy new furniture or go on vacation more often, even if your income goes up. 

We’re not saying that you need to cut coupons or eat Ramen noodles every night. Your lifestyle will change the older you get and you may need to spend more on certain things in life (e.g., childcare). 

But do determine what expenses are most important to you and the maximum you can spend on these expenses without hurting your savings rate. Keep your essential expenses around the same amount.

3. Stop trying to keep up with peers. 

Scrolling through social media can be a huge enemy to your finances. Why? Because as we see peers buying 3-story homes or Porches, we can feel behind. Lifestyle inflation occurs as we try to keep up. 

Don’t compare yourself with peers or purchase things just to match the status quo. Friends might be purchasing luxury items, but that doesn’t mean they can afford it. Their fabulous lives might be hidden by a mound of debt. 

Keep in mind that the money you’re saving and investing now will help you achieve financial freedom. Building wealth comes from sticking to your own financial goals — and ignoring what everyone else is doing. 

Combat lifestyle inflation by being proactive

It’s natural to overspend the money you receive. After all, it’s exciting to get a raise! But lifestyle inflation can easily lead to debt, as well as little to no progress with long-term financial goals. Celebrate your raises, while still placing guardrails on how much you spend. 

Want to learn more about personal finance and avoiding lifestyle inflation? Take the Core Four of Personal Finance including Recession Basics course on Udemy. This course teaches you how to effectively manage your money — even during tough economic times! Check out the course here.