Understanding Lifestyle Inflation

Lifestyle Inflation is the term for spending more money on lifestyle items (housing, entertainment, car) as your paycheck gets bigger. This is not to be confused with normal monetary inflation, which is when the price of items goes up because the purchasing power of your currency has gone down. Monetary inflation is not something you can control. Lifestyle inflation is definitely something you can control.

How lifestyle inflation happens

When you start earning more money, there is a natural inclination to start spending more money. You earned it, right?

I get it. Everybody gets it. Very few people start their careers earning a lot of money. Generally, we increase our wages over time. And as our income goes up, we start rewarding ourselves with the things we couldn’t afford before. Stuff like a nicer house…that’s a little bigger…and in a better neighborhood. Or we move from the Honda to the Audi.

Speaking of that house, how many people go from one bedroom apartments to three bedroom houses without actually increasing the size of their family? If the people I know are any indication, the answer is “a lot.” Including me. After all, it only makes sense to buy a house that has three (or more) bedrooms. Most families are going to have 2+ children, and/or need an office, and/or need a guest room. It’s “wise” to buy the place that is bigger than you need so you can grow into it, right? Right? Plus – resale value, baby!

Other sources of lifestyle inflation

You also see lifestyle inflation for reasons other than receiving a raise. For instance, you might pay off a debt and suddenly free up some money in your monthly budget. Huzzah! That’s like getting a raise and being a responsible adult all wrapped into one! A not-so-great way to fund lifestyle inflation is by reducing your savings rate or account, unless one of the following reasons applies:

1. You’ve discovered you have a terminal disease, you expect to die within the next few years, and you want to enjoy your remaining time on Earth. In this case, go forth with my blessing. Enjoy the heck out of your money. Make your time left on Earth count and to hell with anybody that thinks it isn’t responsible. If it surprises any of you that I am saying that, well, that’s because I haven’t shared too much personal information yet. You’ll find out what got me passionate about FIRE soon enough.
2. You were saving too much money. Yes, in some cases people save too much money. How much is too much will vary by person, but if you are eating nothing but ramen and Cheerios in order to save money while you have $7,000,000 in the bank, it’s probably too much. And that is coming from someone who really loves Cheerios.

What’s wrong with lifestyle inflation?

There is nothing wrong with lifestyle inflation per se. If you already have a great financial plan and are meeting all of your goals, lifestyle inflation might be fine. But there are two things to watch out for.

First, if you are inflating your lifestyle instead of meeting your financial goals, you aren’t moving forward. People will justify why they “need” the bigger, nicer, more expensive items, but don’t realize they are signing up for increased expenses over the long term. If you use additional monies to fund a one-time purchase, such as a vacation, at least that expense isn’t affecting you over and over each month. If you use the money to buy a car with a 72-month loan that costs $100 more each month than your current car, you’ve signed yourself up to pay more for years. And while you may think “it’s only $7,200,” the point of lifestyle inflation is that by the end of that 72 months you will probably want another, even nicer car that costs even more. So your expenses pile on one another, creating an ever-larger pile.

The second thing to watch out for is how your current lifestyle inflation will affect your retirement. If you are currently spending $50,000/year but you inflate that to $100,000/year, you have to plan for replacing $100,000/year in retirement. A rough rule of thumb for retirement planning is to save 25 times your annual spending, or $2,500,000. But if you limit your lifestyle inflation, you can save a lot less money and still fully fund your retirement. For instance, if you limited your lifestyle inflation to only $60,000/year, you’d need about $1,500,000. I don’t know about you, but it seems easier to save $1,500,000 than $2,500,000. Call me crazy.

The really interesting part is that by limiting your lifestyle inflation, you actually free up more money for savings. The less you spend, the more you can save. So you can reach financial independence/early retirement that much faster! Saving more and spending less is key to long term financial success.

So what, I’m just supposed to live like a broke young adult my whole life?

Definitely not.

Instead, what I want you to do is consciously choose when you are going to dedicate more money towards a lifestyle choice.

For instance, when I moved to my current duty station, I decided I was going to spend more than my housing allowance to live in a place I really loved. I’ve lived very frugally throughout my career, always banking at least a small part of my housing allowance. Where I currently live, there is a clear choice between cost and commuting distance. The farther out you live, the cheaper the rent (and the bigger the houses). But I was tired of commuting and decided to take a three-ish year break.

I chose a place that allows easy transit anywhere in the local area. In fact, my house is so conveniently located to work, shopping, restaurants, and public transportation that I sold my car. In exchange for a pricier apartment, I chose to spend far less on transportation. And I kept my  savings rate the same so I could meet my financial goals.

You might choose to upgrade your car. Maybe you hate cooking and decide you are going to get a meal delivery service. Or perhaps you move from Swatch to Breitling. If you can afford these things without negatively impacting your long term goals, more power to you. Just make sure it’s a conscious choice and not the result of not paying attention.

How do you keep lifestyle inflation in check?

Here is my simple 5-step checklist for protecting yourself from out-of-control lifestyle inflation.

1. Each time you get a raise, figure out how much more money you are getting. Don’t just say “I got a $6,000/year raise, so I get $500 more per month!” Make sure you account for taxes, too. You don’t want to start spending $500 more per month and realize you are only taking home $400.
2. Figure out what percentage your raise is, too. To do this, divide the amount of the raise (pre-tax) by your old income (also pre-tax). If you were making $60,000/year and you got a $6,000/year raise, that’s a 10% raise ($6,000 / $60,000 = 10%).
3. Review your financial plan (don’t have a financial plan? We’ll get there soon enough). Do you have an Emergency Fund, and it is fully funded? Have you paid off all of your high interest debt? Are you maxing out your retirement accounts? Do you want to pay off your low interest debt early? Have you started college savings for your children?
4. If you have any financial goals that aren’t complete yet, direct some of your extra money towards the goal you have prioritized the highest. Or, direct some money towards multiple goals. How much money? To fight lifestyle inflation, you want to put at least the same percentage as your raise. So if your raise was $6,000/year, and that was a 10% raise, you would put $600/year towards the goal (10% of $6,000 = $600).

To really beat lifestyle inflation, I mean just pummel it, put your entire raise towards your financial goals. After all, you were living on that money before so logically you should be able to continue doing so. (if you weren’t paying all of your bills on your old salary, though, put the money towards them)

If you can’t or won’t dedicate your entire raise to your financial goals, consider a 50/50 split. 50% goes to benefiting Future You, 50% goes towards enjoying Current You. This is what I’ve done throughout my entire career. Turns out, if you only spend half your raise you can still enjoy the money while amassing a very high savings rate over time.

5. With the leftover money, choose how you will spend it in a way that is meaningful to you.

Being smart about your money doesn’t mean you have to suffer. You can definitely spend your money on things that make you happy. The key is to do it in a smart way that won’t hurt you in the long run.

How have you dealt with lifestyle inflation in your own life?