When you hear the term “inflation” most people automatically think of the economy. This is a natural response in that inflation is defined as an increase in the price of products and services over a period of time. Inflation occurs when the cost of living increases while the value of currency remains the same. This results in reduced buying power for consumers as goods and services cost more money, yet the value of the dollar remains the same. There is also another type of inflation that threatens our personal finances and that is referred to as lifestyle inflation. Here we take a look at this issue and how to properly handle it to manage our personal finances better.
What is lifestyle inflation?
Lifestyle inflation occurs when an individual responds to an increase in earning with an increase in spending. It is a fairly common occurrence and not always a negative if handled correctly. Basically as we make more money, we find more things on which to spend that money. This only becomes a negative when we fail to remain focused on the big picture.
How lifestyle inflation can damage personal finances.
When a person gets in the habit of spending all of their income, regardless of the amount, they risk living beyond their means. This can happen when you make $30,000 per year or $300,000 per year if your spending matches or exceeds your earnings. There are many examples of lifestyle inflation being responsible for poor financial decisions. Think of lottery winners who when faced with a windfall, go crazy with their spending only to be broke and destitute a few years later. The same thing can happen gradually over a period of time for everyday people. Perhaps after a raise you buy a better car, bigger house or some other big ticket item? Soon you realize you make more money but you don’t actually “have” more money.
How to avoid the dangers of lifestyle inflation.
The first step is understanding how to live within or below your means, regardless of your income level. This requires sticking to a budget and establishing financial goals. As your earnings increase, it is natural to want to improve your lifestyle. Doing so while keeping a firm grasp on reality is key to avoid the dangers of lifestyle inflation. A good preventative measure is to always adjust your savings to match your earnings. If you are putting away a certain percentage of savings at a lower income level, you should immediately increase that amount when you receive a raise. This will at minimum guarantee you are still putting aside money toward your financial goals. Also, think twice before making major purchases or lifestyle changes as the repercussions may last much longer and cost more than you initially anticipated. In doing so you can enjoy the benefits of a higher salary without subjecting yourself to the negative aspect of lifestyle inflation.
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Many employers can automatically deduct a percentage or fixed amount of your salary, and put it directly into a retirement plan. That way, you never see the extra money and aren’t tempted to buy stuff.