Personal Finance

The Joneses Are Broke! Avoid the Lifestyle Inflation Trap

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Lifestyle inflation can cause anyone to spend more than they need to. The temptation to upgrade our lifestyle to keep pace with our growing income is a very real danger to our finances. But here’s the good news – you don’t need to become a victim of this common financial trap.

In this article, we will take a closer look at what lifestyle inflation is and how to avoid it.

What Is Lifestyle Inflation?

Lifestyle inflation is essentially making the choice to increase your spending over time. In most cases, this increase in spending matches your increase in income. The result of lifestyle inflation is that it prevents you from saving money to reach your financial goals faster. This means a huge loss in potential savings for the long term.

To understand this further, let’s take a look at two hypothetical scenarios.

Luxurious Lavinia vs. Conscientious Carl

Luxurious Lavinia enjoys the finer things in life. After years of enjoying life on a budget of $70,000, her boss gave her a raise to $95,000. Instead of saving her raise, she decided to increase her housing, shopping, and travel budget. Although she still saved $5,000 per year, she significantly reduced the amount of money that she could save over the long term. If she continues this pattern for the next five years, she will save only $25,000 from her annual salary of $95,000.

Conscientious Carl lives a lean lifestyle but enjoys every minute of it. After years of living on a salary of $50,000, Carl received a raise, which brought his income to $65,000. With his new income, Carl decided to save the entirety of his raise — $15,000 per year – and continue living life on his comfortable budget. At the end of five years, Carl was able to save $75,000 by avoiding lifestyle inflation.

Lavinia and Carl have made dramatically different choices with their income. As a result, their savings look very different. Even though Carl earns less than Lavinia, his modest lifestyle has allowed him to save far more money than Lavinia.

How to Prevent Lifestyle Inflation

It is clear that lifestyle inflation can have a big impact on your financial future. Luckily, it is easy to avoid lifestyle inflation by applying some intentionality to your choices. Here are our top tips to prevent lifestyle inflation:

Create a Budget

A budget is one of the best financial tools to help you reach your goals. If you are struggling to avoid lifestyle inflation, then sticking to a budget can help you stay on track. As you build a budget, use the 50/30/20 Rule to outline a spending strategy. Here’s how that budget strategy breaks down:

  • 50% Needs. Essentially, you should allocate 50% of your spending to needs like food, housing, transportation, healthcare.
  • 30% Wants. Set aside 30% of your spending to accommodate your wants. This part of your budget can include things like home décor, travel, new shoes, hobbies, and anything else that you don’t truly need to survive.
  • 20% Savings. The final 20% of your budget should be left to building your savings, paying down debt, or investing. If you are able to, then it is a good idea to increase this percentage when possible.

You can use a budget to avoid lifestyle inflation by setting a spending cap on your needs and wants. You’ll be able to keep your budget within a lifestyle that you are comfortable with and use any extra money to work towards other financial goals.

Save Your Raises

It is completely natural for your income to rise as you move through your career. As you encounter new raises, take advantage of the opportunity to increase your savings. Instead of choosing to spend the new funds on things that you don’t need, consider paying down debt or increasing your investments.

You might find it helpful to have all new raises automatically transferred from your checking account into a separate savings account. It can be less tempting to spend funds that you intend to save if they are placed out of sight. You can set up an automatic transfer from your checking account to your savings account within a few minutes. To get the most value from your hard-earned money, be sure to use a high-interest savings account like Axos Bank’s High Yield Savings.

Keep Your Expenses Fixed

Although you may intend to keep your expenses low, you should not be surprised when your family and friends choose to inflate their lifestyle.

In some ways, lifestyle inflation is an encouraged part of our culture. After all, who wouldn’t be tempted increase their spending when your new job could afford you more luxuries. Although it may feel good in the moment to upgrade your lifestyle choices, it can lead to serious financial consequences.

Instead of following the crowd, take the time to make any big lifestyle changes based on your own personal needs. If you have completely outgrown your living space, then it might be time to upgrade your house. However, don’t move into a bigger home just because everyone else is doing it.

Put New Expenses on Probation

If you want to add a new expense into your lifestyle, then consider giving it a 30-day probation window. As you add new expenses to your budget, consider whether they are adding value to your life. At the end of the probation window, decide if the expense is worth keeping in your life.

In most cases, you’ll find that some new expenses are simply not worth the cost. However, it is completely okay to keep new expenses that truly add value to your life. The new probation window will allow you to avoid any impulse spending that can add up quickly.

Try a Spending Fast

A spending fast can be the perfect way to stay intentional about your spending. When you choose to take part in a No-Spend Challenge, you are committed to reducing your spending for an entire month. If you are struggling to separate your wants from your needs, a spending challenge can bring your priorities into focus. As you become more aware of your spending desires, you may notice items that you can cut from your budget completely.

Avoid New Debt

If you are forced to take on new debt in order to finance a lifestyle change, then you may want to rethink your choices. New debt can bring an added burden to your budget and decrease your ability to build wealth in the future. The danger with new debt is that it can accelerate your lifestyle inflation habits until they’re out of control.

Unfortunately, many people don’t realize that their new debt is a problem until it is too late. Don’t let the promise of an affordable monthly payment push your lifestyle to the outer limits of what you can truly afford.

The Bottom Line

Lifestyle inflation is a threat to your long-term financial wellbeing. Although you might enjoy the upgrades to your lifestyle in the present, you will be limiting your saving potential. With your ability to save hampered, you will have trouble reaching important financial goals, such as retirement.

Before you allow your lifestyle to inflate, think about your priorities and make sure that your new spending habits align with your goals.

The Joneses Are Broke! Avoid the Lifestyle Inflation Trap

This blog post was published by Axos Bank on June 11, 2020 and last updated on June 11, 2020.

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