All too often our life situation changes and we find ourselves with a sudden influx of cash. We get a raise or a promotion. We change jobs. We inherit a small portion of a relative’s estate. We pay off a big loan that was weighing us down. These life events free up our cash flow, and they trick us into thinking we “deserve” to spend the newfound money in our budget on non-essentials.
Have you fallen into the lifestyle inflation trap? If so, you’re not alone. It’s common no matter what your profession is, or what period of life you’re in. Luckily, there’s a few simple steps you can take to avoid lifestyle inflation, and set yourself up for long-term financial success.
What is Lifestyle Inflation?
In short, lifestyle inflation is spending more than you make, or spending more than you responsibly should. This overspending may seem reasonable in the moment, but over time it can drive you into debt, or make it harder to reach your long term savings goals. People typically fall into lifestyle inflation when they start to earn more, or find extra money in their budget as a result of a one-time cash payout or getting rid of a recurring bill. For example, if you’ve spent a long career working your way up the corporate ladder, and are rewarded with a huge promotion a few years before your retirement - your income could jump significantly. It’s tough to resist spending the extra money you suddenly having in, especially if you’ve lived a relatively frugal lifestyle up to this point.
The Emotional Baggage of Lifestyle Inflation
As with all things financial, lifestyle inflation is bigger than just bad spending decisions. Those decisions are typically rooted in a deeply held belief that we deserve to live the life we want. There’s nothing inherently wrong with this idea, and at Wisely Advised we help our clients create a financial plan that supports the life of their dreams. However, overspending in relation to how much income you’re actually bringing in isn’t living the life you “deserve” - it’s living beyond your means to purchase things that you want, but don’t necessarily need right now. You may feel as though you’ve put in the time and effort to earn your raise or promotion. The sweat equity you’ve poured into your career is finally being recognized, and you feel like you deserve a payout. Unfortunately, this line of thinking often results in a spend-spiral. Once you start living beyond your means, it’s tough to cut back.
If you feel like you’re getting pulled in by lifestyle inflation, your first step should be to take an honest look at your finances. Track all of your spending over a one or two week period, and work to uncover trends. A common area that people overspend is eating out, or getting drinks with friends. You may also find that “big ticket” purchases are eating up your budget. Even if you pay for an expensive new car outright, it still may be too expensive for your budget.
Once you evaluate your spending, try to determine why you’re spending in those specific areas of your life. What value do you gain from them?
Using our above example, if you’re spending too much on dinners out with friends and family, you likely value time spent together and experiences over “stuff.” Try to think of new, less expensive (or free) ways to still spend time with people you love and enjoy to fulfill that part of your value set without spending money there. This can help to drastically reduce your lifestyle inflation.
Finally, if you’re still struggling, it may be time to think about what your funds should be used for. It’s not uncommon to spend frivolously after your cash flow increases, but if you’re financially savvy and nearing retirement, you likely know what your money should be used for. Speaking with a financial planner about how you can put your money to good use as you save for retirement can help you to feel ahead of the game, and ultimately resist the temptation of lifestyle inflation.
Tony Velasquez is the Founder and Managing Director of Wisely Advised an Illinois Registered Investment Advisor. Wisely Advised provides comprehensive financial planning and investment advisory services to both individual and business clients. You can learn more about Tony and his firm here.
As I mentioned in my previous blog, The Benefits of Compound Interest, you can compare compound interest to a snowball rolling downhill. When you’re standing at the top of the hill, and you smash together two fistfulls of snow to make a snowball, it seems very small. But when you set the snowball down and give it a push down the hill, it slowly starts to grow in size. What does that actually look like in real life though?
To help you better understand, I have created a series of documents that lay out how you can expect your money to grow with the power of compound interest. Because so many people feel overwhelmed with investing and thinking about their retirement, I am going to start with a smaller amount, one that is very doable for most people looking to start saving for retirement. Let's see how what kind of growth we can expect for a monthly investment of $50.
Looking for a printable PDF version? CLICK HERE.
Plus, stay tuned for the next blog in this series where we will dive in deeper to the power of compound interest and see how some serious investing now can create a big payoff later.
Tony Velasquez runs Wisely Advised, LLC a full-service Registered Investment Advisory Firm offering comprehensive financial planning and investment advisory services to individuals, families, and businesses.
Whether it's traveling, being at the beach, or at his family's ranch in Texas, Tony loves enjoying time with his family and friends.