by The sad reality for the majority of people living in a first world country is that we really, really, really suck at saving money and much of this is due to lifestyle inflation. We are notorious for spending whatever we have whenever we have it and this leads us to becoming slaves to our employer because we are desperate for the pay check we need to keep living a lifestyle that we can barely afford.
Parkinson’s law states that “work expands so as to fill the time available for its completion” and unfortunately the same is usually true of money.
The more we earn, the more we spend: This is known as lifestyle inflation.
On the surface lifestyle inflation may not seem like such a bad thing because as we earn more and spend more the quality of our life appears to increase… however we will find out in this post exactly why this may not be the case.
In this post we will be covering:
- Common examples of lifestyle inflation
- Why lifestyle inflation is difficult to avoid
- The dangers of lifestyle inflation
- How to avoid lifestyle inflation, enjoy yourself and stay compatible with financial independence
- Why lifestyle inflation probably won’t make you happier
- The benefits of lifestyle inflation
- Other options for lifestyle inflation
- Conclusion
Common examples of lifestyle inflation
Lifestyle inflation usually comes after an increase in available pay; usually from:
- Promotion at work
- Additional sales
- Business performance
This increase in available spending money each month generally results in the cash sitting in the person’s bank account and therefore the obvious thing to do is to treat yourself and spend it on something that you ‘really deserve’.
Personally I remember when I completed my apprenticeship and suddenly my income at 20 years old went from around £1200 a month to close to £2000. Did I have a plan for this money? Of course not, I was 20 and just wanted to go to bars, clubs and spend it on holidays… so that’s exactly what I did for the first couple of months.
Some of the most common examples of lifestyle inflation are:
- New car
- Better apartment/house
- Fancier holidays
- Designer clothes
- More restaurants
- New toys/gadgets
Put simply:
You can earn £200,000 a year and still have £60,000 in credit card debt. You can earn £30,000 a year and be halfway on your road to financial independence.
Why lifestyle inflation is difficult to avoid
There are two main reasons for that many of us fall victim to excessive lifestyle inflation and these are:
Lifestyle creep
One of the biggest dangers of lifestyle inflation is that it creeps up on you slowly and sub-consciously without you even realising. If you look back at all the years you spent working can you ever really remember making a deliberate decision to increase your spending in certain areas? When did you decide to:
- Get takeaway twice a week instead of just once a month
- Buy the ‘premium’ and more expensive brands when food shopping
- Holiday in a 4 star resort instead of a 3 star
- Drink at a cocktail bar instead of in a friends kitchen before hitting the clubs
It’s likely that you have no definitive answer to the above – they just simply started happening more and more often until it became the norm. Your expectations have now increased and you are accustomed to the life you now live and do not want to return to your previous standards.
In percentages of your earnings these new standards however begin to cost the same (or possibly more) than before meaning any previous pay rise will not result in an increase in your net worth or accelerate your progression to financial independence.
The next step? 4 Star resorts become 5 star resorts and therefore you need another promotion to cover this new expense.
Keeping up with the Joneses
Part of human nature is that we compare ourselves to others and then proceed to make judgements about that person based on very little information. Unfortunately, this is simply biological and is not something that we can eliminate entirely. Have you ever been guilty of thinking:
- He drives a 13 year old Ford Fiesta – he’s probably broke
- She lives on that street? – Obviously she can’t afford to be in a nicer neighborhood
- He shops at Lidl? – There must be a reason
- They went camping on holiday? – I would never do that anymore
Because we know that we judge other people for the above reasons many of us will go out of our way to give a different impression in the hope that people will think the opposite of themselves and that they are successful, important and have influence. This manifests itself as he/she buying a brand new BMW because the neighbor got an Audi and this is known as ‘keeping up with the Joneses’.
This phenomenon will lead you to spending money on things that you don’t need just because you want to come across as successful. Unchecked this will play havoc with your financial life.
Amusingly I am a person that drives a fiesta, shops in Lidl and I even spent some time camping last year (although my house is on charming cul-de-sac). Fortunately I am now comfortable with how I come across to others and prefer to spend money on what I actually care about (travel and experiences). Ironically I now look at the people who don’t want to be judged and think to myself
“I hope that 21 year old didn’t take out too much debt to buy a Mercedes just to impress his friends”.
The dangers of lifestyle inflation
There are three core issues regarding how lifestyle inflation can have a negative affect on your life and we will cover each on in turn.
Savings rate
If you know about a FIRE lifestyle (Financial Independence Retire Early) then you know that the most important metric when it comes to reaching financial independence is your savings rate percentage.
Only by saving a percentage of your income will you ever set yourself up in a position in which you are financially independent. If you want to continue to live to your current standards post retirement look at the below figures for how long it will take to reach financial independence with different yearly incomes:
- £30,000 and save 10% = 51.4 years
- £250,000 and save 10% = 51.4 years
- £100,000 and save 25% = 31.9 years
- £45,000 and save 50% = 16.6 years
You may live a more comfortable life by earning more but your time to reach financial independence will remain the same unless you increase your saving rate percentage.
If you get a £1000 a month pay rise and spend it all then don’t expect your net worth to increase or your time to financial independence to reduce any time soon.
Debt
I believe the most dangerous factor of lifestyle inflation is that people will often tie themselves into huge amounts of debt because of the “I can afford it now” mindset. The below is a common occurrence after getting a promotion and earning an extra £500 a month:
- Trade in your car for somethings newer, faster and shinier – Monthly repayment increases from £300 to £600
- Celebrate with a fancy holiday (using a 3 year loan) – Monthly repayment is £100
- Upgrade from your apartment to a semi-detached house – Rent increases from £750 to £1100
All of a sudden you’re earning an extra £500 a month but your expenses have just increased by £750 for the foreseeable future.
This becomes very dangerous because the debt you are now holding begins to take over your life. Even though you justify it by being able to afford the loan repayments and credit card minimum repayments you can suddenly no longer afford to miss a month’s pay or have an emergency.
Even worse most people will then repeat the cycle when their loan or car finance deal ends… or when they get another promotion.
Ability to build your net worth
Lifestyle inflation will negatively affect your ability to save and invest and unfortunately, this will greatly affect the growth of your net worth. Although your investments will likely increase if untouched for the long term it will be at a far slower rate than if you keep investing more and more money each month.
In the below example we will compare the difference of two people:
- Start with £0
- Invest for 30 years
- Average a 7% return
- Person 1 invests £500 a month
- Person 2 invests £500 a month for the first year but increases his contributions by 5% each year
As we can see their is a huge difference in the final net worth of each of these two individuals and that is due to them not being guilty of excessive lifestyle inflation. Of course if you choose not to look for promotions or increases to your pay then this may not be possible to achieve.
How to avoid lifestyle inflation, enjoy yourself and stay compatible with financial independence
Hopefully from reading this blog you will realise that you need to minimise lifestyle inflation when reasonable and some tips to achieve this are:
Outline your plan/target when you receive a pay rise
As soon as you know that your pay will be increasing it is time to create a plan so you know and understand how to deal with it. This is critical because otherwise the extra money will just be sat around waiting to be spent. Your plan should include set percentages of the extra money for:
- Increases to your quality of life – Is there a real pain point in your life which money could fix?
- Just for fun money – We need to have fun and enjoy our life so spend some of this extra money doing exactly that if you wish
- Investment/savings each month – The more the better
By doing the above you will ensure that your lifestyle is able to improve whilst you begin to increase the speed at which you build your net worth and reach financial independence.
Automate your savings
The problem with waiting until the end of the month to invest/save what’s left of your pay check is that unfortunately…. There’s very often nothing left.
To counter this, set-up a standing order which transfers X amount of money each month from your bank account to your investment account the day after you get paid. By transferring the money straight out of your account it will not be sat there waiting to be spent and the chance of you transferring it back into your account to spend on something that you don’t really need is magnitudes lower.
The amount you choose to transfer each month is up to you and will be determined by your salary and expenses. If you are unsure how much to use for investments/savings then you should do two things:
- Begin to budget and keep track of your expenses – this can simply be once a month and takes 10-15 minutes once set up. Read more here.
- Start small and increase your investment direct debit each month until you hit the sweet spot.
Remember that at this point you should have an emergency fund and therefore if you do accidentally invest more than you should have that month it should only be a minor issue. For more info on why you need an emergency fund read this post.
Avoid debt/leases
Where possible avoid using the increase in monthly income to justify signing up for any kind of debt (unless a mortgage) unless absolutely necessary. Just because you now earn and extra £500 a month doesn’t mean that you should now go out and spend £450 a month on a car lease.
Even worse is credit card debt and therefore the best thing you can do instead of increasing this is amount is to throw all of the extra money at your debt each month until it is gone. For more information on why debt is crippling you read this post.
Do not use a higher monthly salary to justify paying a higher minimum balance on a credit card
Celebrate sensibly
You should absolutely celebrate a promotion or increase in business performance and this article is not designed to stop you from doing that.
Instead you should choose a finite thing for your celebration such as:
- Holiday
- Activity/hobby
- New gadget/toy
- Present for significant other
- Fancy dinner/drinks
None of the above should be paid for by a loan. If they do need to be then instead begin to funnel a percentage of you new income into a pot that will be spent on the ‘celebration’ in the near future.
What is important is that whatever you choose does not tie your future self into paying for it.
Why lifestyle inflation probably won’t make you happier
I think it’s important to point out at the beginning of this section that there can be some very large benefits to lifestyle inflation.
If handled correctly lifestyle inflation can improve aspects of your life which are difficult or impossible to rectify without money.
All of the following are situations in which lifestyle inflation may bring you enjoyment:
- Moving from a bedsit (just a bedroom) to a shared/single apartment
- Buying a vehicle so your commute is cut from 60 minutes by bus to 25 minutes by car
- Being able to afford to buy fresh fruits/vegetables and better quality food
- Able to travel on holiday with friends/family
Some of the above are some key reasons why lifestyle inflation can really improve your quality of life. Instead of being completely shackled by your financial situation you will finally have money to spend on what brings you enjoyment.
The reason however why lifestyle inflation may not bring you enjoyment you expect will be explained below.
Maslow’s Hierarchy of Needs
Maslow’s hierarchy of needs is a commonly accepted motivation theory in psychology which shows the building blocks and requirements for a happy and fulfilling life.
This hierarchy of needs states that in order to increase fulfilment you need to ‘unlock’ or level up in the pyramid shown above. It means that if you spend your increase in salary then in order for it to add real value to your life it needs to move you further up the pyramid of needs.
I feel that the best way to explain why lifestyle inflation may or may not increase your happiness is to compare the below examples:
Person 1 – Homeless/beggar: Finally gets a job and uses lifestyle inflation to:
- Find a cheap/basic room to live in
- Buy simple food instead of beg
- Afford public transportation to see family
Alongside this their mental health improves greatly and they are no longer ashamed/embarrassed by their living conditions.
They move from level 1 of the pyramid to level 2.
Person 2 – Apprentice: Is given a permanent role as a technician and uses lifestyle inflation to:
- Move out of cheap room and now share an apartment with a friend
- Afford to engage in their hobby every week instead of once a month
- Go on one foreign holiday each year
- Upgrade their car to something more reliable
Alongside this as they have completed their apprenticeship they now have much greater job security and know they have the qualifications to find a new role if required. Unfortunately this role is still away from home and therefore they still struggle to see family regularly. However now they have private accommodation a partner can come and visit for the weekend.
They move from level 2 of the pyramid to level 3
Person 3 – Overachieves and gets a 10% increase in salary and uses lifestyle inflation to:
- Upgrade to a slightly newer and fancier car
- Go on holiday to a 4 star resort instead of 3 star
- Buy a new mountain bike to replace the one he has used for the last 3 years
This person has spent the additional 10% he receives but none of this spending results in any real change in his life. It ends with is bragging more to friends, family and coworkers about his new car and his holiday to Costa Rica.
They stay at level 3 on the pyramid
Person 4 – Is promoted from mid level manager to a senior manager and uses lifestyle inflation to:
- Upgrade to a brand new Porsche sports car
- Move into a much bigger house in the same neighborhood
- Holiday in a 5 star resort in the Maldives
- Buy diamond jewelry for his wife
This person is now much more ‘successful’ in the workplace and earns more money but has less time to spend with friends and family. They are also more stressed and struggle to take time away from work. Their new possessions give them little pleasure once the initial excitement has worn off and their children miss spending time with the parent.
They stay at level 3 on the pyramid
The benefits of lifestyle inflation
So far we have predominantly spoken about the negatives of lifestyle inflation but it’s important for us to realise that it can be used to drastically improve the quality of lives.
Many of us have hobbies, enjoyments and distractions which cost money and at times it is only through lifestyle inflation that these can pursued. If the cost of something you want to do puts you off or restricts you then getting a pay rise can be massive in funding it and bringing enjoyment to your life.
We covered some of the most powerful ways lifestyle inflation can help you but we will now cover a few further scenarios:
- Moving from a bedsit (just a bedroom) to a shared/single apartment
- Buying a vehicle so your commute is cut from 60 minutes by bus to 25 minutes by car
- Being able to afford to buy fresh fruits/vegetables and better quality food
- Able to travel on holiday with friends/family
- Hiring a cleaner so you can spend a day at the weekend with your children instead of completing chores
- Buying a new camera/lens which you use weekly
- Upgrading your PC/Playstation/Xbox if you are a gamer
- Setting aside £50 a week to do something new in the local area
- Purchasing online courses to develop yourself
- Going for coffee or lunch with a friend each week
Depending on the person all of the above can improve the quality of their life and therefore lifestyle inflation should not only be seen as a negative.
I know that I could holiday in local areas of close countries but I often prefer to travel further abroad because i find it incredibly interesting and rewarding. To me the extra cost is worth it but upgrading my Xbox is not. However for another person the opposite is likely true.
Other options for lifestyle inflation
It may be that you’ve read this article, completely understand the downsides of lifestyle inflation and yet still do not wish to compromise. This is a perfectly reasonable and natural response as why shouldn’t your life be more luxurious and extravagant now that you are earning more money?
If this is the case then there is another option. A way to have your proverbial cake and eat it.
This choice in question is known as geoarbitrage and is something that has been used for years by those not afraid to travel to achieve the lifestyle that they desire.
If you are a person from a high cost of living area (UK, US, Western Europe, Australia etc.) then it is likely you also earn a high salary compared to the rest of the world. Geoarbitrage can be used by these people to take advantage of earning a high income in a valuable currency whilst living and spending in a weaker currency.
The Nomad Wallet
This is done (usually) by working remotely from a laptop either as an employee, as a consultant or as a business owner whilst living in a country with a low cost of living. These people are generally referred to as digital nomads and the trend is becoming increasingly popular.
You also do not need to travel to a new country to take advantage of geoarbitrage – just think about the difference in expenses between someone who lives in London and another who lives in Newcastle.
Varying costs around the world
By living a digital nomad lifestyle you are often able to greatly inflate your quality of living whilst lowering costs. Some example of costs in cheaper parts of the world are;
If we just look at the costs in the above example countries we can see just how much easier it would be to live a higher quality of life in a country like Vietnam or Mexico. You could move to either of these countries, spend an extra £300 a month on improving your life and still manage to invest an extra £6,000 a year. Whether geoarbitrage is for you is a personal choice but it is certainly an option worth exploring.
For more information on Geoarbitrage check out this blog post.
Conclusion
From this blog post I hope that I have successfully conveyed the positives and negatives of lifestyle inflation. Now that you have a deeper understanding you should be able to apply these lessons/thoughts to your own life to ensure that you do not become a victim of this phenomenon like the majority of others around you. Also you should not feel guilty about spending more if that spending brings real and genuine improvement and joy to your life.
A quick recap of what we have covered in this post:
Common examples of lifestyle inflation
Usually comes after an increase in disposable income (salary increase, additional sales, business performance) and some of the most seen culprits are:
- New car
- Better apartment/house
- Fancier holiday
- Designer clothes
- More restaurants
- New toys/gadgets
Why lifestyle inflation is difficult to avoid
- Lifestyle creep – slowly and steadily you begin to spend more sub-consciously as your income increases
- Keeping up with the Joneses – You don’t want to be judged in a negative light so spend money to match or impress others
The dangers of lifestyle inflation
- Savings rate – Your savings rate will not increase (possibly decrease) and this is the most important factor in reaching financial independence
- Debt – You will often take on long term debt because you can afford the increase in monthly payments
- Ability to build net worth – If your expenses increase in line with your salary then the amount set aside for savings or investments will not increase
How to avoid lifestyle inflation, enjoy yourself and stay compatible with financial independence
- Outline a plan/target when you receive a pay rise (allocate the additional money)
- Automate your savings
- Avoid debt/leases
- Celebrate sensibly (one off purchases that do not require you to go into debt)
Why lifestyle inflation probably won’t make you happier
The principles of Maslow’s hierarchy of needs states that in order to have a more fulfilling life you need to ‘level up’ in the pyramid of needs. If your additional spending does not facilitate this then do not expect to be any happier:
- Being able to afford a car to cut commute time by an hour a day – likely make you happier
- Holidaying in a 5 star resort instead of a 4 star resort – unlikely to make you happier
The benefits of lifestyle inflation
By moving you higher in Maslow’s hierarchy of needs you will begin to live a more fulfilled life. Example include:
- Moving from bedsit to apartment shared with friends
- Buying a vehicle to reduce commute
- Afford better quality food
- Able to travel on holiday to see friends/family
- Hiring a cleaner so you can spend more time with your children
- Purchasing something to improve a regular hobby
- Giving yourself an allowance to spend on activities in local area
- Online courses for self-development
- Coffee or lunch with a friend
Other options for lifestyle inflation
Geoarbitrage can be used to earn in a valuable currency but spend in a weaker one. This will allow you to inflate your lifestyle whilst spending the same or less. An example of monthly expenses could be:
- UK/US – £1,369
- Spain – £955
- Vietnam – £481
- Mexico – £532
Final thoughts
In the last number of years I have actively tried to avoid lifestyle inflation in areas in my life. However I have spent more money in a particular field which brings me the most enjoyment – this has been travel.
By not inflating other areas of my life I have been able to increase or maintain my monthly investments whilst increasing my quality of life.
Let me know in the comments below which areas of life you’ve been spending more without really getting any real gratification from :).
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