To achieve our financial goals, we need to be aware of the pitfalls of others. Mistakes that stop other people from ever reaching financial independence. One of these pitfalls that is incredibly common is lifestyle inflation.
This blog will cover a very personal situation that I narrowly avoided and learned from. I hope that hearing about my experience will help you avoid a similar situation for yourself.
What is Lifestyle Inflation?
The modern world hinges on consumerism. We are taught to judge peoples’ success by the things they spend money on. Thus, when we achieve our goals, we think we need to buy more to prove to ourselves and the world that we made it. This is lifestyle inflation.
Lifestyle inflation usually stems from some influx in income. Whether from a raise, a promotion, a side hustle success, or lowering your expenses. We feel that we need to reward ourselves for this success by using that additional income to buy things.
Some lifestyle inflation is completely okay. Necessities like eating healthier food and moving to a slightly nicer, safer neighborhood are good uses of additional income. What good is increasing your income if you won’t live long enough to use any of it?
The dark side of lifestyle inflation is when you start purchasing lavish or otherwise unnecessary items. This could cover anything from frequent vacations, to the newest phone, to a new car, to eating out every single night. These expenses won’t have a meaningful positive impact on your life. They will mainly serve to take a lot of your money in exchange for a short-term hit of dopamine.
My Almost Mistake
When I graduated college, I got hired full-time as a Quality Engineer. I was going from a part-time job at the Student Union to a solid full-time salary.
Initially, I had no lifestyle inflation outside of moving near my work. Outside of that, I was privileged enough to have a car to rely on and didn’t really upgrade anything else in my life. I didn’t even have any plans of making any major upgrades. I was just excited to get out of school and start a career job.
After working for several months, I caught the bug of lifestyle inflation. I have always been a tech person, and with a solid income, I realized a tesla car payment would only take up 25% of my income. At the time, I didn’t feel like that was a bad deal since I’d still be saving money on top of that.
I was genuinely just on the brink of putting a down payment in on the car (Model 3 if you must know). I was just saving to put down a larger down payment to reduce my monthly cost and interest burden. It’s crazy to say, but I was going to put down $25,000 and still pay around $500/month on a 72-month loan. Looking back on it, it makes me queasy to think of that kind of excessive financial commitment.
I was so caught up in the excitement of the new toy that I lost sight of the long-term financial impact it would have on me. It would delay my road to financial independence, retirement, and other large purchases like a house.
Over time, the price of Teslas rose significantly. With supply chain restraints and material shortages, the price of the Tesla I was looking at rose by 20%. Finally, this put the purchase completely out of reach for me.
At the time, I was incredibly frustrated. I had convinced myself I needed it and was going to get it, and it was being pulled away from me. However, to this day, I am incredibly thankful. I absolutely would have gone through with it if not for the price increases.
What I Learned
First off, I learned something personal. I learned that I am, in general, a materialistic person. I love new toys and things to make my life more efficient. However, I need to make sure that these purchases never get in the way of long-term progress toward financial independence. This purchase wouldn’t have ruined my life. But it would have certainly hampered my future success, and I would have been disappointed in myself for making that mistake.
In addition, I learned that personal finance education is invaluable. When I was planning to get the Tesla, I paid little attention to personal finance. Other than being careful to not throw my money away, I wasn’t tracking or categorizing anything. I feel that this stopped me from realizing the true effect that such a large commitment would have on me. Of course, people told me it may not be the best decision. But people want to be polite, so they are rather soft-spoken, and we all know that our own opinions have a far greater effect than someone else telling us.
Finally, I realized the importance of using your saved money for something. If all you do is save all your money in a checking or savings account, it’s easy to perceive all of that money as available. You could easily access it and use it on, oh let’s say a stupidly expensive Tesla, without a second thought.
Alternatively, if most of the money that you save is used to invest in stocks, real estate, etc., you are much less likely to perceive those funds as available. Think of this as paying yourself. With the rest of your income going directly into investments. Not only is the rest of this money perceived as “gone”, but it is also growing your wealth behind the scenes.
How You Can Prevent Lifestyle Inflation
Understand Opportunity Cost
Opportunity cost is the long-term loss of gains due to a short-term purchase. For example, if we assume you will retire in 20 years, we can say that the opportunity cost of a $10 meal is $67. This is because, after 20 years of investing it in the market, you could have had $67 instead of the $10 you spent on dinner.
This is a very powerful tool that can help you understand the gravity of your decisions. For example, spending an extra $200 on rent may seem minimal right now, but you could have $67,000 if you invested that $200/month for 20 years instead. This concept can help you keep lifestyle inflation at bay when you realize that these small luxuries can seriously hold you back.
I want to stress the importance of not taking this too far. It is easy to get caught up in thinking too much about the long-term and suddenly you’re not enjoying anything in the short term. Make it a focus to enjoy your present situation. Just don’t lose sight of the effect that enjoyment could eventually have.
Utilize Your Savings
Most people save money and let it fill up a bank account or their mattress. They always see it as available because it isn’t tied up anywhere. It is extremely liquid, meaning it can be turned into cash that can be used for purchases very quickly. This liquid cash can easily be used to purchase luxuries, contributing to lifestyle inflation.
To fight lifestyle inflation, we need to make ourselves more content with not spending on luxuries. A great way to do this is to limit the amount of money that we see as available.
People are more inclined to spend their money when they feel that they have more of it. If you open your checking account and see $10,000, you are likely to feel you can spend some of it. If you instead had $10,000 total, but $6,000 was invested and $2,000 is in a savings account, you are far less likely to go out and splurge with the $2,000 you see as available.
In this example, all you’re doing is moving your money around. You have no less of it, yet you feel that you have far less available.
For myself, I utilize my savings by automating investments in the stock market, crowdfunded real estate, and savings account deposits. This gives me peace of mind that my savings are working for me 24/7 instead of just sitting there.
If you want to get started down the path of stock market investing, check out my post on the basics of the stock market. Getting started with automated investing as early as possible is invaluable.
Set Up Your Expense Ratios
When attempting to build wealth, it’s important to know where your money is going. Without this framework, you are just guessing at your finances. To get on the path to building wealth, you need a better understanding of your finances than that.
When setting up a framework for your finances, you need to understand and plan out your expenses. The most common framework is the 50-30-20 rule, where 50% of your expenses are necessities, 30% are wants, and 20% are savings. For more information on the 50-30-20 rule, check out my post on expense ratios.
What an expense ratio plan can do for you when combined with the last point, utilizing your savings, is awesome. You can go from saving unknown amounts of money each month to investing a known amount and building your wealth through it. Avoiding lifestyle inflation becomes much more straightforward when you already have a plan for your money.
This 50-30-20 framework won’t work for every situation, so feel free to tailor it to your goals. If you are looking to retire earlier, then maybe step up the savings to 40% and adjust your other expenses. Alternatively, if you have already retired and are looking to maintain your situation, you could lower the savings rate and spend more of your money.
The important thing is to have some sort of framework, regardless of the situation you are in. This will allow you to pave the road towards where you want to be.
A common version of this is the concept of paying yourself. For each paycheck, set up all necessary transfers as automatic. Everything from rent to investments should be an automated process that takes no ongoing input from you.
We can view all these automatic payments as bills. Set up your rent, utilities, subscriptions, etc. to be automatically withdrawn from your checking account.
Included in these “bills” should be paying yourself. Designate a set amount of money that will be yours to spend how you want. This will bring two benefits. First, you won’t have to worry about spending past your budget as you only paid yourself what you would need. Second, it can help avoid burnout. Many people push themselves to their savings limit, beyond what may be necessary, causing them to hate saving in general. When you pay yourself, you can see that you have money to spend with no guilt.
Paying yourself will help stop you from making unnecessary, lifestyle-inflating, purchases. You will know how much you have to spend and be less tempted to spend past that.
Spend on Value
Avoiding lifestyle inflation doesn’t mean you need to stop spending money altogether. The money we earn is meant to be spent in one way or another. To stay motivated, we all need to spend money on some things. Otherwise, burnout is pretty much inevitable.
Instead, it is what you are spending money on that is important. A $15 meal with friends is likely worth it to keep up connections. These human connections are incredibly valuable. However, a $1,000 phone one generation newer than your current one may not be worth it. More than likely, this will bring very little additional value to your life.
When spending money, consider the value that that purchase will bring to your life. The purchase doesn’t have to be necessary to be worth it. It just has to be something that will bring substantial value to your life.
Practice Being Thankful
We have all fallen into this trap including myself, very often. The world is full of better options, upgrades, and people with seemingly superior lives. We feel that we have to buy this next thing to take our lives up a notch. In my experience, a lot of this stems from a lack of thankfulness for what we already have.
I know this all sounds incredibly cheesy. I’m not arguing that. However, I am arguing that being thankful is a powerful mindset that most of us don’t practice enough.
Many of us are incredibly privileged to live the lives that we do and have the things that we have. Much of the time, it isn’t that we need that new purchase, we just want the slight improvement we think it will bring to our lives.
In my situation with nearly purchasing the Tesla, I had a perfectly running car. A car that is by no means old or run down. I simply wanted the fun that the improved technology and speed would provide. Talking about it now, it seems crazy that I almost went through with it. But when we are caught up with new things, we forget about the fantastic things we may already have.
Please understand the situation I almost put myself in and work to avoid it yourself. My hope is that you can learn about lifestyle inflation earlier than I did. Thereby avoiding the horrible mistake I almost made.
Remember, building wealth and working towards your financial goals is fun. We should make the most out of our lives, which includes spending some of the money we have to make ourselves happy. Even if it isn’t always the perfect decision.
You don’t have to be perfect to build wealth. You just have to have a plan where others don’t.
I genuinely wish the best to you on your financial journey. Please let me know in the comments if you had any personal situations regarding lifestyle inflation. How did you avoid or deal with it? We all make mistakes, the important thing is to learn from them. See you next time!
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