What is Lifestyle Inflation?
Most people live for the 5-10% pay increase every year. Many think they deserve the increase for putting in another year on the job. The reality is that most of the time this increase is typically eaten by lifestyle inflation and taxes and does not result in incremental wealth.
What exactly is Lifestyle Inflation and why is it important to know and understand this concept? Lifestyle Inflation is the process by which an increase in income results in an increase in spending. Let's think about this for a second. If we normally receive a bonus at the end of the year, we will count on that bonus. Before we even receive the check, we probably already have spent it. Perhaps, we bought an extra presents for everyone with the expectation that the bonus will pay for it. Perhaps, we bought something nice for ourselves because we deserved it for all of the hard work we've put it. This is all good. We are not opposed to living a good life and being generous with what we have, but we have to be careful not to get caught up in living a lifestyle that does not measure up on paper.
Let's break this down some more with a few more examples. Let's look at the transition from college to the workforce. In college, I remember being able to subsist on a meager amount of resources. Granted I had room, board, a meal plan, but with little pocket money, I did not eat out much, I didn't go out that often, I went without a lot of things, I walked instead of paying for a cab and I got clever with how to do things for little to no money. Flash forward to my first job, making a decent salary and now I was ordering take out a few times a week, having (expensive) drinks at bars, upgrading my wardrobe. In this case, the lifestyle changes and it could be warranted that we want to move away from our college habits, but we don't have to go broke doing so.
In another example, as I was hitting my late 20's, I wanted to upgrade my car. I was driving a Honda Accord that was 4 years old (brand new when I got it) and it was all paid for. In my mind, I felt I deserved a new car. I had the nice income, nice job title, nice apartment and a luxury car would complete the deal. A part of me wanted to be inline with my peers being single and driving a sleek car, but I knew this was not the right move for me. Was the urge to upgrade strong, absolutely! I wanted it, but in the end after reviewing my financials and my goals for Financial Independence, I didn't do it and I don't have any regrets.
The world is constantly telling us to get the latest, shiny thing. Upgrade to this, upgrade to that. If we are not careful, we will always be chasing the next best thing and each time we do so, it will cost us a little bit of our future Financial Independence.
For a lot of us too, we have to be careful about keeping the lifestyle that we are used to because with the introduction of children, a mortgage and everything else in between, costs exponentially increase quickly. We want to live a good live, but let's not get too extravagant that we end up asking our children for money in our 60s.
It's important to take control of our lifestyle now that we are still younger so that we can retire because of our income, not because of our age.