Lifestyle inflation is the rise in your expenses when your earnings go up. So when you get a pay hike, or switch to a better paying job or get an unexpected (or expected) bonus, your lifestyle has a tendency to upgrade. If your lifestyle in inflationary, your new expenses are likely to eat up any increase in income.
Here, I’ll be sharing some tips to avoid lifestyle inflation (beyond the generic “live below your means” and “don’t spend” tips) and hope that it is of some value.
However, before this, one needs to be aware of the existence lifestyle inflation. If your lifestyle remains the same irrespective of increase in your income, you don’t have a problem of lifestyle inflation! You are the best judge of your lifestyle and how it has evolved/ upgraded over the time and how lifestyle inflation impacts you.
5 Tips to avoid lifestyle inflation
(Zeroth tip – Follow basic principles of handling personal finance. It is kind of prerequisite before benefiting from any of the following tips.)
1. Invest any additional money first
If you receive a raise or bonus, invest that additional money immediately after it hits the bank account. Increase the SIP amount, or invest the lump sum amount. If you are unable to figure out what to do or where to invest immediately, park the money in a liquid fund or a fixed deposit while you figure out investment option.
The idea is to get a good chunk of money out of savings account (and hence, out of your immediate reach) and eventually be invested towards your financial goals.
2. Put a limit on the things you need to upgrade
If you think of upgrading your house, car, motorbike, vacation plan, kids’ schools, television, refrigerator, sofa and few more things, don’t upgrade all of them. Prioritize what is more important. Upgrade any one or three (or pick any small number!) of these to begin with. Not all upgrades are necessary.
3. Upgrade gradually
If you have figured out few things to upgrade, don’t do all of it immediately. Upgrade gradually. Maybe spread the upgrade over few months. Before upgrading, understand the reason why you want to upgrade – is it utility or showing off? Avoid getting into debt (or even virtual debt) while upgrading.
Remember, you have limited cash flow for the upgrade (you might already have invested a part of the excess amount, as in step 1)
4. Calculate maintenance & recurring costs in your calculations
If you are going for a bigger car, you are not just making a one time cost of buying the car but also increase in running cost, insurance cost, maintenance cost etc. More expensive the car, more likelihood of increase in running costs. Similarly, if you are upgrading the home, your recurring costs may include increase in maintenance, cost of additional furnishings etc.
Do the math before taking a decision to upgrade. And then decide if the upgrade fits well into your scheme of things.
5. Upgrade the basics first before considering others
Few upgrades may be more important than others. Upgrading to a healthier diet may be more important. And so may be increasing your insurance cover(s). Review your health and/ or term life insurance covers & decide. Upgrading your car or sofa may or may not be that important. Identify which all upgrades are important and decide.
Example – how can you avoid lifestyle inflation when you get a pay hike
Suppose you get a 20 percent hike (in terms of take-home pay).
If the inflation rate is 5 percent, then this 5 percent will be the natural rise in expenses. (The number can vary from person to person, but let us assume 5 percent only for sake of simplicity of calculation).
Of the remaining 15 percent raise, how much do you contribute to an “upgraded” lifestyle”?
This number can typically be between 0 to 15 percent. If you do not upgrade your lifestyle, you can save that 15 percent entirely and invest it. If you are looking to upgrade lot of things, then this increase in expense can soon exceed 15% , and you may end up saving much less. (Or maybe fall into a lifestyle trap. And eventually debt trap!).
One of the pragmatic (not necessarily the best) ways can be contribute some amount (about 5 percent of balance 15 percent post inflation raise) to better lifestyle and keep the remaining (about 10 percent of balance 15 percent post inflation raise) for investing.
Within that, prioritize what all are the most important upgrades.
Eventually it boils down to how much you want to upgrade and how much you want to save towards your financial goals. How you leverage your increased cashflows or fall prey to lifestyle inflation will depend upon what holds higher priority foe you. – Your lifestyle or your financial goals.
Avoiding lifestyle inflation can be a great step towards achieving financial independence, if that is in your scheme of things.