Most people will spend more money if they have more money to spend.
Consider a college graduate just embarking on a career who settles into a comfortable apartment for $750 a month. A couple of years later, their salary has increased, so they find a better apartment for $1,250 a month.
The old apartment was adequate—good condition, great location, nice neighbors—but the new one is located in a more exclusive neighborhood. Despite the fact that the original living arrangement was fine, they traded up to a more expensive apartment—not because they needed to, but because they could.
When a person advances into a more profitable position at work, their monthly expenses typically rise correspondingly. This is a phenomenon known as lifestyle inflation, and it can present a problem because you might still be able to pay your bills, but you are limiting your ability to build wealth.
Why Lifestyle Inflation Happens
People have a strong tendency to spend more if they have more. A couple of factors are at work here.
One is the "keeping-up-with-the-Joneses" mentality. It’s not uncommon for people to feel that they have to match the buying habits of their friends and business associates. If others drive a BMW to the office, you might feel compelled or pressured to buy one as well, even if your old Honda Accord gets the job done just fine.
Likewise, your house on one side of the city may have been your dream home when you moved in, but with so many of your colleagues talking up life on the other side of the city, suddenly you may feel the need for a new address.
Lifestyle inflation creeps into more areas. You can end up spending more money than you need to (or should) on vacations, dining out, entertainment, boats, private school tuition, and clothing, just to keep up with the Joneses.
Consider the Joneses
Keep in mind that the Joneses may be paying off a lot of high-interest debt over a period of decades to maintain their appearance of wealth. Just because they look rich doesn’t mean they are, and doesn’t mean they are making financially sound decisions.
Another contributing factor to lifestyle inflation is a sense of entitlement. You’ve worked hard for your money, so you feel justified in splurging and treating yourself to better things.
While this is not always a bad thing, rewarding yourself too much for your hard work can be detrimental to your financial health now and in the future.
When Spending More Makes Sense
There may be times when increasing your spending in certain areas makes sense.
You may need to upgrade your wardrobe, for example, in order to be dressed appropriately at work following a recent promotion.
Or, with the birth of a new baby, you may really need to move into a house with an additional bedroom so the grown-ups can get some sleep.
Your situation will change over time—both professionally and personally—and you will likely have to spend more money on things you previously avoided altogether, like a car, or things you could skimp on, like your wardrobe. A certain amount of lifestyle inflation is to be expected as your work and family obligations evolve.
Spending a little extra to improve your quality of life might also make sense, as long as you can afford it.
As you advance in your career, for example, you may not have time to mow the lawn and clean the house. Even though it’s an added expense, it’s reasonable to spend the money and pay someone else to do it, so you can free up some time to spend with family, friends, or doing a hobby you enjoy.
Being able to enjoy a bit of free time helps promote a healthy work-life balance and can make you more productive at work.
Avoiding Lifestyle Inflation
While some level of lifestyle inflation may be unavoidable, remember that every spending decision you make today affects your financial situation tomorrow. In other words, that $800 pair of Jimmy Choo heels you just bought is coming straight out of your retirement nest egg. Can you afford to spend that much on shoes? Even if you can, should you?
Even with a substantial pay increase, it’s possible, and even quite easy, to end up living paycheck to paycheck, just like you did when you were making much less money.
The increased spending that results from lifestyle inflation can quickly become a habit: the more you earn, the more you burn. You buy more things than you need just to maintain your new (inflated) standard of living.
Spend or Save?
Assume you splurged and bought that $800 pair of Jimmy Choos when you were 25 years old. Imagine you had invested that $800 instead. When you reach age 65, your $800 would be worth $5,632, assuming no additional investment and a 5% interest rate return.
Even though the shoes are awesome, would you rather have great shoes for a couple of years or almost $6,000 extra entering retirement?
Needs and Wants
While some purchases are necessary, it always pays to separate needs from wants. Keeping needs and wants in mind—and making realistic, honest assessments about whether a potential purchase is a need or a want—can help you make better financial decisions and avoid excessive lifestyle inflation.
Another way to avoid excess spending as you make more money is to save or invest a healthy percentage of your increased wages. For example, if you now earn $1,000 extra each month, plan on saving or investing $750—an extra contribution to your 401(k), adding money to your emergency fund, or funding your IRA.
If you stash the extra money away, you won’t be able to spend it on things that don’t really matter.
The Bottom Line
While an income boost is generally welcome, you can be just as broke and in debt whether you’re earning $20,000 or $200,000 a year—it depends on how you spend and save your money.
Putting some of your good fortune to work through savings and investments and being mindful of the differences between needs and wants can help you manage lifestyle inflation before it manages you.