What Is Lifestyle Inflation?

Lifestyle inflation refers to an increase in spending when an individual's income goes up. Lifestyle inflation tends to become greater every time an individual gets a raise and can make it difficult to get out of debt, save for retirement or meet other big-picture financial goals. Lifestyle inflation is what causes people to get stuck in a cycle of living paycheck to paycheck where they have just enough money to pay the bills every month.

Key Takeaways

  • Lifestyle inflation refers to a situation where an individual's income increases and their spending also increases.
  • Common events that can trigger lifestyle inflation are graduation from college, a job promotion or a significant raise.
  • Lifestyle inflation can result in situations where people place great emphasis on the acquisition of objects in order to achieve happiness.
  • Strategies to avoid lifestyle inflation include prioritizing financial independence and valuing experience over the acquisition of objects.

Understanding Lifestyle Inflation

One instance in which lifestyle inflation typically occurs is the transition from being a student to being a full-time employee. Despite surviving on very little money as a student, once a first paycheck arrives, things that were once "luxuries" can easily become “necessities,” resulting in increased spending. Sharing a two-bedroom apartment with three other roommates to keep housing and utility expenses down suddenly seems less attractive. An individual experiencing lifestyle inflation might go out and lease a one-bedroom apartment where they can live alone.

An Example of Lifestyle Inflation

After graduating from college, Gal found employment at a bank in New York City. In college, Gal worked odd jobs as a waitress and a librarian in order to make ends meet. She shared a three-bedroom apartment off-campus with two other students. She subsisted on sandwiches and ramen while balancing college and work demands.

After she got a job, Gal moved into a studio apartment in New York City. She adopted a pet and joined a boutique fitness club. Among her extravagances was eating out at all of the Michelin-starred restaurants in New York City.

Although Gal was experiencing lifestyle inflation, Gal was also wise enough to set aside a portion of her income in a savings account. She also invested in a Roth IRA to prevent lifestyle inflation from controlling the state of her finances.

Strategies for Avoiding Lifestyle Inflation

Lifestyle inflation causes many people to live paycheck to paycheck, make the minimum payments on their credit cards, and lack cash resources to fall back on when an unforeseen setback like a medical bill or job loss occurs.

People tend to increase their spending when their income increases because they believe that the additional goods and services they can now buy will make them happier. Often those purchases don’t actually make them happier. A better option would be to work toward financial independence by saving more.

It's possible to avoid lifestyle inflation by consciously establishing spending and saving amounts. Setting up an automated savings plan can be a good way to ensure that savings goals are met and spending is capped. Avoiding lifestyle inflation can mean achieving financial independence at a younger age, having the financial flexibility to choose a dream job over a higher-paying option, and retiring early. Some more strategies below:

Calculate Real Changes to Budget

After taxes and expenses, the net effect of a raise is often less significant than it appears. Take the time to calculate the real change to your budget and determine how that extra money is going to impact you.

Value Experiences Over Things

If you start making more money, instead of buying a new car, a house, or an expensive wardrobe, consider investing in experiences. Going on a vacation or signing up for an educational class can create memories that give you lasting satisfaction.

Make Gradual Changes

An expensive car might require a pricier mechanic, and a big house requires more upkeep. Don’t make huge changes to your lifestyle in the first few weeks; rather, celebrate modestly.