The Lifestyle Inflation Trap — And How to Avoid It

“It won’t happen to me.”

How many of us have thought those words to ourselves, especially when receiving financial advice? There’s a reason financial advisors repeat the same mantras over and over again — it’s because they see countless people falling into the exact same financial traps, including lifestyle inflation.

This shouldn’t be a surprise. Marketers, credit card companies, and our financial systems know exactly how to prey on the weak spots of consumer psychology. 

Just think of the common financial pitfalls: living beyond your means, overusing credit cards, living on borrowed money, not having a budget, and impulsive spending. From a big-picture viewpoint, most financial challenges can be categorized under one of those umbrellas. 

Still, most of us end up thinking: “It won’t happen to me.”

It’s a symptom of what psychologists call optimism bias, and it’s exactly what makes lifestyle inflation so commonly dangerous. 

You see, there’s a tangible element to all the other money traps to avoid. For example, living without a budget is a common trap, but that can be remedied by either a written or digital budget. There’s a sense of ownership or responsibility that comes with creating a budget.

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Another example is credit card debt. Whether or not you are in debt, you will receive a statement every month from your credit card company. That creates a tangible component (i.e., the statement) that keeps you grounded to the reality of having a card in your name.

However, lifestyle inflation is invisible. And it looks different for every single person. Whether you are working as a part-time employee or are a seasoned practicing physician, lifestyle inflation is a trap that can tempt anyone at any income level. 

If you find yourself thinking, “It won’t happen to me,” then that’s exactly when you want to be on the lookout for the telltale signs and different types of lifestyle inflation.

Here’s what the budget-conscious need to know.

What Is Lifestyle Inflation and How Does It Work?

Simply put: lifestyle inflation is when your spending increases with your income. Lifestyle inflation tends to turn into a cycle where every time a person receives a raise, their cost of living also increases. People begin spending more on food, clothes, and housing with the mindset of, “If I worked hard for the money, shouldn’t I enjoy it?”

But as lifestyle inflation increases and more money is spent on the cost of living, there’s less money to pay off debts, save for retirement, or meet other big picture goals, such as saving for a down payment on a house. In a way, lifestyle inflation is a trap that can get people stuck in the rat race, working to pay the bills rather than building the life they want.

Here are some things about lifestyle inflation that might surprise you:

• It can create a trap for anyone. Yes, even high-income earners. In fact, high-income earners might find themselves tempted the most. Physicians, for example, spend years training in medical school, residency, and fellowships. They’re used to living on such small stipends that when they get their first “real” paycheck, it’s multiples of what they’re used to living on. If they’re not careful, lifestyle inflation can result in expensive cars and homes that eat up the paycheck.
• For most people, it’s mental. Unless you are currently in a situation where you are being underpaid, lifestyle inflation is typically due to one of two reasons: (1) the desire to impress your peers by flaunting success through material wealth or (2) the justification of increased spending with “I worked hard, so I deserve this and can afford it.” However, even though the cause of lifestyle inflation may be internal, its real-life consequences of being a wealth killer are very real.
• It can cost you more money. The paradox of lifestyle inflation is that it can cost you money in both the short and long terms. Unless you are proportionately increasing your saving and investing, you might find yourself short-changed in retirement. How? Well, lifestyle inflation causes higher demands and expectations for your quality of life. If your retirement plan isn’t updated to account for this inflation, then you’ll either have to retire later than intended or accept a lower quality of living in retirement than you’re used to.

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This is not to say that you can’t reward yourself or enjoy your money. Of course, you can! But reward shouldn’t turn into permanent lifestyle inflation.

Fortunately, there are practical steps you can take to prevent lifestyle inflation from derailing your financial plans.

Take Control of Your Optimism Bias

When it comes to any financial trap, one of the leading pitfalls is the mindset of “It won’t happen to me.”

Psychologists call this optimism bias because humans almost universally look at the future with optimism. Even pessimistic people tend to think optimistically about the future.

Take a moment and think about the following items in your life 10 to 20 years from now:

• Your bank account balance
• The kind of car you drive
• Where you live
• Places you’d like to travel to
• The clothes you are wearing

It is human nature to think that the future will be better than it is today. Even if you’re worried about long-term issues (such as climate change), chances are that you think your personal situation will be better. 

We hope that we will be earning more in the future than we are today, which translates to a higher bank account balance and a better car that we drive. It means we can finally move into our dream home and afford that luxurious vacation.

According to psychologists, this optimism about the future is what leads to optimism bias — the “it won’t happen to me mindset.”

It might not seem like a big deal, but taking control of your optimism bias is key to combating lifestyle inflation.

Why?

Because lifestyle inflation is both short-term and long-term.

Yes, there are short-term consequences such as living paycheck to paycheck, making impulse purchases, or spending beyond your means.

But it’s easy to mask, excuse, or “forget about” the long-term consequences of lifestyle inflation because of optimism bias.

Awareness is key.

If you find yourself making excuses for lifestyle inflation, it’s important to check yourself. Ask, “Am I really making the smartest financial decision for myself and my family? Or am I being blinded by my own bias?”

Once you master this mindset, it will be easier to stick to a healthy budget, even after a raise. Below are more practical steps you can take to keep your spending in check after a considerable income increase.

4 Ways to Avoid Lifestyle Inflation

Recognizing those changes in spending behavior and preventing them is key. Before you even get a raise, bonus, or unexpected windfall, it’s important to have a plan for what you’ll do with that extra money. By having a plan in place, you’ll find it easier to navigate new financial waters.

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Consider these tactics:

1. Always pay yourself first. You can do this by setting up a monthly transfer of money that goes into a separate savings or investment account. I personally like CITBank’s Savings Builder, which offers a high 0.40% APY for monthly savers.
   Furthermore, always pay yourself a consistent amount. For example, if you are saving 15% of your income for retirement with your current salary, then make sure that when you get a raise or a bonus, you are still saving 15% for retirement. In other words, keep adjusting the transfer amount to reflect your new income.
2. Wait 30 days before a splurge purchase. Consumer researchers believe that wanting things makes us happier than actually buying them. Specifically, the experience of shopping and the anticipation of making that big purchase are what trigger us to be happy. This appears to be especially true when it comes to impulse buying.
   So if there’s something that you “just can’t wait to have,” try waiting 30 days. Most of us will find that 30 days later, we’ll realize that we didn’t actually want or need whatever it was that we almost purchased. If you don’t still want it after 30 days, then forget about it. It was an impulse desire that almost wasted money.
   On the other hand, if you still want to purchase something (such as a new phone or piece of jewelry) after 30 days, then factor the splurge into your budget. Don’t put it on your credit card. Instead, create a plan to pay for it so that you can spend without regret.
3. Give your money a purpose. When we create a budget, it’s easy to just view it as numbers without meaning. Unless you love math, numbers are easy to ignore. But if you give your money a purpose, then suddenly those numbers also have a purchase, making it psychologically easier to stick to a budget.
   So… instead of simply creating a budget, assign a purpose to every dollar and every budget category. When your money has a purpose, such as making bigger loan repayments, bulking up your emergency fund, or investing in your future, then lifestyle inflation is less likely to “steal” from those funds.
4. Clearly visualize your future goals. Early retirement? Paying for your kids’ higher education? An all-expenses-paid vacation? The reason it’s so easy to short-change and sacrifice our future is because it seems so unreal and so far away. When you visualize your future goals and visualize them vividly, it makes them feel more real. Suddenly, they aren’t far-off dreams; they’re part of who you want to become and what you want to achieve. Don’t short-change your goals by indulging in lifestyle inflation.
   

It’s never too early or too late to begin planning to fight against lifestyle inflation.

At some point in time, your income will change, if even just to keep up with regular inflation. So that raises the question: are you prepared to handle your money when you experience an increase in income?

What steps are you taking to protect your budget and your future?

If you have any other strategies or tactics for keeping lifestyle inflation in check, please let me know in the comments section below! I’d love to hear from your perspective and experiences.