Slowdown, Big Spender: Avoiding Lifestyle Inflation

Let’s start with a very common scenario: you’ve just received a big promotion at your job. Very few things feel quite as good as getting a nice pay-raise at work. It’s almost like the adult version of acing the big exam. We won’t even begrudge you a fancy celebratory dinner afterward. You’ve earned it. But we caution you against a major pitfall: lifestyle inflation.

What is lifestyle inflation? It 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. In simpler terms, when you get a boost in your income, you replace your old car with a more expensive new car.

A very common scenario that occurs is when a person transitions from being a student to being a full-time employee. Despite being thrifty 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 help keep housing and utility expenses down suddenly seems very unappealing. An individual experiencing lifestyle inflation might go out and lease a one-bedroom apartment where they can live alone.

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.

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.

Below are more strategies:

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.

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, but, rather, make the changes gradual. Not all new expenses are created equal. A dream vacation is a one-time cost. Expenses like a new car, a new home, or a country-club membership are ongoing, long-term, and difficult to reduce once obtained.

The key takeaway is to not overdo it. Enjoy the pay raise, absolutely. But cautiously integrate the increase of income into your usual budget to avoid the common pitfall of lifestyle inflation.

Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.

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