My friend is nurse.
Because of COVID-19, she has one of the most secure jobs on the planet right now. Also, because she already has one year of experience, she got her first job raise. Woohoo!
The new money hasn’t landed in her checking account yet, but she is already looking for a new car.
It’s going to be an SUV with all the bells and whistles. Her current car is a compact car that is running perfectly well.
She is going to get it because she deserves it. She has been working hard, studying to past her exams, and now working all kinds of crazy hours.
My friend has other plans for her money, but our conversation got cut off by other people sitting at the table.
What is lifestyle inflation?
Is the tendency to increase expenses as earning increases. If a person gets a raise of a few thousand dollars, that person increases their expenses by a similar amount and thus never has an opportunity to save money for retirement or other financial goals.
Some lifestyle inflation is justifiable
According to Financial Planner Ed Rempel, some lifestyle inflation is acceptable, like when you transition from college life to working life.
Assume that I just graduated from university.
Before graduation, I was working part-time as a waiter and sharing a three-bedroom apartment with two other guys.
Now, after graduation, I can afford to live on my own, not sharing my space is very important to me. Well, in this instance, I could find a place of my own and stop living like a college student.
How to avoid lifestyle inflation
The objective is not to avoid lifestyle inflation. As you earn more money, you would like to spend more money. The trick is not to match increases in earning with increases in income.
For example, let’s say that I get a raise of $10,000 per year. I could increase my lifestyle expenses by $5,000 and increase my savings by $5,000.
People fall victim to the comparison trap
One of the reasons why people slide into lifestyle inflation is that they are always comparing themselves with others.
If in your neighborhood everyone has a luxury car, you feel inclined to get a luxury car as well, even though your car is working perfectly fine.
If in the office everyone wears fancy clothes then you have no option but you wear fancy clothes as well.
The list goes on and on, but at a given moment you have to change the people you surround yourself with, or you have to stop caring about their opinion of how you spend or not spend your money.
When is OK to let your lifestyle inflate?
Lifestyle inflation is acceptable when you have met all your financial goals.
Let’s say you have saved enough for retirement, your mortgage is paid, and your kids already finished their college education.
In that case, why not?
You are already in a secure financial position, you probably have two or three year’s worth of emergency fund, your portfolio continues growing. Why not go on that fancy vacation? Why not go to that luxurious restaurant?
To each his own, but I think that there is a time to sow and there is a time for harvesting.
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