Lifestyle inflation, otherwise known as lifestyle creep, happens when your expenses increase with your income. For example, imagine making $60,000 per year and having annual expenses of $30,000. If your salary increased to $120,000 and your expenses increased two-fold to $60,000, you experienced lifestyle inflation.
Many individuals spend more when they receive a pay raise. Lifestyle inflation isn’t always a problem; it’s normal to increase expenses with a higher annual income. However, it’s essential to focus on your costs as a percentage of your income. Circling back to the example above, the proportion of your expenses to income remained the same (50 percent). Therefore, you have $60,000 in discretionary income with your new salary compared to $30,000 with your prior salary. If you could increase your expenses to $40,000 instead of $60,000, you would have $80,000 in discretionary income. That extra $20,000 per year could make a big difference when it comes to meeting your short- and long-term financial goals.
Although lifestyle inflation is relatively standard, you should do your best to avoid it. If you’re not careful, your increased expenses could negate any benefit from your pay raise.
How to Avoid Lifestyle Inflation
Increasing your income is exciting, but don’t get too over your head, or you could end up in a challenging financial situation. Avoiding lifestyle inflation is key to reaching your long-term financial goals. Not only that, but properly managing your higher income enables you to pay down debt and reduce total interest expenses.
If you’ve recently boosted your income, follow these vital steps to avoid lifestyle inflation:
Don’t Forget Your Long-Term Financial Goals
Whether you’re saving for a second home or a brand-new car, you shouldn’t overlook your long-term financial goals. You may think these goals are easily attainable with your newfound income, but that’s not always the case. Lifestyle inflation could cause you to spend more on entertainment and travel, eat out more frequently, and splurge on new clothing. At the end of the month, you may have less money to allocate to savings than before your pay increase.
Although you can tweak your financial goals, you should continue to save for them. Putting the goals aside because you’re making more money could make them less achievable. Better yet, try to allocate more funds towards your long-term financial goals now that you have a higher income.
Automate Your Savings
It’s easy to overspend when your entire paycheck hits your checking account. Most employers allow you to deposit a portion of your salary into your checking account and your savings account. Through most online banking platforms, you can also establish a bi-weekly automatic transfer between your savings account and checking account. Since your income increased, you’ll likely allocate a large percentage to savings each month, depending on other budget categories.
Automating your savings makes it easier to stick to your budget and avoid overspending. However, nothing stops you from dipping into your savings account and spending some extra cash. Thus, it’s essential to carefully monitor your spending and avoid situations where you have to rely on savings to fund your monthly expenses. You could also open a savings account at a different bank than your checking account, making it less tempting to withdraw cash and overspend.
Use an Income Calculator
An income calculator shows you how much you’ll bring home after considering federal and state taxes, 401(k) and IRA contributions, and other non-taxable benefits. You may end up taking home less than expected if your pay increase bumps you into a new tax bracket. Therefore, it’s an excellent idea to use an income calculator before making any changes to your budget or significant expenditures.
Keep Your Budget Intact
After receiving a pay increase, many people are tempted to allocate additional funds to their budget’s entertainment, dining out, and other leisure categories. While it’s not a crime to increase your budget, you should do so strategically. If you were previously living paycheck-to-paycheck, it’s perfectly acceptable to treat yourself more (without going overboard). Nonetheless, it’s not a good idea to entirely refine your budget because you’re making more money. Many financial advisors recommend allocating more money towards savings and debt to improve your overall financial health.
Pay Down Debt
A pay increase enables you to aggressively pay down debt using various categories, including the debt avalanche method. Although you’re technically spending more, you’re actually improving your financial situation by lowering long-term interest costs and potentially improving your credit score. Not only that, but you avoid lifestyle inflation by paying down debt instead of spending money on unnecessary items.
Our debt pay-off app allows you to find the quickest and most cost-effective way to pay down debt and achieve financial freedom. Our debt analyzer supports various paydown methods, such as Snowball, Avalanche, and Highest First.
Reconsider Your Friend Group
Do you have a friend group that likes to go out every weekend? We get it – peer pressure often leads you to spend more money. Unfortunately, going out weekly with a particular friend group could cause lifestyle inflation. Does this mean you have to make new friends? No, but you must learn to say “no,” or monitor your spending when you’re out on the town.
Want to Avoid Lifestyle Inflation? Join Chunk Today
Our platform is a valuable tool that features a transaction tracker, credit card management app, and an easy-to-use debt tracker. With Chunk, you can effortlessly manage your spending, work towards your financial goals, and avoid lifestyle inflation. Get started today and embark on your financial freedom journey!