Lifestyle Inflation Is the Enemy of Financial Freedom

Lifestyle inflation defers our financial freedom. By taking the right approach to controlling it, we can greatly improve our financial futures without compromising our enjoyment in the present.
How to control lifestyle inflation

Picture the scene. You’ve just secured a new job. It pays more – much more. It will see your take-home pay increase by a whopping 50%. Think of all that extra money, all those options for what you could do with it.

Now ask yourself something important and give yourself an honest answer. Now that you’re earning more, will you spend more?

Where an increase in spending results from an increase in income, this is known as ‘lifestyle inflation’. So if you’ve answered yes to the above question, you would be experiencing this financial phenomenon.

We might decide to take an extra holiday a year, eat out at restaurants more often, buy more clothes, take up golf.  Whatever the change – perceptible or imperceptible – if we spend more in real terms than we spent before an income increase, it’s lifestyle inflation.

We call it ‘lifestyle inflation’, of course, because it’s associated with changes in lifestyle that result from income increases. That’s not a bad thing in principle. We’d expect our ‘standard of living’ to improve as we earn more – or else what’s the point?

But our personal correlations of ‘lifestyle’ and ‘standard of living’ are extraordinarily diverse. And it’s incredibly important to understand how our answers to the question posed at the start of this article can impact our personal finances. Your answer – along, of course, with the extent of additional spending – is of huge significance to your financial future.

The problem with lifestyle inflation

The obvious problem with lifestyle inflation is that as we spend more, we short-change our financial futures. By choosing to spend £500 of extra pay every month on going out to restaurants and buying new clothes, the opportunity cost is literally years of extra work.

If you instead invested that £500 into the stock market every month for 10 years and achieved an average annualised return of 5%, you’d have grown your money to more than £75,000 at the end of the 10 years.

The second problem with lifestyle inflation is it’s very hard to undo. Once we form habits and adjust to our new spending-supported lifestyle, lifestyle deflation is not something most of us are keen to engage with. This means our extended time becomes even more protracted as we become trapped in our higher spending lifestyles.

But let me be clear. This is not a case against enjoying the fruits of your labour or living in the moment. Instead, the problems of lifestyle inflation highlight the value of objectively assessing what brings us real intrinsic value and what doesn’t. Generally, once we understand that, we can control lifestyle inflation and provision for our financial futures without compromising the present.

How to control lifestyle inflation

#1: Visualise your future

What is it you want to achieve and why? What is it that makes you tick and why? Having a clear vision for your long-term future can help keep excessive lifestyle inflation in check. As you consider spending pay increases on things that aren’t really going to bring you much fulfilment, a big vision on the horizon can help to self-regulate. A long-term vision also provides the framework for goal setting and tracking progress.

#2: Set short-term and long-term financial goals

Forming and achieving specific goals can play a crucial role in controlling lifestyle inflation. Set yourself a small number of short-term and long-term goals. As you weigh up spending decisions, you’re more likely to take these into account and evaluate spending choices more carefully. It’s a psychological benefit of goal setting that’s well supported by empirical research.

#3: Track your money

There are a wide range of benefits to properly tracking your personal finances. As well as reinforcing positive personal finance habits, a financial tracker allows you to see everything in one place. It provides a holistic view of your overall progress against goals and offers opportunities to identify and address trends in your personal finances. This is invaluable in raising your personal finance awareness and self-regulating against lifestyle inflation.

#4: Automate your money

Putting your money on ‘autopilot’ strips away lifestyle inflation risk and instead tucks away your cash for the future. By setting up automatic transfers and payments, money gets allocated where it is needed as soon as it hits your bank account. This eliminates the need to grapple with difficult spending decisions, reducing the risk of spending more as you earn more. And it’s proven to bear financial fruit, backed up by research.

#5: Destroy your debt

It’s not rocket science. If instead of paying down debt when you get a pay rise, you’re increasing your spending on other things, you’re punishing your future self twice. Once through the opportunity cost of spending versus investing, and once through the additional interest you’ll bear because of not paying down the debt earlier. So use income growth to destroy your debt. This will help to offset the drag effect that debt has on net worth. And what’s more, it will enable you to make a freer choice on how to spend income gains once you’re debt-free.

#6: Increase your retirement contributions and investments

As your income increases, give more thought to how you can top up retirement contributions and investments. Increase your defined contribution pension sacrifice to maximise your employer’s matching. And adopt a wealth growth mindset, focusing on how you can invest your additional income to supercharge growth in your wealth.

#7: Kill those comparisons

Just because your friends are doing it, it doesn’t obligate you to do it. Forget comparing your friend’s car since he got that pay rise and focus instead on what brings you real intrinsic value. You don’t have to spend the same money to experience the same levels of pleasure from life. Take pleasure in saving and enjoy the control you have over your future.

#8: Enjoy it

Lastly, controlling lifestyle inflation is not about cutting out reward altogether. If you’ve taken a brilliant step forward, you deserve to treat yourself from time to time. Allocate yourself a pot of money to enjoy yourself each month. By having a clearly defined budget for enjoyment, you’re far less likely to dip into impulsive splurges of spending. You’ll feel more in control of your money.

The enemy of financial freedom

This article has focused in on the huge array of things we can do to control lifestyle inflation. But if you’re on a journey to early financial freedom, this is even more important. A lack of control over lifestyle inflation is perhaps the greatest impediment to achieving financial independence. If you’re unable to reinvest, reduce debt and consolidate your income gains, you’re far less likely to achieve a goal of getting out of the rat race quickly.

Whilst these pointers may help bring some structure to controlling lifestyle inflation, one of the most salient points is attitude to spending. Judging the effects of additional spending on our happiness in the present is a lot less ambiguous than trying to judge the effects of future spending on our future happiness. This difference in clarity can shift spending attitudes considerably.

When pursuing early financial freedom, we need to be seriously tuned into what really brings us short-term value. An awareness of the real value of spending will help to avoid unnecessarily extending financial dependence even further. So with an appropriate structure and mindset, lifestyle inflation can be suitably controlled – without compromising enjoyment in the present.

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