Let’s say you’re a college student and just skating by financially. You can afford rent and basic necessities, but you’re living off ramen noodles and working two jobs to make it happen. After graduation you get a nice job with benefits, and all of a sudden you can afford a bigger place and fancier foodstuff. After a promotion, you’re able to buy your own house, a shiny new car and a kitchen stocked with organic and fair-trade groceries.
You’re also thousands of dollars in debt, and in danger of losing your home. How did this happen, when just a few years previous you were getting by on a retail salary?
This unfortunate scenario is called lifestyle inflation, and it happens when someone scales up their expenses to keep pace with a rising salary. This is how so many seemingly successful people are drowning in debt or living paycheck to paycheck. It’s surprisingly common, but easily avoidable.
Read ahead for the skinny on how lifestyle inflation can ruin your finances, and how to stop it from taking hold.
How it happens
Lifestyle inflation is one form of hedonic adaptation, a situation where humans quickly adjust to their former levels of happiness and satisfaction after experiencing a big event. For example, getting married can boost happiness for the short-term, but over time, a person’s satisfaction and contentment will go back to where it was before.
If you think that getting a raise or an inheritance will increase your happiness and ease your financial troubles, you’re correct – to a point. After time, you’ll get used to your new salary, and it will no longer feel the same as when you first got it.
The good news about hedonic adaptation is that even something difficult, like a divorce, does not affect happiness levels on a long-term basis.
Unfortunately, that means constantly increasing your lifestyle is not a guarantee that your happiness will continue to rise. In other words, buying a $5,000 car can bring you the same amount of happiness as a $25,000 one. But if you keep upping the ante, eventually you’ll need a bigger and better car to reach a higher, temporary state of pleasure.
Why you should avoid lifestyle inflation
The biggest reason to avoid lifestyle inflation is that there’s no guarantee you’ll always be earning as much as you do now. Layoffs and job losses happen all the time, and sometimes you might not be able to find a job where you earn the same as you did before. If you’re older, you could even be considered too old to reenter the workforce.
If you avoid lifestyle inflation, you can afford to take a job with a smaller salary or switch to a career that doesn’t pay as well. While living on the same salary can feel pointless when you have more money, you’ll be grateful for it if the time comes that you have to cut back or you want to transfer to a new gig.
How to prevent it
Avoid permanent upgrades
Buying a huge house might feel like an improvement that will pay off over time, but it can lead to big problems if your salary changes and you end up stuck with a mortgage you can’t afford.
Instead, choose small improvements that you can cancel if need be. For example, keep your current home but hire a monthly housekeeper. That way, you’ll be freeing up your time without binding yourself to a permanent budget change. If you get laid off, you can cancel the service with no problems.
Make small changes
When you upgrade to a 3,000 square foot home, anything less than that will feel like a downsize. The easiest way to avoid lifestyle inflation is to make small, incremental increases. For example, don’t go from sharing a $1,000 apartment with two roommates to buying a home with a $2,000 monthly mortgage.
Be deliberate with your purchases
Lifestyle inflation often occurs when people stop being conscious of what they’re buying because they have more disposable income than they’ve ever had before.
For example, if you’re living on $30,000 a year, you’re probably careful of what you buy at the grocery store. You debate between buying the generic or the name-brand box of cereal. You choose the matinee movie instead of the evening feature.
When you get a raise and all of a sudden make $40,000, you start to feel like a rock star. Why check coupons or weekly sales flyers? You may be more financially capable of splurging now, but everyone should be deliberate of their purchases no matter how much they earn. Don’t buy something you don’t need or replace something that’s still working.
As your salary increases, so should your savings. An easy way to do this is to make your retirement savings a percentage of your salary instead of a set dollar amount. For example, instead of saving $500 a month, save 10% of your salary. That way, your savings will always go up as you make more money.
Some people who work in variable fields such as real estate might find that they have an amazing year followed by a slow one. If you did your diligence and saved that abnormal salary, you’ll be ok when there’s a slump. Don’t assume that your high salary is protected or a given; you never know when the market will crash or the bottom will fall out.
You can also start saving for other expenses, such as a larger emergency fund, a repair fund for your home or a replacement for your used car. Having more in savings will make it less likely that an emergency disrupts you financially. You’ll also be less tempted to spend your money frivolously, because acquiring it will require dipping into your savings fund. Sometimes all you need to make the right choices is a small barrier between doing something responsible and doing something irresponsible.
Increase your withholding
Many people who suddenly start making more money fail to account for one thing: taxes. A large salary increase, especially if it’s a bonus or commission, can push you into the next tax bracket without you realizing anything until you’ve already spent that money.
Use the withholding calculator from the IRS to determine what you should have taken out from your paycheck. If you are self-employed, talk to an accountant about what you should save every month and how much to pay each quarter. They’ll be able to give you targeted advice on what your new tax situation is and how you can prepare for those pesky deadlines.
Stick to a budget
Budgeting isn’t just for people who live on a tight income every month – it’s also for those who have more money than they’ve ever had before. Even if you can’t see yourself spending more than you currently earn, you should still have a budget.
“It’s easy for lifestyle costs to increase especially if you’re making more money or if you aren’t paying attention what you’re currently spending,” said personal finance expert Karen Cordaway. “It’s easy to rationalize purchasing an extra pair of shoes or another mobile device that you don’t really need. Give yourself a certain amount of spending money each month so you don’t feel deprived.”
A budget should be flexible and work with your lifestyle, so someone earning $60,000 a year and someone earning $20,000 will have different budgets. Still, their goals should be the same: save for the future and spend less than they earn.
“Having an idea of what you spent last year versus what you’re spending this year can be very important,” said financial planner Katie Gampietro Burke, CFP® of Wealth by Empowerment. “Keeping track of income and expenses (cash flow) is more important than ever. Ways to avoid the trap are really just being aware, and knowing your limitations and sticking to them, as hard as it seems.”
Avoid “keeping up with the Joneses”
One of the most significant motivating factors for lifestyle inflation is material envy of friends, family and coworkers. When the woman working in the cubicle next to you just bought a brand new Prius, it’s easy to let your mind wander to thoughts of buying a Tesla. “If they can afford a nice car, why can’t I afford something even better?”
The problem with this way of thinking is the cyclical way it feeds back on itself. If everyone is constantly trying to one-up their neighbor, eventually the bar will be set too high for anyone to reasonably clear. That leads to debt, bankruptcy and financial ruin. Plus, the “fear of missing out” never goes away when you indulge it – it only gets worse.
Try to practice gratitude for the things you have, and indifference to what your peers have. It’s not easy in the age of social media, but comparing your behind the scenes to everyone else’s highlight reel will only leave you feeling unsatisfied and broke.
The bottom line
It’s natural to want to spend more when your salary increases, and you can indulge in that – to a point. Try to limit your spending and stick to a budget, even when you don’t need to. If you get a raise, don’t automatically buy a new house or car.
Enjoy your money by going on vacation, taking cooking classes with your kids or splurging on tickets to a Broadway show. Spending more on experiences will have fewer repercussions than buying a new home – and it’ll make you more fulfilled.