How to guard against lifestyle inflation

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Lifestyle inflation

Most of us are familiar with the concept of inflation - the fact that each year it costs a bit more to buy everyday goods or services. In fact you can probably remember when a KitKat or a round of drinks in a pub cost a fraction of what it does today.

The idea of ‘lifestyle’ inflation might be less familiar. This term describes the tendency we all have to spend more as we earn more. If unchecked this can create the unwelcome situation where people are actually poorer, despite earning more.

Of course, a level of lifestyle inflation is probably inevitable. Most of us don’t live as frugally as we did when we were students, or starting out in our first job. For example you may now have a mortgage, own your own car and the weekly shopping bill covers more than just supermarket-branded baked beans and the cheapest bottle of red on the shelves.

One of the reasons that we work hard to get on in life is to have the money to buy the things we want. There is nothing wrong with this, but it is important to be aware of this lifestyle inflation so it doesn’t have a negative impact on your overall finances.

Problems with lifestyle inflation

If your spending increases in line with your earnings you won’t be better off overall. Your idea of how much is ‘enough’ will always be just out of reach. In fact, you may even be worse off if a higher salary has enabled you to take on more debt.

This may be in the form of a bigger mortgage, but can also include car financing, credit cards and personal loans. Many of these have high APRs which can mean costly monthly repayments.

This can reduce your ability to put aside savings, be it a short-term ‘rainy day’ cash fund or longer-term retirement savings.

At the same time if an increased disposable income is simply being spent on home improvements, holidays or the latest must-have technology this is not helping to put your finances on a firmer footing, and building long-term wealth.

These factors could leave you vulnerable to financial shocks — whether that’s losing your job, being unable to work through ill-health or other external problems, such as an increase in interest rates.

Putting life-goals before life-style

If you want to improve your relationship with money and curb lifestyle inflation it can help to focus on a few basic financial principles.

Think long-term

Many of us overspend because we are focused on the short-term needs instead. Work out what your longer-term goals are: be it becoming debt-free, enjoying your retirement or helping the children through higher education. Then look at what savings you need to make to achieve these goals. Put a positive spin on this ‘sensible’ saving: think of it as buying financial freedom instead of the latest phone.

Practice “mindful” spending

It’s easy to see spending as a justified ‘reward’ if we’ve had a stressful week or when other problems arise. But this immediate gratification might be contributing to more financial stress over the longer term. Take a more mindful approach to spending money, and try to prioritise essential items over nice-to-have luxuries.

Don’t keep up with the Joneses

Try not to compare spending, or lifestyle with work colleagues or friends, as this can easily ramp up your lifestyle inflation. Be particularly wary of trying to ‘keep up’ with those who you know earn more, as this may lead to excess borrowing. Remember someone else’s dream lifestyle might not be all it seems, and may be financed through expensive and unsupportable debt. If you were already comfortable living at your previous level of income, don’t feel the need to increase your spending just because you can.

Inflate your savings

Even if you save a fixed amount each month into your pension or ISA, it’s easy to neglect these if you get a pay rise. Each time your salary increases, aim to boost regular savings by the same proportion: so if you get a 5% annual increase, boost pension savings by the same margin. This will help ensure your savings more accurately reflect your current living standards.

Save smart

There are a number of tricks that can help you stick to your saving goals. Set a budget, covering both short and longer-term aims. Many people find it easier to have different savings or investment accounts for different goals, be it next year’s holiday or a retirement plan. Give them enticing names: ‘my pension fund’ might sound a bit boring, but your ‘Give up work to see more of the world fund’ might encourage you to pay more in. Decide how much you want to save into each account each month and stick to it. Technology can also help. Set up direct debits so fixed amounts go into these accounts at the day you get paid, removing the temptation to spend this money instead.