The phenomenon of Lifestyle inflation is often consistent throughout one’s career. This term refers to the gradual increase in regular spending as income goes up. Some occasional increases in spending are natural. For instance, if you are transitioning from single life to having a family, this increase in spending is quite necessary. However, if lifestyle inflation becomes a habit, it can have dire consequences. Perpetually increasing ones spending in line with income can make it difficult or impossible to get out of debt or successfully attain any medium or long term financial goals. This habit is the reason there are so many that earn a large income but somehow find themselves practically living paycheck to paycheck. In addition to failure to becoming financially independent, someone who falls prey to lifestyle inflation could find themselves in dire straits due to not uncommon occurrences like family medical emergencies or job loss.
The most common contributor to lifestyle inflation is the idea that once our income has increased, things once deemed to be “luxuries” are now “necessities”. As discussed in other articles on how to budget, things start to get out of hand once the line is blurred between “the needs” and “the wants”.
Fretting over these distinctions can on the surface seem tedious. It is also not difficult to make a rational argument as to why you do in fact deserve to treat yourself from time to time. For example, those who have reached certain higher levels in their career do often have the need to present themselves in a certain manner which necessitates higher discretionary spending (and for instance cannot ride a bicycle to work, wearing thrift-store clothes, eating porridge for every meal). Financial prudence does not mean living like a student for the rest of your life (though some people are quite happy and enjoy the challenge of doing so!). However, the devil is in the details. If left unchecked, lifestyle inflation can creep up and out of control quite rapidly.
We often meet with people who genuinely believe their own words when they describe themselves as not being big spenders; perhaps because not too many years ago they were in fact very thrifty. However, although their income has gone up considerably over the years, somehow each year their savings are about the same, or only slightly increased. The savings difficulties are no longer a mystery when they wake up and realize that their mental self-image that used to drink only convenience store beers with friends, would never take taxis without at least four people, and lived in a tiny apartment now eats out almost every meal, goes on a trip every time the season changes, and is happily paying rent two or three times higher than before.
The way to strike a balance between living like an ascetic monk in the mountains and spending your entire paycheck each month in Japan is with careful budgeting. Above a certain level, increases in discretionary spending have been proven to provide almost no correlation to further increase in quality of life. Accordingly, taking the time to consciously establish spending limits and savings targets each month can go a long way to providing for your long term security while also living a more than sufficiently comfortable life. Automated savings plans are an excellent tool to effectively “pay yourself first” each month, enabling you to get the savings requirements out of the way. From there you are free to spend whatever is left over, knowing that you already have met your savings target. Taking it one step further, it would be worthwhile to break your monthly savings into more than one bucket. A popular method is using “the three accounts“, splitting your savings into short term, medium term, and long term savings; each for unique financial goals while utilizing different and appropriate investment strategies.
Younger workers who finally landed a job with a good salary are notorious for watching their discretionary spending skyrocket. This can derail retirement savings, prolong their student debt burden, and make it difficult to acquire capital for a home down payment. A concrete financial plan while living in Tokyo goes a long way towards fending off bad spending habits while still gradually increasing quality of life as your career progresses.
However, twenty-somethings are not the only ones that can fall prey to lifestyle inflation. This increased spending phenomenon impacts those on both ends of the career spectrum. People in the latter part of their career are not immune to very similar urges to spend windfall profits. Similar to those getting their first big paycheck, empty-nest parents experience pressure-relieving financial windfalls when the mortgage is paid off and the kids are all out of the house. Getting through to the other end of the tunnel as a parent certainly warrants letting your hair down. However, as always, this increased spending should be in moderation. The last decade or so of your career after your financial liabilities have mostly disappeared is your last chance to save. It is also a period whereby, depending on your career, your income could be the highest its ever been. Accordingly, savings rates of 50% or more of annual earnings are well within the realm of possibility.
Wherever you may be in your career timeline, you should be aware of how lifestyle inflation may be impacting your life. Young people have an excellent chance to get a head-start on their savings and investment plans. Likewise, those later in their career have an opportunity to make the most of this time and avoid being one of the many that have insufficient savings to support themselves after reaching an age whereby they are unable to continue working. Consequently, failure to exhibit discipline in your personal finances could lead you to end up becoming a liability to your children.
[ Sources ]
– Stein, Michael K. “The decision decade: A new focus for retirement planning.” Journal of Financial Planning 13.6 (2000): 36.
– Brunel, Jean LP. “Goals-based wealth management in practice.” CFA Institute conference proceedings quarterly. Vol. 29. No. 1. CFA Institute, 2012.
– Concepcion, John N. “Young and Indebted: A Closer Look at the Future of Young Professionals.” Journal of Financial Planning 29.9 (2016): 24.