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2023 23 October 2023

Understanding Lifestyle Inflation and How to Combat It

What is Lifestyle Inflation, and Why Should You Be Aware of It?

Why do some lottery winners who win millions become broke in a few years? Why do some athletes or players who earn millions during their careers suddenly become bankrupt a couple of years into retirement? The answer is a phenomenon known as lifestyle inflation, which is simply the tendency of individuals to increase their spending as their income rises.

As our income rises, we often have a unique opportunity to increase our savings and investments, which are ways to build long-term wealth.  However, without being conscious of our spending habits, most of us will likely increase our spending to match or outmatch our rising incomes.  While it's natural to want to enjoy the fruits of our labour, it is important to note that unchecked lifestyle inflation can have detrimental effects on your finances.

Being aware of lifestyle inflation is crucial because it can prevent you from falling into a cycle of financial stress and debt. One can maintain a healthier and more sustainable financial future by recognizing it and taking proactive steps.

How Lifestyle Inflation Affects Financial Well-being

Lifestyle inflation may initially seem harmless, but its long-term consequences can be significant. Here are some examples of how it can impact your financial well-being:

  • Reduced Savings and Investment: Lifestyle inflation can significantly impact your financial freedom and wealth creation by affecting your savings and investment culture. As your spending increases, you save and invest less money for emergencies, retirement, and other financial goals.
  • Debt Accumulation: Most people with an inflated lifestyle may rely on credit cards or loans to sustain it. This may accumulate high-interest debt, which can be challenging to repay.
  • Stress and Financial Instability: having some unexpected setbacks in life is inevitable. Living paycheck to paycheck due to inflated expenses can lead to stress and financial instability, making you vulnerable to unforeseen setbacks.

Signs of Falling Victim to Lifestyle Inflation

To combat lifestyle inflation, you must first recognize the signs that you might be succumbing to it. Here are some common indicators:

  • Increased Spending: Gradually increasing spending on non-essential items like frequently dining out, vacations, expensive clothing, or gadgets.
  • Ignoring Budgeting: Not tracking expenses or deviating from a budget you previously adhered to.
  • Peer Pressure: Feeling the need to keep up with friends or colleagues who may have a higher standard of living.
  • Minimal Savings Growth: Growth in savings or investment accounts that are not commensurate with rising income.

Strategies to Avoid Lifestyle Inflation

Overcoming lifestyle inflation requires discipline and willingness to change. Here are some effective strategies to help you avoid it:

  • Set Financial Goals: Create specific financial goals, such as paying off debt or saving for a home and prioritize them over unnecessary wants and expenses.
  • Create a Budget: Establish a clear budget that allocates your income to your needs, savings, and discretionary spending. Stick to it as much as you can as your income increases. Always save before you spend.
  • Automate Savings: Set up automated transfers to your savings or investment accounts to ensure consistent saving, regardless of your spending habits.
  • Live Below Your Means: Instead of spending everything you earn, consciously choose to live below your means and allocate excess income toward your financial goals.
  • Review and Adjust: Periodically review your financial habits and adjust your budget and goals as your circumstances change.

Lifestyle inflation is a subtle but powerful force that can derail your financial future if left unchecked. Awareness is the first step to combatting it, followed by a deliberate effort to save and invest while prioritizing financial goals over short-term indulgences. By intentionally avoiding lifestyle inflation, you can create the necessary foundation to achieve financial stability while building a secure future.

Wendyliza Kwarteng

Investment Analyst - Stanbic Investment Management Services