Despite earning a higher income, you might feel like your finances are dwindling instead of growing. While the rising cost of living is certainly the culprit in many cases, another phenomenon may also be at play: lifestyle inflation.
According to a recent Leger poll, almost half of Canadians are living paycheque to paycheque. As income increases, so does spending on luxuries, which can stagnate financial growth and wealth building. Let’s take a closer look at lifestyle inflation and how it can gradually impact your finances.
What Is Lifestyle Inflation?
Lifestyle inflation is a trend that involves increasing spending as your income climbs. Rather than putting that extra money away or investing the extra funds, individuals steadily modify their lifestyle to match their bigger pockets and spend the extra cash on niceties such as vacations, eating out, or expensive electronics, among other things.
Enjoying the money you earn is fine, as long as you keep your budget in check. If you’re not careful, you could spend far too much on frivolous items without ensuring that you build long-term financial security. In a worst case scenario, you could find yourself living paycheque to paycheque, and even eventually find yourself drowning in debt without a nest egg to fall back on in retirement.
| What’s The Difference Between Lifestyle Inflation And Living Beyond Your Means? Ultimately, the difference lies in your ability to sustain yourself financially. While lifestyle inflation means a rise in spending along with an increase in income, it doesn’t necessarily mean you’re spending more than you can afford. On the other hand, living beyond your means can lead to financial ruin, as you’re essentially spending more than you make. |
Living Beyond Your Means Vs. Lifestyle Inflation
Living beyond your means and lifestyle inflation both have to do with spending habits. However, they differ somewhat, particularly in terms of your financial capacity and the accumulation of debt. Understanding and managing both concepts is important to ensure financial health over the long run.
Lifestyle Inflation
Definition: Also known as ‘lifestyle creep’, lifestyle inflation involves a tendency to gradually increase your spending as your income rises, often leading to a more luxurious lifestyle filled with more upscale housing, luxury items, expensive hobbies, costly gadgets, and vacations.
Lifestyle Inflation Signs
Here are some telltale signs you’re experiencing lifestyle inflation:
- Expenses Rise As Income Increases: Upon getting a raise, you may feel as though you deserve to have and do more. As your income grows, you may find yourself steadily upgrading your lifestyle in several ways, such as: taking extravagant vacations, upgrading your housing and driving an expensive car.
- Needs Vs. Wants Are Tough To Distinguish: Gradually, the lines are blurred between essentials versus nice-to-haves. You may justify expensive purchases, thinking you deserve such extravagances given your increased income.
- Your Savings Haven’t Increased: Instead of readjusting your budget when your income increases, you’re spending more wants. Saving for a rainy day or retirement, or investing in wealth-building assets, may take a back seat to your luxurious expenditures. If you’re not careful, you could wind up living paycheque to paycheque despite earning more money. You’re eventually left not making much financial progress despite an increase in income.
Example
You have an income of $3,500 and you save 20% ($700) of it each month. The other 80% ($2,800) goes towards rent, bills and debt payments.
Now assume you get a salary bump and you now earn $4,500 a month.
With lifestyle creep, you’ll continue saving 20% of your new income which would be $900 (or worse you continue saving $700 a month and using the rest for spending). And you’d continue spending 80% of your new income which would be $3,600.
However, is that necessary? If you kept your expenses the same, you could be saving $1,700 ($4,500-$2,800) instead.
| Impact: While lifestyle inflation doesn’t necessarily mean that you’re living beyond your means, it can get in the way of saving or investing for your future. Instead of making your long-term financial goals a priority, you’re choosing to give your standard of living a boost every time you get paid. |
Living Beyond Your Means
Definition: Living beyond your means involves spending more money than you earn, which can lead to debt and financial instability. Oftentimes, it involves taking on debt to maintain an elevated lifestyle that is beyond your financial capacity.
Causes Of Living Beyond Your Means
Living beyond your means can happen for several reasons:
- Social Pressure And Comparisons: It’s not uncommon to feel the need to keep up with friends, family, and others in society. You may feel pressured to spend more money than you can afford on non-essential items. Social media and advertisements can make this situation worse, provoking a desire to live as others live.
- Psychological Factors: Instant gratification is a common phenomenon that causes people to prioritize immediate pleasures over long-term financial health. The need to have something right now versus saving can lead to overspending.
- Lack Of Financial Literacy: A lack of understanding about personal finance can lead to living beyond your means. If you don’t have a grasp on saving, budgeting, managing debt, and investing, it’s easy to fall into a financial trap. Without adequate financial literacy, you’re more likely to make poor financial decisions.
| Impact: Living beyond your means can quickly lead to financial stress. Not only will you drain your savings, but you’ll also accumulate lots of debt, which can quickly put you in a dire financial situation. |
How Do You Know You’re Experiencing Lifestyle Creep?
The following are some red flags that you may be experiencing lifestyle creep:
- Lower Savings: Even though your income has increased, your savings remain stagnant, and may even decline as you continue to allocate more of your income to leisurely spending.
- Increased Debt: Even though your income is increasing, you’re accumulating more debt rather than paying it off. For instance, your credit card balances may be growing every month, or you’re taking out personal loans to cover the cost of your enhanced lifestyle.
- You’re Spending More On Non-Essentials: With more money in your pocket, you may be spending more on non-essential items, like entertainment, dining out, travel, and designer clothing. However, you’re not making the necessary adjustments to your savings or investing habits.
- You’re Not Reaching Your Financial Goals: If you’ve got a list of financial goals — such as buying a house or saving up for retirement — but are not making any strides to achieving these goals, this is a sign of lifestyle inflation. Instead, more of your income is going toward an upgraded lifestyle.
How To Live Below Your Means
Living below your means is a sound financial approach that helps you save, invest, and achieve long-term financial stability. Here are a few helpful tips to help you live comfortably:
Create And Stick To A Budget
Having a budget in place is key to maintaining financial health for several reasons:
- Financial Control: A budget helps you see where your money is going, allowing you to have control over how you spend and save.
- Avoiding Debt: A budget helps you live within your means and minimizes the risk of spending more than you can afford and accumulating unnecessary debt.
- Having An Emergency Fund: With a budget, you’ll be better able to set aside money for emergency expenses, such as car repairs or urgent travel needs.
- Achieving Financial Goals: Allocating a portion of your income to specific financial goals, such as saving for a home or planning a holiday, helps you remain focused.
Budgeting can be tedious, but the process can be made easier with the help of a budgeting app, like YNAB or KOHO. These apps track your income and expenses in real time, providing you with an up-to-date view of your finances.
Learn more: Best Budgeting Apps In Canada
Prioritize Needs Over Wants
Part of living above your needs involves distinguishing between needs and wants. Your needs involve costs such as housing, food, and utilities. Your wants include non-essential items, like entertainment, dining out, or spa treatments.
Focus on spending money on necessities and be mindful of whether certain purchases are truly necessary. Only spend money on discretionary spending if you have funds left over after all your needs have been covered.
Focus On Saving And Investing
Having a financial nest egg to fall back on, especially when it comes to saving for retirement, is key to achieving long-term financial stability. Make a conscious effort to set aside a certain amount of money each month for your savings or investments.
One savvy way to do this is to automate your savings. By setting up automatic transfers from your chequing account to your savings, retirement, or investment accounts, you won’t have to manually set this money aside. Instead, it will be done automatically each month and ensures that you’re saving for the future before you have a chance to spend that money. Then, any funds left over can be used to spend at your discretion.
One strategy to consider is the 50/20/30 budget rule. This tactic involves allocating 50% of your net income to essentials, 30% to wants, and 20% to savings. For instance, if your after-tax monthly income is $5,000, you would allocate this money as follows:
- Needs (50%): $2,500
- Wants (30%): $1,500
- Savings (20%): $1,000
In this example, you would set aside $1,000 per month towards your savings to help you achieve long-term financial stability while still ensuring that all your bills are paid and that you have some money to spend on a leisurely basis.
Bottom Line
Financial discipline is key to a secure financial future. By making informed and conscious decisions about your money and being mindful of how you spend, you can avoid accumulating debt and build long-lasting wealth. By remaining committed and consistent with your efforts, you can achieve financial freedom.
