Lifestyle inflation means that as income rises, so does spending on amenities and luxuries. The reason for the increase in spending is simple: people now simply have more money available and may want to treat themselves to something.
Lifestyle inflation becomes a problem when income falls or disappears. Because then you can no longer afford your comforts and the running costs eat up saved assets. Lifestyle inflation also prevents savings rates from increasing, making the goal of financial independence (FIRE) a distant prospect instead of a more tangible one.
What is Lifestyle Inflation? Meaning, definition, explanation
Lifestyle inflation basically follows the same dynamics as economic inflation. Just like economic inflation, consumers:inside have less money available at the end of a given period than they had before.
In inflation (Latin inflatio = to inflate), prices rise and money loses value at the same time. We can afford less than before. If, for example, a good becomes scarce, i.e. it is no longer available to the same extent as before, it becomes more expensive, often much more expensive than before. The increase in cost is not always immediately apparent; it is often disguised. Especially when it comes to food and drinks in restaurants, consumers are slow to notice that they are spending more money than usual. So it can quickly happen that you lose track of your finances.
Lifestyle inflation can be dangerous
In lifestyle inflation, as income increases, so does the standard of living. Young people earning their first own money are particularly susceptible to this. They lose track of their money more quickly and often cannot get out of this kind of compulsive buying without outside help. Students who had to limit themselves a lot during their studies and finally earn their own money then afford luxury products that previously seemed unaffordable. Whether it’s expensive clothes or a visit to a posh restaurant, suddenly everything seems easily doable.
Buying expensive products is particularly tempting. But at the end of the month, there’s less money left over than in the days when you had to turn over every penny. Despite or precisely because of their earnings, those affected by lifestyle inflation live beyond their means. Instead of saving some of the increased income, they spend most of it again. They are unable to build up assets, which would be important for retirement planning, for example. They find themselves in the reward trap.
Who is particularly affected by lifestyle inflation?
Lifestyle inflation mainly affects young professionals and the group of young academics. These experience a high with their first self-earned money, which makes it difficult for them to correctly assess their financial possibilities. In addition, they do not yet have any experience in realistically weighing up how much money they need for which lifestyle. As a result, they greatly overestimate their financial situation, while at the same time raising their standard of living. They feel the need to compete financially with other peers and regularly reward themselves with consumption that does not fit their budget.
What are the consequences of lifestyle inflation?
As a result of this unthinking behavior, many young people end up in debt despite often earning good money. Typical cost traps are frequent eating out, renting or leasing/buying expensive cars or apartments.
The debt trap is a poverty risk, so that the newly acquired standard of living of the first earnings phase can not be maintained. Buying expensive clothes, jewelry and cosmetics can also lead to debt. As soon as more money is spent than is taken in, a negative spiral is set in motion. Lifestyle inflation is supported by banks, which willingly grant overdrafts because they earn good money from them.
The next step is a negative SCHUFA entry, which also has an unfavorable effect in the long term. If those affected would like to make a major purchase or perhaps build later on, it is difficult for them to get the necessary loans. Lifestyle inflation means that less money can be set aside for retirement, as short-term consumption is the main focus. For young people, retirement age is still a long way off, so they cannot yet assess the relevance of retirement planning.
Ways out of lifestyle inflation
The way out of this behavior pattern is called renunciation. Because even today, saving still has a high priority. Very few people become wealthy through inheritance. Therefore, the first step out of lifestyle inflation is realistic, down-to-earth financial planning.
1. define financial goals for life stages
Studies show that defining goals makes it easier to achieve them. What purchases are planned in the coming years? (Home purchase, travel, retirement age, etc.) Capital is required for a home purchase. For people with expensive plans, it is essential to put money aside. But everyone else also benefits from a frugal lifestyle.
2. plan fixed budgets for all projects
The following formula has proven effective: 50% of income is budgeted for fixed costs such as rent, utilities, food and other living expenses. 20% is saved or invested and 30% is reserved for consumption/consumables. As income increases, the newly available budget is divided equally among all three areas.
3. an account for special expenses
Financial planning alone does not protect against lifestyle inflation. People need constant rewards or they will become unhappy. A visit to the amusement park, new sports equipment or the purchase of an exclusive coffee machine can be financed from the specially set up special account.
In addition to providing an optimal overview of one’s options, financial planning offers another major advantage: You can virtually watch your available budget grow and your financial freedom gradually increase.