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If you’ve ever heard the phrase, “The more you make, the more you spend,” you’re likely already familiar with the concept of lifestyle inflation. Lifestyle inflation is when you increase your household spending as your income levels rise. Learn how this can hurt your long-term finances, and how to manage it.

Lifestyle Inflation: The Basics

Putting it simply, lifestyle inflation is when your cost of living increases as your income does. A boost in income could be a result of a promotion and raise at work, or perhaps a new job. It could also occur when you graduate from college or complete a graduate program and go from being a student to working full-time and earning a steady paycheck.

This is a financial misstep that can be easy to fall into. After all, when your paycheck increases by a large amount or you go from living frugally as a student to earning a healthy paycheck every two weeks, it’s easy to spend with less restraint. It’s also natural to want to increase your standard of living. But extras like a large mortgage, nicer clothing, expensive trips, and fancy dinners out can add up quickly.

How It Affects Your Finances

Allowing your spending to grow right along with your earnings can have potentially disastrous effects on your finances. Not only can it perpetuate the cycle of living paycheck to paycheck, but it can also prevent you from reaching long-term financial goals, such as paying off debt, padding your emergency fund, building your investment portfolio and saving for retirement.

If you’re living paycheck to paycheck, you’re not the only one. One study found that 49% of Americans live paycheck to paycheck, while another 53% said they do not have an emergency fund that covers just three months of living expenses. That’s why it makes sense to avoid lifestyle inflation and instead focus the extra funds on other financial priorities, such as building an adequate emergency fund. Lifestyle inflation can also lead to more debt since you are essentially increasing your cost of living without saving or having any sort of safety net.

Avoiding Lifestyle Inflation

Sign that says, "This is my year to save."There are a number of ways to avoid lifestyle inflation. For starters, it’s important to maintain a set budget, even when your income increases. Staying committed to a budget with spending categories for rent or mortgage, eating out, and extras like clothing or trips can help keep lifestyle inflation at bay. You don’t necessarily need to keep your spending caps exactly where they are, and it’s okay to loosen the purse strings a little when your income increases. But it’s important to do so in a controlled way, such that you don’t wipe out all your income gains with increased spending.

Also be aware that a huge raise might not be so huge after taxes and other costs. Be sure you do the math regarding exactly how much extra will be hitting your bank account each month. Spoiler alert: it may not be as much as you think. A paycheck calculator can help you see how much you’ll really take home from your new salary.

Another thing to keep in mind is that with increased income also comes increased debt, such as a bigger home, a new car, or another big-ticket item you thought you couldn’t afford before the bump in earnings. But taking on even more debt – even when you can afford the payments – can be risky. It can increase your cost of living, affect your debt-to-income ratio, even your credit score.

Instead, use this opportunity to set up automatic contributions to your savings account, emergency fund, retirement accounts, and even investment portfolios. Allocating a purpose for those extra funds before you have a chance to spend them is one way to avoid lifestyle inflation, while still building financial stability.

The Bottom Line

Man working on his budgetLifestyle inflation is when you increase your household spending as your income levels rise. It can occur after a large raise, bonus, or when new college graduates get their first job. It perpetuates the cycle of living paycheck to paycheck, and gets in the way of reaching other long-term financial goals, such as paying off debt, padding an emergency fund, contributing to an investment portfolio, or saving for retirement. Avoid lifestyle inflation by sticking to a budget, not taking on new debt, and setting up automatic contributions to savings, retirement, and investment accounts.

Tips for Financial Planning

  • A financial advisor can help you build a solid financial plan that keeps you on track for your financial goals. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
  • If you’re experiencing lifestyle inflation, use this budget calculator to shine a light on the problem and help bring your spending into line with your earnings.

Photo credit: ©iStock.com/Borislav, ©iStock.com/CatLane, ©iStock.com/BartekSzewczyk

Rachel Cautero Rachel Cautero writes on all things personal finance, from retirement savings tips to monetary policy, even how young families can best manage the financial challenges of having children. Her work has appeared in The Atlantic, Forbes, The Balance, LearnVest, SmartAsset, HerMoney, DailyWorth, The New York Observer, MarketWatch, Lifewire, The Local: East Village, a New York Times publication and The New York Daily News. Rachel was an Experian #CreditChat panelist and has appeared on Cheddar Life and NPR’s On Point Radio with Meghna Chakrabarti. She has a bachelor’s degree from Wittenberg University and a master's in journalism from New York University. Her coworkers include her one-year-old son and a very needy French bulldog.
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