You know the pattern: your income goes up (yay), but so does your spending (boo). It’s called lifestyle inflation or lifestyle creep, and it’s keeping you from building your wealth.
Do you also have a bit of a laugh when you look back at your first salary? Mine was $18k a year, which even then was significantly below the average income earned in Australia. I have no idea how I ever lived off such a tiny amount of money and chances are you’re wondering the same thing. Like mine, you were probably not living a lavish lifestyle back then (for me it was share housing, limited beers at the pub and rare meals out), but it was still a good life.
Like me, you’d probably have Buckleys of living off the equivalent of $18k today. Or roughly $36k adjusted for inflation since 1990 (according to the RBA’s inflation calculator). No way, not even close. That said, if we were able to get even slightly close, we’d have a significant proportion of our money left over each month to invest. If we could dial back the lifestyle creep that has meant $36k a year is laughable, we’d actually be laughing all the way to the bank.
Here’s an approach to reduce lifestyle inflation that should set us on the right track.
1. Be clear on your long-term goals
We’re all pretty good at outlining how we want to live right now, but what about down the track? A long way down the track. It really helps to define what life you want for ‘future you’ if you’re got any hope of setting money aside now that you won’t see for years.
The fact is, building wealth is a long game. If you want to win the long-term game, you have to make some short-term sacrifices. This is the really hard part. With so much delicious stuff to buy and things to experience, the FOMO alone can be torture.
Which is why you really need to know what you ultimately want for your money and your life. Future financial security and being in control of your own time are very powerful allies when it comes to saying no to present temptations.
2. Define your wants and needs
It’s the wants that get in the way of saving any financial windfalls to reduce lifestyle creep. You get the longed-for pay rise, but you’ve already got a list a mile long of things you want to spend it on.
Instead of a spending list, write a list that clearly outlines the difference between things you need and things you want. This is your opportunity to get real about the kind of lifestyle you want to lead. There’s no point lying to yourself here, as you won’t stick to any commitment you make if you’re not honest. This list is for you and only you, so don’t bother with what other people define as a ‘want’ if it feels like a ‘need’ to you. If you think a luxury car is a need, then it’s a need.
Just be realistic about how quickly you’ll be able to grow your wealth if your need list is too long. Remember, every need you spend your money on today reduces your ability to buy what you want in the future.
3. Lock in your budget
It’s wealth creation 101: you need a detailed budget. Your budget is all the things you need to spend your money on (see above). Over time, unless you’ve experienced a big lifestyle change, your budget shouldn’t change very much at all.
Incidentally, big lifestyle changes are things like having your first baby or adding to your family. Or reducing your work to part time or losing your income completely. Or getting married or getting divorced.
They don’t include upgrading your wardrobe, going on bigger holiday or dining out on a more regular basis.
4. Treat yourself, but just the once
Of course, you’ve worked hard for that pay rise and you deserve to splurge on things you want sometimes. Just do it with your first pay check only, not every single month. Or allow yourself 10 or 20 per cent of a windfall to spend on whatever you want, provided you invest the rest.
Whatever you do, don’t leave the money sitting in your everyday account like a mermaid on a rock, luring you to spend with its irresistible mermaidy ways. Commit to the amount you will spend, then quickly move the rest somewhere less tempting.
5. Allocate extra cash immediately
When you get your pay rise, arrange for the increase to leave your everyday account as soon as it hits. Depending on your financial goals, that might mean it hits your mortgage straightaway or your long-term savings account. It might get added it to your investment portfolio or sent it straight to your super.
If you don’t see it in your everyday account, you won’t miss it.
6. Reverse your current lifestyle creep
All of the above will help you avoid the trap of lifestyle creep. But what if you’re already too far gone. You’ve been spending more than you earn for years. Every pay rise, every bonus, every inheritance, every tax return, every win has already been spent and your debts just keep growing.
This is when you need to hit the frugal lifestyle hard for a while. It’s not enough to budget your needs and save your wants. Forget the wants, you need to reduce the cost of your needs. Out goes that luxury car, of course. But you’ll also need to scrape around to reduce your basics like electricity, food, clothing and housing costs. All the tips you need to do this are here: 101 frugal tips to help you live a richer life
The big trick to reducing lifestyle inflation is to pay off your debts and then keep on living like you still have them. The money you scrimped together to pay down your debts each month, you invest instead. In other words, you stop spending more than you earn, neatly avoiding the trap of lifestyle creep altogether.
This article contains general information only. It should not be relied on as finance or tax advice. You should obtain specific, independent professional advice from a registered tax agent or financial adviser in relation to your particular circumstances and issues.