According to the definition from Investopedia.com, it is increasing your expenses as your income goes up.
It can also mean inheriting some money or getting a really nice raise and then use it to live a better life instead of putting it into savings. For example, you could rent a better apartment, you could go to restaurants that are a bit fancier or you might decide to splurge on a whole new wardrobe. All of this is what would be called lifestyle inflation. Experts in personal finance warn against this because once you get started you could very well end up buying or consuming too much and end up paying a stiff price in the future.
Your spending could get out of control
Lifestyle inflation can become a bad thing if it results in going into debt or raiding your savings. This can happen only too easily if you let your spending get out of control. Experts in personal finance hate lifestyle inflation because of what’s called the Diderot Effect. This is where you buy a new item then wake up the next day realizing that it doesn’t go with your current sense of style so you go out and buy a bunch of other things to redefine your style. This is a perfect example of lifestyle inflation at work. If your income changes there’s nothing bad about buying some new stuff. However, the problem with the Diderot Effect is if you link your identity to continued spending. Given the fact that your identity is probably very important to you this could end up creating a big problem.
If you’ve never heard this term you’re not alone. We had never heard of it until just a few weeks ago. What this means is you introduce something cool and new into your life and that new thing becomes the new normal. You then need something even cooler and newer to satisfy you. It doesn’t take a rocket scientist to see how this would lead to overspending. Here’s an example. You buy a fancy new smart phone and get used to all of its great features. You then decide other things in your life need to be as intuitive and convenient as your smart phone so you go out and buy a tablet, a Nest and a Roku despite the fact that you can’t really afford them.
Hedonic adaptation all by itself isn’t bad unless it leads to spending more than you earn. If you do the math and find out that you have more money going out than coming in, you’re headed for trouble. You’ll start getting calls from creditors, you won’t be able to get loans, you’ll find it’s hard to make ends meet and all those other terrible things that come with not having enough cash available. Always understand that lifestyle inflation costs money. If you’re happy with your lifestyle don’t spend money to improve it. Use the cash for something else more important.
There is a case for spending money
On the face of it there’s nothing bad about spending your money. After all, that’s what money’s for and you work hard every day to get it. If it’s not stopping you from achieving your other goals in life then using money to enjoy a better life isn’t necessarily a bad thing.
Many people are turned off about personal finance because they believe it’s all about giving up on stuff and the experiences they enjoy and pinching every penny. While frugality can play an important part in your personal finances it doesn’t mean you have to live like a pauper. If you save wisely for a purpose this can make sense. But saving without a purpose doesn’t. One good way to look at it is that you’re not rejecting spending money on something, you’re saving it to spend later.
It’s just a tool
The important thing to always keep in mind is that money is just a tool and personal finance is what helps you figure out how to use it successfully in ways that will benefit you the most. This could mean using your money on creature comforts or travel which is okay so long as you can afford it.
It’s good to be careful about lifestyle inflation. Do this and it will keep you from overspending. Understand that overspending and lifestyle inflation are not the same thing. You need to practice conscious spending or purposeful lifestyle inflation. This is where you do things like spending your money on travel this year because travel is your passion and you do it consciously. In comparison, there is unconscious lifestyle inflation, where you spend money without even thinking about it. An example of this is when you buy a $30,000 car without thinking how you will pay for it and whether you can even afford it.
The first tool for keeping lifestyle inflation under control is your budget. If you look at a new expense and see that you literally can’t afford it and it’s going to make your financial situation shaky, just say no and forget about it. Lifestyle inflation becomes a problem if you end up going into debt or stretching your finances too thin.
Next, think about what’s called the opportunity cost. While you may be able to afford that expense it could come at the expense of some of your other goals. Even though it’s hard to think long term, consider how that new lifestyle expense will affect your retirement goals or any other of your important goals.
You also need to consider the long-term effects that new expense might lead to. Be aware of how a lifestyle inflation expense will affect your overall budget and what will happen down the road. One good strategy is to focus on percentage. This is where you spend a certain percentage of your income on luxuries, savings, housing and so on. If you do this and your income increases the value of each of your spending and saving categories stays the same. But you get to have a better lifestyle and save more.
It’s not necessarily overspending
Lifestyle inflation doesn’t necessarily mean living beyond your means. It isn’t inherently bad or evil to spend money. Money, in general, is just a tool for financial freedom. There’s nothing wrong with spending it and living a better lifestyle than you did when you’ were in college. But never spend to the point where money is in control of you rather than you in control of it.