Last Updated on September 20, 2019 at 10:21 am
We often focus a lot on regular inflation while planning for our goals and cash flows. But a very important aspect which gets missed is ‘Lifestyle Inflation’. This is the concept where a person increases their expenses when there is an increase in their income, in addition to the regular increase in the cost of goods. Sebi registered fee-only investment advisor Vikram Krishnamoorthy discusses solutions in this article.
About the author: Vikram is a member of fee-only India (FOI) and part of the freefincal fee-only planner list. He is an MBA in Finance and a Post Graduate in Financial Planning from Canada. He provides fee-only financial planning and investment advisory services for individuals and families from all over India. His website is: insightful.in
Lifestyle Inflation impacts all age groups, but especially young people. We often get excited when our income increases, and we tend to increase our lifestyle immediately. For example, a person with a decent salary pays an EMI for his car worth 7 lakhs and rents an apartment for Rs. 15,000. He gets a promotion with a salary increase of 25%. As a result of this increase, he upgrades his car to a 12 lakhs car with a higher EMI and moves to a new apartment with a rent of Rs. 25,000. This is a simple case of lifestyle inflation.
In my opinion, the difference between ‘can spend’ vs ‘should I spend’ is one of the biggest factors that define a person’s long-term financial success. Just because you can increase your lifestyle, it does not mean you have to. An extreme example of this is the lottery winners in the US. More lottery winners go bankrupt faster than the average person because they never think about the long-term sustainability of their lifestyle. They increase their lifestyle multi-fold immediately and are not able to sustain it after a while.
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There is no end to how much we can increase our lifestyles. This cycle of increasing expenses every time there is an increase in income makes it difficult to achieve your goals and attain financial freedom sooner.
Impact of lifestyle inflation on personal finances
You achieve Financial Freedom when you are not dependant on your ‘active’ salary income or business income to maintain your lifestyle. The money you need to maintain your lifestyle should come from ‘passive’ sources. This passive income can be achieved only when you save up enough to generate that income.
You will not achieve financial freedom if you keep increasing your lifestyle proportional to your higher income, and not increasing your savings towards generating passive income. You may always end up living paycheque to paycheque and getting caught in the spending trap.
‘Income’ is not the only metric for financial success, it is only one side of the equation. The other side of ‘expense’ is as important. Often, people focus so much on trying to increase their incomes but ignoring what is happening to the other side. A person earning 1 lakh may have more financial success than a person with 2 lakhs income and we often see that a person with a lower income having a larger saving than a person with a higher income.
How should we approach this?
There is nothing wrong with wanting better things and raising your lifestyle. The important thing is to focus on the long-term lifestyle sustainability first, rather than just focusing on your current lifestyle. In fact, it becomes very difficult to reduce your lifestyle once it goes up, and we end up making bad decisions to maintain our higher lifestyles. As a result, many people go bankrupt too, getting into debt to maintain it.
You should try to guarantee your current lifestyle for the rest of your life before increasing your current lifestyle. When you have an increase in family income, understand how that can be used to achieve financial freedom faster to automate your current lifestyle.
Make gradual increments to your lifestyle. There’s nothing wrong with stepping up your lifestyle as you earn more but resist the urge to make big jumps suddenly. Do it gradually, trying to put most of the additional new resource towards guaranteeing your future lifestyle.
Most people make bad decisions when they don’t understand the long-term impact of an immediate small decision. When you have a financial plan, you understand the ‘cause and effect’ of every decision you take today. You will be able to understand how your spending today is impacting the long term picture and may reduce your chance of making temporary bad decisions that may adversely impact your long term financial stability.
Financially successful people are not necessarily the ones who have the highest incomes or the best cars and houses. They are people who are financially free, not dependant on their active incomes to maintain their lifestyle. Some people who look to live a high life, spending on material things to showcase their financial success, may in reality not be built on solid ground.
When you spend everything you have today, remember that you are borrowing from YOUR future financial stability.
Being able to sleep well at night knowing that no matter what happens to your job or business tomorrow, your current lifestyle is guaranteed for the rest of your life is true financial freedom.
In summary
-An increase in income should first increase your savings, not your expenses.
-Your income alone does not necessarily define your long-term financial stability and success, your savings does.
-There is nothing wrong with increasing your lifestyle. However, make gradual changes, not drastic sudden increases.
-Have a plan, so you can understand the ‘cause and effect’ of your current spending decisions, and focus on achieving your goals and financial freedom at the earliest.
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If you wish to work with Vikram, his website is insightful.in
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