With a worryingly large proportion of Americans and Britons having little to no savings and investments, lifestyle inflation is a very real and prominent issue affecting hundreds of thousands of people. But what is lifestyle inflation, why does it matter and how can you avoid it and prevent it from affecting you? Read on to discover everything you need to know about the ideology that could be holding you back from achieving your financial goals.

What is lifestyle inflation?

Lifestyle Inflation is a term used to denote the increase in costs associated with an improvement of lifestyle following an inflow of money perhaps from a bonus, promotion or change of job. Let’s use an example to help explain the concept more vividly:

Josh (not a real person) is currently living at home after graduating with a degree in Computer Science. He earns a respectable £22,000 a year and since he lives at home, his outgoings are rather low at only £200 a month, meaning he can save a few hundred each month. A year later Josh is up for annual review and his salary gets bumped up to £26,000. With this new promotion and extra income, Josh decides it’s time he moves out. What was once £200 a month in rent at has now become £500 a month as part of a professional house share. He also now needs to buy his own food and contribute to the utility bills as he can no longer rely on his parents. So although he’s making more money he’s unable to save any more than he was previously.

Two years down the line Josh sees his dream role open up at a prominent technology company. He applies and, to his surprise, is offered the job! However, it’s not a remote role and the company aren’t local meaning he has to relocate. The role does bring with it a substantial salary increase though taking him to £40,000! After two years of house sharing Josh looks for his own place and settles on a cosy two bed with a rent of £1050 a month – over double the price of his previous place. As he now needs to get into the office everyday, Josh takes the time to upgrade his car and wardrobe so he can look respectful and set a good first impression. As you may have guessed, even though he’s now earning nearly double the starting salary at his old place he hasn’t been able to increase his savings.

Josh is a victim of lifestyle inflation.


While the above example might have been a bit exaggerated, it does help clarify the issue. Most people match their increase in paycheck with an increase in spending. This ultimately leaves them back at square one from a financial standpoint. Let’s take a look at why this is important and how bad lifestyle inflation can be.

Why is lifestyle inflation important?

Lifestyle inflation is important because there is an alarming number of individuals who claim to be living paycheck to paycheck. Reports from Statista state that most Americans lack savings, with 45% claiming to have no savings at all and 69% claiming to have less than $1000 saved. Only 20% of Americans have a reasonable emergency fund should things go wrong, suggesting 80% would be in financial trouble within a month or two of losing their income.

Things aren’t too much better across the pond either. Data from Finder suggests that 9% of Brits have no savings and a third of Britons have less than £600 saved. Similarly, just over 40% of the British public don’t have enough savings to live for a month without income. While these statistics aren’t as high as they are in America, they are still striking.

So why is it that so many people are unable to save? While lower income might be part of the problem, it is not the only contributing factor. With a median monthly household income in the US of between $3000 to $4000 and average rental prices between $700 – $1500 a month (depending on your state), the average American should have more than enough to cover their livings costs. A similar, but less convincing, story presents itself in the UK, where there is a median household monthly income of nearly £2,000 and the average rental price is £861 a month (excluding Greater London). This can only mean that a large number of people are spending above their means and inflating their lifestyle to match their salary – they are victims of lifestyle inflation.

5 Ways to avoid lifestyle inflation

Fret not, it’s not all doom and gloom. Lifestyle inflation is ultimately the result of poor money habits and a lack of financial education, meaning it is easily avoidable and escapable. Trust me, I’ve been there once myself and managed to turn myself around. So if I can do it, you can too! Here are five ways to avoid lifestyle inflation in the future.

1. Make a budget and stick to it

While it’s an overused cliche in the financial world, budgets do work wonders as long as you stick to them. Budgets work because they force you to analyse your financials which helps you have vision on where your money is going. If you don’t know how much money you are spending each month and where and why you are spending it, it will be harder to save a consistent amount.

The other great thing about budgets is that you don’t need to be 100% accurate, which is a plus if you don’t want to dive deep into the numbers. Simply work out how much you are spending on key areas like bills, subscriptions and living costs, and then add a few % of your salary for breathing room. For example, if you work out that 56% of your outgoings are on bills, you could allocate yourself 60% of your budget instead. That way if your bills are higher one month for whatever reason, your system has already factored that in.

Moreover when you analyse your financials you might find hidden costs you weren’t aware of. Perhaps it’s a subscription fee you thought you cancelled, or a phone bill for a phone you no longer use. Whatever it is, you might find some money you can free up you didn’t know you were wasting!

Finally, the best reason to have a budget is because percentage based allocation helps you avoid lifestyle inflation. Remember Josh from our fictitious example earlier on in this article? Well Josh was only saving a fixed sum each month, which didn’t scale with his salary increases. If Josh was making sure to save a percentage of his salary each month instead, say 10%, then he would have started saving £220 a month, then £260 after his first promotion and then £400 when he changed jobs! Percentage based savings ensure your savings don’t idle as your financials increase.

2. Pay off and avoid debt

Debt was how I personally managed to fall victim to lifestyle inflation. Even though I could afford to buy things on my debit card, I would put the occasional more pricey item on my credit card. The idea was that this would help build my credit rating and free up some extra cash-flow each month.

While my intentions were good, it ending up having the opposite impact on my financials. At the start of each month I would pay off the credit card to avoid late fees and then realize that I didn’t have enough money left to save anything. So what would I do? I’d repeat the cycle again! It took a while to break this habit and free my money up so I could start saving again. As a result of this experience, I now try to limit credit card usage to only essentials such as unexpected costs.

Unfortunately, some of you might find yourself a bit further down the credit card hole. Perhaps you were unable to fully pay off your balance and are now being charged interest and late fees. If you’re unfortunate enough to be in this camp, you’ll know all too well that your once innocent purchases have evolved into money grabbing fiends. A £100 purchase could easily become £120 due to 20% interest and a little while later that £120 could become £144 and so on. This makes it even harder for you to save as you end up paying more than your original purchase cost. If this resonates with you, try to make a plan to start paying off your debts even if that means sacrificing the lifestyle you’re accustomed to. Make sure to focus on the highest interest debts first to have a greater impact.

3. Create an emergency fund

Lifestyle inflation is a result of spending superfluous income, so what better way to decrease it’s impact and possibly avoid it altogether than by reducing the amount of spendable income you have? An emergency fund is the most sensible way to do just that.

As mentioned above, 69% of Americans have less than $1000 in savings and approximately 40% of Britons don’t have enough saved to survive for a month with no income. If you think you’re one of those then building an emergency fund or nest egg should be high up your list of priorities.

An emergency fund is essentially easily accessible cash savings for unexpected costs or surviving should you lose your primary source of income. How much your emergency fund totals is up to you, but consider your tolerance to risk, the strength of your industry and any dependents you may have. Typically people look to save enough to survive for either 3, 6, 9 or 12 months depending on their answers. For example, a software developer with no dependents will probably be fine with an emergency fund that covers 3 months since they are in a thriving industry and could easily replace their job. However, a university lecturer that specializes in earth science and has three children, might be safer building a larger fund as they are likely to find it harder to replace their source of income.

4. Open an ISA or a Roth IRA

Once you’ve built your emergency fund you could choose to continue to add to it to reduce your spendable income, but unless you’re saving for a specific goal e.g. a deposit for a house, there are better ways.

In the current economic climate, traditional savings accounts are almost useless. The advertised interest rates are pitiful compared to the average yearly inflation rate. For example, the inflation rate in the UK in 2020 was 0.85% according to research by Statista, where as the average savings interest rate in the UK in 2020 was as low as 0.19% according to Moneyfacts. This ultimately means every £1 you saved in 2020 was worth less in 2021. As a result, once you’ve squirreled away enough for your emergency fund you should look past cash savings.

So if you shouldn’t save your money, what should you do instead? Invest it! And no I don’t mean in volatile entities like cryptocurrencies, but things like tax-free funds such as a Roth IRA in the US or a stocks and shares ISA in the UK. While investing does come with risk, it also comes with reward. However, you should always be prepared to lose whatever you choose to invest.

Personally, I invest in a Vanguard Target Retirement Fund that has returned +15.62% over the course of the last year. This is a lot more than the 0.01% I’ve received on my cash savings.

5. Donate to charity

The final way to reduce your spendable income and reduce the likelihood of lifestyle inflation is by donating to charity. While you might prefer to spend £40+ a week on a night out or a takeout, it’s ultimately going to have a bigger impact in better hands. Not only will your money likely be better spent, donating is going to keep you grounded and you’re likely to feel better about yourself too! You can always choose to have a night in with friends instead or go out on the cheap if you really can’t part with your social life.

Here are a couple of ideas to help you share the wealth:

  • Sponsor your friends and family when they do fundraisers
  • Buy food and snacks for the homeless in your area
  • Pay it forward at your local coffee shop, corner shop, bookshop etc.
  • Set up a monthly direct debit to a charity you care about
  • Visit sites like JustGiving and GoFundMe and look for people who are raising money to pay for medical bills or bucket list experiences

Summary

Lifestyle inflation is a common problem affecting many across the globe, ultimately preventing people from reaching financial stability and freedom. However, it is totally avoidable and this article has covered five ways you can prevent it from affecting you. Just remember to stay grounded, stay within your means, reduce your spendable income and make sure you have an emergency fund in case things go wrong!