People start upgrading their lifestyles immediately or gradually after getting a salary hike or a promotion. This increase in spending is driven by their unconscious expectations of what they deserve and makes them feel happier. This impulse to spend more after getting a raise is called "lifestyle inflation."
While spending more isn't intrinsically bad, an increased purchasing power can easily cause your expenditures to spiral out of control and strain your finances. Lifestyle inflation is one of the reasons why many people get stuck in a paycheck-to-paycheck cycle, even if they have just enough income to pay their bills and debt every month.
The consequences of lifestyle inflation include living beyond your means and a high debt-to-income ratio, making it hard for you to save for future goals. Here are tips for incorporating lifestyle inflation into your financial plan to avoid these pitfalls.
Tracking your expenses tells you where you stand in your finances. It shows where your money goes every month and whether you're unconsciously overspending. Once you're financially aware, you'll start making conscious decisions on your purchases.
Also, keeping tabs on your spending gives you a clear picture of your needs. As a result, you can make room for more important financial goals, such as paying off your loans or saving up more.
In monitoring your spending, closely analyze your spending patterns. Cut back or adjust them if needed, but don't give up everything. Remember that getting back on track is for increasing awareness of your expenses and deciding what your financial priorities are.
In tracking your expenses and income, you create or revisit your budget. Having it in place ensures you're living within your means and not overspending. It should break down your expenses into buckets, including essentials, discretionary spending, and savings.
According to research, there are three main benefits of creating a budget. First, it provides "guardrails" or designated limits for your spending. Second, it helps achieve your financial goals by considering savings as a fixed expense. Lastly, it gives you peace of mind.
Start budgeting by listing down all your income sources and expenses. A budget is meant to be flexible, so shuffle the numbers until you figure out a reasonable and doable income/expenses balancing point for yourself.
Building a financial cushion isn't only meant for covering emergency costs, preparing for retirement, or saving for other financial goals. It can also prevent you from dipping into it for nonessential purchases and eventually suffering from the consequences of lifestyle inflation.
Automate your savings to avoid spending them for another purpose. It also pays to put all or a portion of a new raise directly into savings and other long-term financial goals. Paying yourself first through increased savings keeps you from spending it.
Emergency funds can also act as buffers against increased spending over time. When your income increases, it's better to funnel your raise into an emergency savings account to have an added financial cushion to fall back on, preventing accumulating debt.
Apart from savings, experts recommend putting all of a new raise directly into paying off debts. The key is to make consistent extra payments to pay your outstanding balances off more quickly and save on interest. But before doing so, ensure that there are no additional fees or prepayment penalties in your loan terms.
Another way is through consolidating your debts. For example, roll multiple balances into one personal loan with a lower interest rate. Doing so helps you pay your balances faster and save more money. Plus, anyone, regardless of credit standing, can easily apply online. Hence, in case of unexpected events, debt consolidation loans can be your go-to financing.
Paying off your debt doesn't only improve your monthly cash flow but also your credit score. Lower balances improve your credit utilization and debt-to-income ratio (DTI). These two are among the determining factors of your creditworthiness and financial health.
It's seemingly counterintuitive to bring in another income stream when more earnings are the root cause of lifestyle inflation problems. However, if you're living beyond your means, having other income sources can help you be back on track financially.
Understandably, taking on yet another job is the last thing you want, especially if you're already hustling hard to get by. So how about taking on side hustles you can enjoy? It doesn't only improve your financial health but also your well-being.
If you don't want to put in more hours and make any active effort, start passive income streams instead. For example, you can open a high-yield savings account, be a peer-to-peer (P2P) lender, rent your car, parking space, or storage, or invest in real estate.
Plan a financial milestone that you plan to achieve. Having a big-picture plan helps you resist the temptation to spend unnecessarily. Keep your eye on the prizes of your financial goals, and remember what's important to you.