Have you ever heard of the term? It’s not the traditional definition of inflation as it relates to macro economics. If you’ve read any long established personal finance blog, it’s very likely that they’ve talked about it at least once, particularly to warn against it. If they didn’t, you probably need to start reading a new blog.
Before I go into the explanation, we’ll do some simple math.
What’s 500,000-500,00? Zero right? Ok, so what about a million – a million? Still zero. If you grasp this, you can grasp the concept of lifestyle inflation. Most importantly, it will help you understand why it’s bad.
The idea is that for every increase in pay or income, your expenses go up. Any “inflation” in your income translates into an inflation in your life style. Did you get a nice performance bonus? Here comes the Louis Vuitton luggage. Did you get a promotion that came with a 10% salary increase? You trade your Corolla for a new 5 series BMW. What you’ll find in those circumstances are people with well-paying jobs who still struggle to remain above water. They still have worries, they still have debts. Their net worths don’t go up with their salaries. While on the surface they’re are enjoying the fruits of their labor, in reality, there is no long term benefit to their ever expanding paycheck. A blogger talks about her personal experience with this issue in the a post about additional sources of income.
Does that mean lifestyle inflation is always bad? It’s bad most of the time but not always. If your income goes up by $400/month after taxes and you take that opportunity to pay off your credit card debt, it’s a temporary inflation that will benefit you in the long run. If you increase the contribution to your employer-sponsored 401(k), you may not have access to the money right now, but it’s being put away for your future. If you decide to take that money and build an emergency fund, you’re building a cushion for rainy days. But we all know that’s not what people do with extra money. They celebrate raised by buying out the bar for their friends, buying expensive gifts for their significant others or rewarding themselves with something fancy.
Do you feel like if you work hard for a raise you should reward yourself with an expensive purchase? I guess it depend on what your definition of “reward” is. As far as I’m concerned, your biggest reward is ensuring your financial security, both in the short term and long term. The rest is vanity.