Awesome! You just got a raise! Or maybe your first job post-college.
Now we need to put that money to good use.
One of the best tips in the personal finance world is to avoid lifestyle inflation. So first, what is lifestyle inflation?
Lifestyle Inflation Defined
Lifestyle inflation is all about spending more money as your income goes up.
For example, you’ve been living the poor college student life for years now. You get your first paycheck and you immediately go out and get the nicest apartment you can afford. And then you furnish it. And then you get an awesome new wardrobe to go with your awesome new job. See how this gets out of hand quickly?
Or you get a cool raise. You’ve got an extra $500 coming in a month so you decide to go get a new car with a $300 a month payment. But you also decide that because of that raise you can afford some new clothes at $250 a month. Or perhaps an extra night out every week. So many times people spend more than their raise.
But how do we stay out of this trap and avoid lifestyle inflation?
Ways to Avoid Lifestyle Inflation
Calculate How Much Your Raise is Really Worth
Do you know the difference between gross pay and net pay? If you get a $12,000 gross pay raise, you’ll have to pay taxes on that. Depending on your tax bracket and state income taxes, you can be talking 15-40% of the raise that will go straight to taxes. Don’t think you’ll have an extra $1,000 a month because you’ll definitely end up spending more. Instead, you’ll need to make sure that you think your raise is really the smaller $600. Sometimes personal finance is about mind games. Here it definitely is.
Put It Towards Retirement
If you are not maxing out your retirement contributions, do so immediately! Even better if it is an employer sponsored plan because you can up your contribution by the amount of your raise and never see it in your take home pay. Without more money in your bank account, you won’t be tempted to spend more money. And you’ll have more saved up for retirement!
Pay Down and Avoid New Debt
Want a guaranteed rate of return on your “investments?” Pay down your debt! You’ll be guaranteed a rate of return equal to your interest rate. By paying down your debt, you’ll put yourself in a better financial position for that eventual recession. Again, you won’t see more money in the checking account (or at least not for long) so you won’t be tempted to go out and buy more lifestyle.
It’s also very important to avoid new debt. It is so easy to get in the mindset of “I can afford the debt.” Nope! You can’t. You don’t want to be living paycheck to paycheck. Stop it. Just don’t do it. Instead, use your new income to save up for your next big purchase. What an awesome feeling it is to go in a write a check to buy a new car with no car loans! (Wait, do people still write checks for a car???) You may also be able to negotiate a better deal if you are paying with cash! Win-Win for your net worth and progress towards financial independence!
Keep Housing in Check
One of the places you’ll see lifestyle inflation in the biggest chunks is in housing. Yep, you got the raise, now you qualify for a bigger mortgage! Don’t immediately go out and get the next biggest house you can. Remember, it costs money to buy and sell houses and move. Save that money plus take advantage of a smaller house payment.
Same goes for apartments. If you can keep living in the same rental place, assuming rent hasn’t been jacked up too much, you’ll come out ahead. Don’t upgrade to a fancier apartment just because you got more money in the bank. You really don’t need all that extra space. Or granite countertops.
If you only avoid lifestyle inflation in this area alone, you’ll be so far ahead of your peers. Remember the 80/20 Rule and focus on the big things first.
See Also: Nest Egg Ninja: “Same house, same spouse, same car”
Invest in Car Maintenance
Just because you can afford it does not mean you need it. If your car is still in good working condition and gets you from point A to point B reliably and safely, don’t go upgrade the car. You don’t need to impress your boss and co-workers or even clients with a fancy new car.
What you should do with your raise, instead of buying a new car, is to invest in preventative maintenance. Make sure you’ve gotten the oil changed on a regular schedule. Then make sure that you’ve done all the big mileage checkups. Taking care of these things will help your car last for 200,000 or more miles. Think about all the money you’ll be saving by not buying a new car!
Setup An Online Bank Savings Account
One of the best things that I’ve done with my savings is to transfer it to an online savings account. By being at a different bank than your normal checking, the money is out of sight, out of mind. You won’t see that money when you check your balance on your smartphone or at the ATM. You’ll be so less likely to spend that money.
Also, it usually takes a few days for transfers to happen. If you use a savings account at your normal bank, the transfers are generally immediate. That’s not good for you because it makes impulse shopping so much easier. And the online banks generally have better interest rates than your Too Big to Fail brick and mortar banks. Make money on your raise by putting it away!
Setup automatic transfers from your checking account for each pay period. Make this transfer equal to your new take-home pay raise. Again, out of sight, out of mind. And you’ll have a nice savings account built up.
Delay Your Lifestyle Inflation
OK, it is inevitable that you will let your lifestyle go up. We really don’t expect you to live like a poor college student forever. Congrats to those that can because you are on the path to early retirement!
Instead, how about you delay your lifestyle inflation by 2-5 years? First, you can make sure that your job is stable and you’ll really get that raise long-term. Second, if you are always 2-5 years behind your peers in lifestyle inflation, think about how much less debt you’ll have! Or more money in savings or retirement! Remember, it’s all about the compounding growth and time matters.
Tortoise, Not the Hare
Once you do decide to improve your lifestyle, don’t do it all at once. The newness will wear off and you’ll want to spend more to be happy again. So do everything gradually.
Instead of going out and buying everything at once, do one thing at a time. Enjoy your new car for a good six months to a year. Then plan and take a nice vacation the next year. If you got the car and the vacation at once, what will you do next year? So spread it out and take it slow, like the tortoise. Don’t be the hare, rushing to enjoy everything at once.
What Are Your Tips to Avoid Lifestyle Inflation?
I want to hear from you! What are some ways you’ve managed to avoid lifestyle inflation? Comment below with your tips!