Personal finance is not about living like a poor university student for the rest of your life. Spending and lifestyle inflation get a bad rap, but they're not necessarily the enemy when it comes to your finances. It's more about how you approach spending. You want to find a balance between enjoying life and saving for it.
Illustration by Tara Jacoby.
What Is Lifestyle Inflation?
Let's say you get a big 10 per cent raise this year. And instead of using that money to pay off debt or put toward your savings, you use it to live a more comfortable life. You move into a nicer apartment. You go out to fancier restaurants. That's called lifestyle inflation, and in the personal finance world, it's never a good thing. Experts warn against it because, as consumers, we have a tendency to consume too much, and we end up paying the price later.
At its core, though, I don't think there's anything wrong with lifestyle inflation. I'm certainly not living the same lifestyle I was living in university, and that's a good thing. At the same time, when lifestyle inflation makes it hard to get out of debt, save for retirement, or break out of a paycheck-to-paycheck cycle, that's when it becomes a problem. Some people define lifestyle inflation by those problems, which may be fair, because they often go hand in hand.
The Case Against Spending: It Spirals Out of Control
The personal finance world hates on spending for a reason: it can easily screw up your finances. For example, take the Diderot Effect. It's what happens when you buy something, realise it doesn't go with your current sense of style (or even identity), so you buy a bunch of additional crap to redefine yourself or your sense of style.
The term was named after French philosopher Denis Diderot who wrote an essay called, "Regrets on Parting with My Old Dressing Gown." He writes about being gifted a beautiful new dressing gown, which he loves. Only, it makes all of his other things look like crap. To remedy this, he buys a bunch of new stuff to go with that beautiful new gown. Diderot writes:
I was absolute master of my old dressing gown...but I have become a slave to my new one … Beware of the contamination of sudden wealth. The poor man may take his ease without thinking of appearances, but the rich man is always under a strain.
This is lifestyle inflation in action. There's nothing wrong with buying new stuff as your income changes, but the problem with the Diderot Effect is that continued spending is linked to your identity. The problem with that is: your identity is pretty important to you, so you become a big, unstoppable spending machine.
Similarly, we can become victim to Hedonistic Adaptation. When something new and cool is introduced in your life, suddenly that new and cool thing can become the new normal, and it now takes something even newer and cooler to satisfy you. You can probably see how this can lead to a spending problem. You buy a fancy new phone, you get used to all of its cool features, and you can never see yourself going back to a boring old flip phone ever again. In fact, you need everything in your life to be as convenient and intuitive as your phone, so you buy a tablet, a Roku, and a Nest...even if you can't afford them.
Spending isn't bad, but it often leads to spending more than you earn. When the maths doesn't add up and you've got more going out than coming in, that leads to trouble. Creditors start calling, you can't get loans, you find it hard to make ends meet, and all the other awful stuff that comes with not having enough cash. The bottom line is: lifestyle inflation costs money. If you're happy with your lifestyle as it is, why spend more to improve it when you can use that cash for something more important?
The Case for Spending: What Else Is Money For?
On the other hand, what's so bad about spending your money? After all, that's what it's for, and it's what you work hard to obtain every day. If it's not robbing you of any of your other goals, it doesn't seem so bad to use money to enjoy life a little.
People get turned off of personal finance because they assume it's about penny pinching and giving up on stuff and experiences you enjoy. Personal finance is not about living like a pauper. Yes, frugality has a place in personal finance, but it's just one way to reach your goal. Saving without a purpose doesn't make much sense, but saving wisely does. In this way, personal finance doesn't reject spending — in fact, it embraces it. You're saving in order to spend money.
Here's how Ramit Sethi of I Will Teach You to Be Rich describes his approach to money:
I've chosen to focus on helping people define rich and spend extravagantly on the things you love, while cutting costs mercilessly on the things you don't. I especially focus on psychology and automation because none of us want to be financial "experts" — we just want our money to do the right thing so we can get on with our lives.
We "want our money to do the right thing" so that we have enough of it. And we want enough of it because we want to spend it! I'm not saving for retirement because I'm responsible and boring; I'm saving because when I retire I want to do a bunch of fun stuff. At the same time, I want to do fun stuff now, too. As much as I love cheap cup o'noodles, I don't want to eat them every night, and it's nice to be able to turn on my air conditioning when I'm hot, instead of sweating my face off because I can't afford my electric bill. My lifestyle has definitely inflated since my early twenties. But I would also love to increase my lifestyle at retirement: live abroad, dine out whenever I want, and travel all the time. That costs money.
The key is finding a balance between saving for the future and enjoying the present. You want to spend your money wisely, but the goal is still to spend it. Spending is not a bad thing.
Money Is Just a Tool
Money is a tool, and personal finance helps you figure out how to use that tool in a way that benefits you most. That might mean spending money on travel or creature comforts. As long as it's a sustainable and affordable lifestyle, you're not doing anything anti-personal finance just by spending money.
It's good to be cautious about lifestyle inflation. Doing so will help you avoid overspending. But the two are not the same, and it's all about finding the right balance between them with conscious spending. Here's how finance writer Will Lipovsky puts it:
Purposeful lifestyle inflation is saying you will spend money on travel this year because it is a passion. Or, you will use that expensive AM face wash because it makes you feel rejuvenated.
Undeliberate lifestyle inflation is spending money without even realising it. You eat out every night without thinking about it. You drive a S30,000 car when you would be perfectly happy with a $5,000 car. That's dangerous. But purposeful lifestyle inflation… it's ok.
There are a few useful ways to spend mindfully, to find the balance between spending and overspending. A while back, I contemplated whether or not I should move to a nicer, more expensive apartment in my building. I could afford it, but that didn't necessarily mean it was a smart financial move. I wrote about the steps I took to decide whether or not to increase my lifestyle spending. Here's what it came down to:
- Look at your budget: If you literally can't afford the new expense and it's going to make your financial situation iffy, just stop and forget about it. You don't want to go into debt or stretch your finances thin. That's when lifestyle inflation becomes a problem.
- Consider the opportunity cost: Even if you can afford it, the new expense might still come at the cost of your other goals. Think about how the new lifestyle cost will affect your retirement goals or anything else you're saving for.
- Consider the long-term effects: Think about what spending problems this new expense might lead to. I knew that if we moved, we'd be tempted to buy new furniture to go with the place (Diderot Effect), so I budgeted that into the cost when I was weighing my decision. Basically, you want to be aware of how this increased lifestyle spending will affect your budget overall and down the road.
Lipovsky suggests a helpful strategy that we've discussed before: focus on percentage. Spend a certain percentage of your income on housing, luxuries, savings, and so on. This way, when your income increases, the value of each category of spending and saving remains the same. You get to save more, and you also get to enjoy a better lifestyle.
If you're looking to cut back on inflation, on the other hand, you'll want to focus on saving money and coming up with a plan for deflating your lifestyle.
Some may argue that lifestyle inflation is defined by living over your means, and that's one thing. But simply spending money isn't inherently bad. In general, money is just a tool for financial freedom. It's ok to spend it and live a better lifestyle than you did as a college student. You just don't want to spend to a point that you're at the mercy of money, rather than having control of it.