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As a recent college graduate, one topic that has fully engaged my attention lately is lifestyle inflation. I recently accepted a job where I am making quite a bit more money than I ever have and it has been a real challenge to keep my expenses down. For those not familiar with the term “lifestyle inflation”, it simply means that human beings have a tendency to increase their expenses when their income increases. I’m sure everyone has been there, whether it is buying a new house like I did, or eating out more often. I actually think that some sort of lifestyle inflation is to be expected and deserved when climbing the income ladder; the key is in making sure it doesn’t keep pace with your income growth.
Income – Expenses = Wealth Building Capital
To me, this simple equation is pretty enlightening. It goes to show that no matter how much you grow your income, it can never make up more the 50% of the contribution to your wealth. To put it another way, the lower your expenses the more money you will have to save. Pretty simple right? Now that we have established that income is good and expenses are bad, let’s talk about some ways that lifestyle inflation can be avoided.
Apply Your New Income to Your 401k
My favorite strategy for avoiding lifestyle inflation is to increase your 401k contribution. If you are getting a raise, it is pretty easy to implement this on the same day you get your raise. Say, for example, that you get a 3% raise. If you elect to have that 3% go directly into your 401k, you will never suffer any lifestyle inflation at all because you won’t ever “see” that money come to you on your check. This plan wins in my book for two reasons; one: it is automatic and you don’t ever touch the money, two: you get to boost your retirement savings!
Admittedly this plan does not work as smoothly when you start a new job, but it still works. When you start a new job you may not have immediate access to a 401k. At my current job I have to wait until I have been with the company for six months before I can enroll in my 401k benefits. The disadvantage here is that you may get used to having all of that extra money and it could be harder to roll it in to your 401k when you are eligible. The key is to consider your increase in salary as temporary and try to keep that mindset until you can start the 401k contributions.
Utilize Automatic Transfers
The automatic transfer strategy is very similar to the 401k strategy, except everyone can do it. Nowadays, most employers allow their employees to specify multiple accounts for their paycheck to go into. Usually you can specify a dollar amount, or chose a percentage of your pay to be deposited into a separate account each pay period. If that is not an option for you, most banks allow you to set up automatic transfer between accounts, so that is always an option. If you don’t qualify for either of these options you can always manually transfer the money yourself!
The concept with automatic transfers is the same as it is with 401ks, if you don’t “see” the money, you won’t spend the money. If you are anything like me, having to make an additional transfer to spend your money will be a huge deterrent! If you can’t put your money into a 401k, automatic transfers are the easiest way to avoid lifestyle inflation.
Pay Down Debt
I like to call this strategy “lifestyle deflation” since it is pretty much the opposite of lifestyle inflation. Is there really a better way to control your spending than to spend your excess money on debt? This strategy pretty much kills two birds with one stone and will leave you feeling great when you are finished. Seriously, there is no better feeling in the world than being debt free. If you throw every extra penny you make towards debt payoff you will be amazed at how quickly your debt will melt away.
If you are a rock star and have already completed all three of the steps above there are still other options to help you avoid lifestyle inflation. I consider investing in any assets that appreciate (stocks, real estate), or investing in yourself (college, community courses) to be great ways to avoid overspending. Sure, you have to spend a little bit to make them happen, but the returns outweigh that expense. I am also a big advocate of giving to those in need if you can. Not only will it be extremely helpful to those that receive the gift, it is also good karma!
Avoiding lifestyle inflation is an important part of becoming wealthy. What have you done to help you keep your costs under control? Do you think I’m crazy and want to spend all of your money as soon as you get it? Let me know in the comments below.
Author Bio: Nick graduated with a degree in Information Systems in December 2012. He spent the bulk of his last semester in college focusing more on transitioning to the workforce than my classes. Making the transition into the workforce was something that he doesn’t feel school prepared him for, so he blogs about the lessons he is learning.