Beware of lifestyle inflation!

Inflation has an impact on your purchasing power, but lifestyle inflation can also have a detrimental effect on your financial management. As your income rises, you may be tempted to make corresponding adjustments to your lifestyle. If you don’t manage this properly, there is a risk that you will start to live outside your means. In order to avoid becoming over-indebted, you must get into a few good habits.

Inflation relates to a sustained rise in prices across the board over a given period, whereas lifestyle inflation refers to the tendency for people to increase their outgoings in line with the rise in their income. Although the temptation to behave in this way is understandable, is it appropriate and risk-free? After all, if you’re earning more, why shouldn’t you spend more and improve your lifestyle, or simply treat yourself?

If you receive a pay rise or bonus, or come into an inheritance, that’s excellent news! But before you embark on a spending spree, take the time to consider what you really want, and any risks that may be associated with certain expenditure. Of course it’s very tempting to treat yourself. And if your income rises on a permanent basis it’s quite appropriate to think about raising your standard of living. Being lucky enough to have this extra income provides you with a degree of assurance, which enables you to increase your spending levels, gain easier access to credit, and to think about a different future. This is of course true, but lifestyle inflation entails two key risks:

• • the very real difficulty of reducing your standard of living once you’ve exhausted any financial windfalls, or if your income declines, even by a modest amount; and
  • higher indebtedness from taking out larger loans. You may find yourself with more debts to repay than you had before your income increased. This could be a problem if your income were to fall.

Things to think about

Caution is your best ally when it comes to spending. So keep a regular eye on your budget. Monitoring movements on your account and keeping your savings goals in mind will help you to live within your means. If your income has increased recently, ask yourself the right questions before going on a spending spree: could I use this money to settle a debt? Do I have enough money to deal with any unforeseen expenses? What is my current savings rate? Should I increase this? And could I maintain this standard of living tomorrow, if my income were to fall by 10% or 15%? Do I have the means available to pay for the upkeep of anything I buy today?

Owning a car is a very simple example. The cost of the vehicle is not limited to its purchase price. A bonus or financial windfall could provide you with the money to buy the car of your dreams. But once you have your sports car, you may find that the cost of its upkeep and insurance put a real strain on your budget.

Which life goals should you devote your money to? Lifestyle inflation is often indicative of hurtling forward in order to dodge this key question.

A final and more fundamental question also needs asking here: which life goals should you devote your money to? Lifestyle inflation is often indicative of hurtling forward in order to dodge this key question. Although your purchase will bring immediate gratification, managing your finances will become a source of frustration if your money is not being used to realise your fundamental goals. This is the only way to have happy money.

Appearances

In a society where appearances are so important, the drive to always want more can have dire financial consequences. This is particularly true as those we compare ourselves to change as our revenue rises. The richer we are, the more likely we are to compare ourselves to higher social classes who enjoy the same or a better lifestyle. This leads to rampant lifestyle inflation, as we are never satisfied with what we have, and may end up over-indebted.

Over-indebtedness linked to social representation can rapidly become a reality in Luxembourg. There’s no point in trying to keep up with the Joneses: the same type of car, a bigger house, the same holiday destination. Spend your money based on your financial means and your own specific life goals. Don’t worry about appearances, which are often very misleading and not worthy of our attention.

Debts and goals

If you own your home and a vehicle, or if you took out a loan to finance your education, you probably have to repay this money each month. Why not use any extra money coming in to reduce this debt burden? If this makes sense in your situation, seize the opportunity to repay part of the amount received from your creditors. This is of course a less attractive proposition, but it will be beneficial.

And while you’re on the right track, take the time to establish a financial strategy. If you have a comfortable amount left over, take long-term action to meet your objectives: top up your pension fund, put money aside for your children’s education or make essential purchases that you postponed temporarily.

Properly planned and based on the investment pyramid, this type of strategy will allow your capital to grow and will in turn generate rising levels of income. This is the secret to avoiding unbridled lifestyle inflation. Rather than using the rise in your professional income or extraordinary windfalls to inflate your lifestyle, why not use them to establish your asset base? And as these assets gradually start to generate recurring income, you can use this revenue to raise your standard of living without any risk.

Unbridled lifestyle inflation can become a real source of risk and financial problems. To avoid getting into this position, try to use your income to achieve your life goals and to establish your asset base, which will in turn generate additional revenue. We highly recommend that you draw on the expertise of your bank to help you achieve this.