It’s Lifestyle Inflation That’s Killing Your Retirement (Not Something Else)
There’s still time.
A good friend of mine from college received funding to study his personal interests and worked part-time to be able to afford the expensive course.
I always admired him because he had a desire to succeed in life. Sometimes I thought anything was possible with him.
After graduating, he finally reaped the credit for his hard work.
He started at a major consulting firm in the IT field and finally earned what he deserved. Instead of scouring brochures for special offers, he could now eat out every day.
He realized a big dream by replacing his Polo with a Mercedes. Finally, he was able to travel the world.
As the months went by in his first job, I saw him less and less.
His workload was heavy, and exhaustion and fatigue took over the weekend. The transition from flexible study to a 50–70 hour week was obviously difficult for him.
But when I saw him once, I was thrilled: instead of jeans and a shirt, he now wore a suit and tie. Everyone in the company did that, and he was adapting, he said.
Just when I thought all his financial problems were over, something happened.
One day he confided in me and admitted to having problems.
He showed me his bank statement, and I held my breath.
His debt facility was over $5,000 monthly. I no longer understood the world and asked him how this could have happened. His answer was uncertain and shaky.
It was clear to me that he himself did not know how this could have happened.
As I read a lot of financial books at the time and we exchanged views on money, he asked me for help. When we decided to clean up his finances together, I realized one thing: he was suffering from lifestyle inflation.
You can imagine that when there is inflation in an economy, prices go up.
Inflation means we all pay increasing prices, and our money becomes less and less valuable over time. This is where you have less money left over to retire comfortably.
Why Lifestyle Inflation Is So Dangerous, Especially For Young Professionals
In this context, lifestyle inflation means that young people tend to significantly increase their standard of living in their first job.
My friend had to do many things during his studies for years. As soon as the first salaries came in, it was clear that he would treat himself.
Many young academics are vulnerable to lifestyle inflation. During their time at university, they are forbidden to do much work in addition to their studies, so as not to jeopardize their student status.
When young people enter the profession, they also want to compare themselves with others and show off what they have.
This is where lifestyle inflation hits.
Instead of investing at least part of their additional earnings, many academics throw their money out the window like there’s no tomorrow.
The first apartment costs $10k and a new car is leased instead of buying a cheap used car. In addition, people eat out more and more.
This becomes dangerous when more money is spent than received.
Because banks are happy to grant overdraft facilities when they recognize the high salary payments on the accounts. As a result, my friend also slowly but surely got into a debt maelstrom.
What many young people don’t understand is that happiness is short-lived. Lifestyle inflation ensures that less money can be set aside for retirement than is necessary.
Short-term consumption is prioritized over long-term retirement. As retirement is still far away, especially young people do not recognize the relevance of this important topic.
What You Can Do Against Lifestyle Inflation
When my friend asked me for help, I didn’t hesitate. We cleaned up his finances and established 3 simple rules for handling money. This helped him stop falling prey to lifestyle inflation:
Rule #1: Have Realistic Financial Horizons
The first thing we did was set financial goals. Among other things, my friend thought about when he would like to retire and what purchases would be interesting for him in the coming years.
The purchase of a house, for example, was planned for 10 years. For this, he needed capital. Based on these framework conditions, we developed financial goals for him.
The moment my friend wrote down on paper the amounts for the purchase of the house, he realized that it was worth giving up part of the consumption in the short term.
Rule #2 — Use Budgets
My best recipe for beating lifestyle inflation is to set budgets for all personal endeavors.
I also recommended the budget method to my friend.
He now calculates a maximum of 50% of his income for fixed costs and living expenses such as groceries.
His savings and investment rate is 20%. The remaining 30% is his consumption budget, for example for going to restaurants and everything else that gives him pleasure.
If he consumes more than planned, his savings rate will automatically drop. Whenever his income increases, he distributes the difference equally between the three budget pots.
Always keep an eye on your savings rate to avoid falling prey to lifestyle inflation. Even if you earn less than my friend in consulting.
The amount of income does not play a role in the usefulness of budgets.
Rule #3 — A Fun Account Can’t Be Missed
Financial goals alone do not prevent you from consuming your income in the short term. Because our brain needs rewards.
My friend is now getting this continuously through a fun account. It feeds into the consumption budget mentioned in Rule №2 and is intended for slightly more expensive wishes.
Whenever my friend plans a trip, he uses this account.
He may also turn to his fun account when planning larger purchases, like a fully automatic coffee machine or a visit to the amusement park.
By regularly giving your brain pleasure, you won’t feel handicapped. This ensures that you stay away from lifestyle inflation in the future.
Bringing it all together
Only those who recognize the dangers of lifestyle inflation can avoid them
If my friend hadn’t cleaned up his finances, he would probably still be stuck in a pile of debt with no way back.
He has now changed jobs and traded the Mercedes back in for a Polo. Whenever possible, he invites me to cook. Hopefully, in two years, he will be pursuing his new hobby in his own home.
If you are a career starter, lifestyle inflation can also be dangerous for you. The sooner you take the rules of financial planning seriously, the sooner you can start filling your savings pot and reaching your financial goals.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.