There's this one financial mistake people make all the time. Anyone can make it, and often, they don't even realize they're making it before it's too late.
Video Summary by BetterThanYesterday
Key Takeaways
There’s this one financial mistake I see people making all the time. Anyone can make it, and often, they don’t even realize they’re making it before it’s too late.
And it doesn’t matter if they’re earning 10 thousand or 10 million dollars per year. This mistake can keep people poor forever. And even if they’re wealthy, it has the power to make them broke.
So what is that mistake? It’s falling prey to lifestyle inflation. Here is a concrete example:
This is Mike. Mike currently works at a job, where he makes 30 thousand dollars per year.
- He spends roughly 25 thousand to cover his essential expenses. Which are: food, housing costs, his car and gas, insurance, etc. Things that are essential and are needed to live a normal life.
- And the leftover 5 thousand dollars, he spends on vacations, gifts, new clothes and other non-essential stuff. Things that are nice to have and experience, but are not required to sustain himself. Luxuries basically.
That’s how Mike allocates all of his annual income. He doesn’t save or invest, since he doesn’t have any money left over at the end of the month.
But then Mike gets a promotion and a raise at his current job. He is now making 45 thousand dollars per year. That’s 15 thousand dollars more annually. Finally Mike will have some money left-over at the end of the month, which he can save and invest.
So what does he do with that extra money? As his income increased, his standard of living also increased.
- Mike now feels like he deserves a better, fancier and more expensive car, which he decides to buy. He can now afford to move to a bigger apartment, and that also means higher housing costs.
- Making more money, also means being able to afford more exotic vacations.
- And he can now afford to eat regularly at fancy restaurants or just use food delivery services.
- But at the end of the year Mike breaks even, and again, basically has no money saved. Just like before.
This phenomenon is called lifestyle inflation. It usually happens when you start making more money, but you also end up spending more money.
Instead of maintaining the same lifestyle, you upgrade it. Things that were once luxuries, become necessities. Instead of saving or investing the extra money, you now need more money to maintain your life.
And just like Mike, this is something a lot of people fall for. 78% of American workers are living paycheck to paycheck and more than 58% have less than 1 thousand dollars in savings.
At a first glance, this might not seem like that big of a deal. People can choose to spend their money however they like. But when an emergency comes up, or an unexpected expense, this can be extremely problematic.
Mike is perfectly healthy right now and there’s nothing holding his lifestyle back. But what if he gets into a car accident where he’s injured badly? Suddenly he doesn’t have to cover just his living expenses, but medical bills as well.
And what if Mike loses his job? A similar problem occurs. His living expenses stay the same, but he doesn’t have the necessary income to cover them.
This is why Mike should keep his lifestyle the same, and save the money, instead of spending it. One might argue, that Mike should just try to make even more money. Then he could keep his new lifestyle and save the rest.
It’s true that the more money you make, the easier it is to save more of it. But it has to be noted that not even rich people are safe from lifestyle inflation. Many former athletes file for bankruptcy just a few years after retiring.
Whether it’s NFL or NBA players, they often suffer financial stress. Yes, those athletes were making millions and they did save a lot of money. But because they kept the same luxurious lifestyles, even after their income stopped coming in, they ended up broke.
Higher income doesn’t necessarily translate to financial security. Good financial habits do.
Another stereotypical example is lottery winners. After they receive that massive amount of money, in a few years they usually end up right where they started. Instead of controlling their spending and being set for life financially, they make bad financial decisions and they end up broke.
So what good does it do if someone makes 1 million dollars per year, but their lifestyle requires them to spend the whole 1 million? Being rich isn’t just about how much money you make, but also about how much money you can keep.
And don’t fall for society’s illusion of wealth. Some people might seem wealthy, because they spend so much money on trying to look rich. But just because someone wears 5 thousand dollars worth of clothes, or drives a sports car, it doesn’t mean they’re wealthy.
A lot of those people are struggling financially and just waste their money on expensive brand items. That’s just the society we live in right now. We put a lot of value on things that we can show to other people. So it’s not completely your fault if you fall prey to lifestyle inflation.
Your lifestyle habits come from your friends, social media and the culture you’re a part of. And if you look around, most people are living an extravagant lifestyle.
So you might feel like you’re expected to do so as well, since it’s normal because everyone else is doing it. But remember that “normal” in this case, means being broke and living paycheck to paycheck.
So what can you do to avoid lifestyle inflation?
Knowing about it and acknowledging it, is half the battle. If you understand that it’s something that can happen to you, you’re probably going to spot it if it does.
The other half is being self disciplined. Before spending money on anything, you should sleep on the decision and really ask yourself if it’s going to improve your life in any way.
A lot of our buying decisions these days, are impulsive and done mindlessly.
- Do you really need a brand new Iphone every single year? What’s wrong with the current one?
- And do you really need to get a $600 watch, just because you can afford it? Again, what’s wrong with a $60 one? They both show the same time.
Stop wasting money on things that don’t bring you any long term benefits, just because you have some money to spare right now. There will always be something you can splurge the money on. After all, it’s very easy to spend it. Making money however, is a little harder.
Whenever your income or salary increases, so should the amount of money you save and invest.
- Your income is never guaranteed, that’s why it’s a necessity to live within your means, while putting money away for the unexpected.
- People with a higher income might have an easier time saving, but if they just splurge, they can easily end up broke.
- And people with a lower income can still save money, if they just budget carefully. They need to figure out what amount of money is enough to fund their lifestyle. And then they must not spend more than necessary.
Now I’m not saying that you should only save money, far from it. There’s no point in saving every penny, while being completely miserable as a result.
Instead I’m only suggesting that you live within your means and when your income increases, you keep a similar lifestyle. The money that you do spend, should be spent on things that you enjoy and that benefit your life.
If you think having a Lamborghini is what truly matters to you, go ahead and get it. As long as you don’t go into debt for it and it’s not to impress others or just for the sake of spending. And be sure to keep in mind that it requires expensive maintenance.
“We buy things we don't need. With money we don't have. To impress people we don't like.”
Are you going to be one of those people who falls for lifestyle inflation? Or are you going to rise above it? The choice is yours.