Thursday, June 28, 2007

Life Style Inflation is a Good Thing

Many of us personal finance bloggers constantly warn against lifestyle inflation. Well, I am about to break rank with my colleagues. I am all for lifestyle inflation. Lifestyle inflation is a good thing.

For the uninitiated, let me take a step back and explain what the term lifestyle inflation means. Typically this term refers to the fact that people's spending habits increase to match their available income. For example, say you used to make $40K and got along great. Now you get a 25% raise and all of a sudden you are spending $50K without saving any more than you did previously.

So here is my take on the situation. The reason we strive to increase our income is so that we can improve our lifestyle, enjoy life, and get some of the luxuries that we desire. If you have more money to spend, why not do it? It means you are enjoying your hard earned income. What's the point of getting a raise if all it does is inflate the number at the bottom of your bank statement? Where is the fun in that?

I would like to introduce a new concept. Average long term lifestyle inflation. Lifestyle inflation is a good thing, so long as it is sustainable. The problem with lifestyle inflation as most personal finance bloggers refer to it, is that the increase in spending may not be sustainable. Sure, you got that raise and can afford to spend more now, but will you be able to maintain the same lifestyle in retirement? Would you be able to maintain the same lifestyle if you lost your job or had a medical emergency?

The problem is not that your lifestyle has inflated, but that your spending levels may not be sustainable in the long term. You may be setting yourself up for a fall if something goes wrong. However, if you are able to inflate your spending in a way that is sustainable throughout your life, that is the very definition of financial prosperity. This is exactly the objective of everyone who is interested in personal finance.

As a bottom line, here is the solution that I propose. If you find a way to sustainably increase your income, first ensure that you are financially able to weather any unexpected turbulence, such as job loss or disability. After you have addressed those critical needs, increase your spending. However, increase it in such a way that you will be able to sustain your new, higher level of spending even in retirement. If you follow this strategy, your lifestyle will continue to inflate sustainably throughout your life. Wouldn't it be great to know that things are likely to only get better? That's the power of financial planning.


Presh said...

This is excellent advice. The problem isn't that people spend too much or too little--it's that they get it wrong. The goal is sustainable consumption, or as I've heard it also called, consumption smoothing.

You offer refreshing and sensible views--I look forward to reading more.

Shadox said...

Thank you for the kind words, Presh.