How to Reduce Lifestyle Inflation and the Wealth Effect

Odds are, the more money you earn the more money you tend to spend. Some consumers that earn $300k-$400k+ are still unable to effectively manage their finances due to this issue. They should have a high net worth but they don't. Psychologically speaking, lifestyle inflation and the wealth effect are very real phenomena and although it’s not something that often takes high consideration it’s still a phenomenon worth exploring, even if you’re a consumer who doesn’t earn nearly as much money.

From experience there are two solutions that can typically help fix this issue; you can gamify budgeting and try to make use of automatic payments and deductions. If you’re not the best at budgeting automatic payments can make your life somewhat easier with this regard. However, they can tend to make you complacent in the long term and have a habit of putting things out of mind and out of sight.

Counter the Bad Habits

When your income increases, counter the trend! Save more of your money, invest it, establish a rainy day or emergency savings. The best way to do this is by better understanding human nature. Account for the fact that things may not always be as “rosy” as they are now and things can change especially in today’s economic climate. In the long term, investing this money is a much wiser decision than upgrading your apartment because you now earn more. Keeping up with the Jones’ is never in your best interest! Moreover, “if you can avoid keeping up with the Jones’ in the short term, you’ll be able to surpass them in the long term”.

Spend Less

To avoid spending more allocate more of your income into automatic distributions for savings. It’s best if these distributions are automatically deducted from your paycheck. Tactical budgeting will also help in this scenario. If your income has increased by 20% you need to be fully aware of what you are spending on and understand that you should not increase spending by the same amount “just because”. This tends to pronounce the effects of lifestyle inflation and can lead to serious financial decay.

The best way to reel in expenses is to gamify budgeting. High earners tend to be very competitive and love games! Moreover, there is a very concrete connection between saving money and having a well-planned budget.

Become Better at Budgeting

Consumers with concrete budgets keep track of their spending more and therefore are much more conservative in how they spend. Like anything else, this is a habit and skill we must learn to build on and practice repeatedly. The best way to incentivize budgeting habits are by gamifying the experience. Treat each month as a benchmark that you are looking to surpass. Every time you set a new high score (meaning you cut more expenses) you will setup a positive feedback loop that reinforces budgeting habits, incentivizes saving and bolster the psychology of your financial situation.