What is Lifestyle Inflation?

Lifestyle inflation is a term used in personal financial planning for the tendency of people to increase their spending and standard of living right along with any raises and monetary resources, even if it’s is at the detriment of any plans for debt reduction or long-term savings.

Monetary inflation describes the phenomenon when more money has no more utility value than a lesser amount used to because the cost of goods is going up. Lifestyle inflation is when people select higher-priced goods and lifestyle spending habits when they have the money available to do so.

While the quality of the goods they consume has increased, they aren’t really in a better position financially-speaking. For most people, that money would be better spent paying off some old debts and sticking to a retirement savings plan.

Sadly, people often use their newly increased cash flow as leverage to get larger loans and sink themselves further into debt. To some degree, it is healthy and natural to live a slightly better lifestyle when you can afford to, but the cost of ignoring debt, or letting it pile up, and foregoing aggressive retirement savings in favor of frivolous spending, can really come back to bite you later.

Even some doctors end up getting part-time jobs in retirement, to the detriment of their health in some cases, because they just didn’t have the self discipline and wherewithal to save the appropriate amount for retirement. Most financial planners would suggest that unnecessary debt be eliminated and a plan for retirement savings be established before any step-up in lifestyle should be taken.

In economics, this is known as induced consumption, which can be quantified in the marginal propensity to consume (MPC), which models the likelihood that various amounts of disposable income (which are not being spent on autonomous consumption, i.e. dire necessities) will go towards consumption instead of savings.

Induced consumption is the amount of discretionary spending that occurs as a function of fluctuation in income or resources.

Where do I Get Started in Saving for Retirement?
How Does a 401(k) Compare With Other Retirement Plans?