Get off the treadmill! The hidden trap of Lifestyle Inflation.

We've all been there, getting a pay rise or a bonus and immediately thinking about how to spend it: a new car, a lavish holiday, or just one too many frequent dinners at high-end restaurants.

While it’s natural to want to enjoy the fruits of your labour, there's a lurking danger in these behaviours that’s keeping you from your wealth goals – Lifestyle inflation.

Lifestyle inflation, or lifestyle creep, is the gradual increase in your discretionary spending as your income rises. This subtle yet pervasive habit can erode your financial freedom if left unchecked. The more you earn, the more you spend, and before you know it, your financial situation hasn’t improved despite your higher income.

The Hedonic Treadmill: Why More Doesn't Mean Happier

One of the key psychological drivers behind lifestyle inflation is a concept called the Hedonic Treadmill. In a nutshell this is the observed tendency for people to quickly return to a stable level of happiness. Think of buying a new car and the excitement and increased happiness it brings. After a while you become accustomed to the vehicle, and it no longer brings you any additional enjoyment. Of course, now there’s that shiny new model and its time for the next new car, an opportunity to experience an increased level of happiness.

Another way to think of how the hedonic treadmill functions in your life is to consider a yummy desert. That the first bite of something delicious is experienced as more pleasurable than the third or the tenth. We become accustomed to the pleasure rather quickly, and soon, the same mood-enhancing treat doesn’t bring the same influx of joy.

Think of the last significant pay increase you received. Instead of feeling perpetually happier, you quickly adjust to this new income level and start seeking new, often expensive, ways to maintain that same feeling of happiness. This constant chase keeps you on the treadmill, never truly progressing toward greater contentment.

This is the problem with being on the treadmill, it limits your potential to create wealth due to poor financial decisions and lifestyle inflation. You are constantly chasing more money to spend and buy possessions in an attempt to increase our happiness, only to find that it's never seems enough.

What's Your Inflation Rate?

To understand how lifestyle inflation affects you, consider two individuals who both receive an income increase to $100,000:

Gary: Uses the increased income to finance a loan for a new car.
Russell: Goes out to dinner to celebrate, and splurges $500, but keeps his monthly expenses the same.

Gary’s decision results in a much higher rate of lifestyle inflation compared to Russell’s because he has permanently increased his monthly outgoings. Russell celebrates the win with relative modesty while maintaining their usual spending habits. His additional income is surplus and can be used for investments and additional savings. From time-to-time Russell has the opportunity splurge again as long as he doesn’t make it a habit.

Of course, the choices we arrive at are determined by all sorts of circumstances. Gary’s old car might have been a real bomb and was costing him money. The savings he’s making with the new car might put him in front financially. However, this example illustrates how your behaviour ultimately determines how much real inflation you experience.

Strategies to Keep Your Inflation Rate Low

Here are some practical steps to help you manage lifestyle inflation and preserve your financial freedom:

Maintain a Frugal Mindset: Just because you have more money doesn’t mean you need to spend more. Continue to Look For Value and avoid unnecessary expenses.
Avoid Wasteful Purchases: Don’t buy things for the sake of it. Evaluate whether a purchase will genuinely add value to your life. (Gary’s Bomb car scenario)
Resist the Pressure to Keep Up with the Joneses: Focus on your financial goals rather than comparing yourself to others. Be smug knowing you’ve got $25,000 invested blue chip shares.
Treat Yourself Occasionally: It’s important to celebrate your successes but do so in a way that doesn’t derail your long-term financial plans.
Maintain a Healthy Savings Habit: Prioritise saving and investing overspending. This will help ensure that your financial future is secure. Pay Yourself First
Invest in Growth Assets: Put your money to work by investing in assets that have the potential to grow over time, such as shares, real estate, or superannuation.

By being mindful of lifestyle inflation and taking steps to control it, you can enjoy your increased income without sacrificing your plans for financial freedom. Remember, true wealth isn’t about how much you make—it’s about how much you keep – and grow.