Earning more tends to lead to spending more – risking falling into financial unfreedom. Perceptions of “richness” are often based on clichéd symbols like a polished sports car or a city villa, creating an illusion of wealth. However, this often reflects income wealth rather than asset wealth. The phenomenon known as lifestyle inflation is the automatic expansion of one’s lifestyle as income increases, often without the individual realizing it. This can occur across various income levels and may lead to dangerous consequences.
Increasing Expenditure with Increasing Income
Germans, on average, receive a 2.5% salary increase per year, allowing for a gradual increase in spending. This is evident in an Income and Expenditure Sample (EVS) by the Federal Statistical Office in 2018, showing that higher-income households spend more on daily life. The automatic nature of this process poses risks, especially when it comes to building wealth.
| Net household income | Households total | Under €900 | 900–1.300€ | 1.500-2.000€ | 2.000–3.600€ | 3.600€–5.000€ | 5.000€ |
| Private consumption expenditure / month and household on average | 2.704€ | 901€ | 1.152€ | 1.625€ | 2.551€ | 3.253€ | 4.657€ |
Maintaining Lifestyle Through Life Changes
Certain life stages witness a significant increase in both income and expenses, such as after completing education and entering the first proper job. However, this shift doesn’t always align with necessary investments. It might involve leasing cars, dining out more, and adopting a generally more luxurious lifestyle. This can lead to increased spending without a corresponding increase in wealth.
Most Spending Occurs Between 45 and 53
A report from the Federal Statistical Office in 2018 revealed that Germans spend the most between the ages of 45 and 54. This demographic allocates a considerable portion of their income to various expenses, with housing and transportation being the most significant. Interestingly, spending tends to decrease with age after reaching a peak in midlife.
Automatically Rising Costs
Not all instances of rising costs are due to a lavish lifestyle. Family expansions, like having more children, often necessitate larger homes and increased holiday budgets. However, this doesn’t negate the fact that some lifestyle choices contribute to escalating expenses.
Why is Lifestyle Inflation Problematic?
- Creating Dependencies: Allowing spending to rise proportionally with income can lead to dependence, limiting one’s freedom. Commitments like leased cars, expensive rentals, vacation home loans, or premium fitness club memberships can become constraining.
- Spending on Unnecessary Items: Increased income often results in spending on unnecessary items. This consumption spree may lead to a psychological compulsion to keep buying, known as the “Diderot Effect,” where individuals acquire more products to maintain a consistent image, often at the expense of sensible investments.
- Neglecting Wealth Building: High income, when matched with high spending, can lead to financial unfreedom. The “HENRYs” phenomenon in the USA exemplifies this, where young high earners, despite six-figure salaries, fail to accumulate wealth due to an extravagant lifestyle.
Importance of Saving Percentage Over Saving Rate
To secure a comfortable retirement, it is crucial to focus on the savings percentage, representing the proportion of income saved and ideally invested. While fixed savings rates are beneficial, they may not be sufficient for top earners facing a higher retirement income gap.
Preventing Lifestyle Inflation
- Early Monitoring: Individuals can avoid falling victim to lifestyle inflation by closely monitoring income and expenses, using tools like budgeting apps or financial management software. This helps identify and address sudden increases in expenditures.
- Establishing a Fixed Savings Percentage: Setting a fixed percentage of every salary increase to be directly invested can help strike a balance between enjoying an increased lifestyle and ensuring adequate retirement savings.
Conclusion
How one deals with lifestyle inflation is a personal choice, contingent on individual goals. Whether one finds it unbearable to be dependent on high income throughout life or is comfortable exchanging some freedoms for enhanced comfort is subjective. The key is to ensure that the lifestyle does not rise without awareness, ultimately jeopardizing wealth-building efforts.
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