Could you live on half your current budget?
Your knee-jerk reaction was probably no. But you likely did live on a fraction of your current budget in your early 20s. In the years since then, you’ve let your spending become bloated right alongside your paycheck. And you probably never even thought about it.
If you want to build wealth and passive income fast, beware of lifestyle inflation.
Avoiding Lifestyle Inflation
Lifestyle inflation, also known as lifestyle creep, refers to spending more money as you earn more. When we get a pay raise, most of us immediately start imagining ways to splurge. That could mean moving into a larger or more expensive home, buying a more expensive car, buying more expensive clothes, going out for costlier meals — are you sensing a pattern here?
My spending certainly bloated as my income rose. But then I made a conscious financial decision to become financially independent at a young age, and I turned back the clock on my spending. In the three years since getting serious about it, I’ve tripled my net worth and am halfway to early retirement.
Try these tips to keep money in your pocket and avoid the trap of lifestyle inflation.
1. Define Your Long-Term Goals
For example, in the medium-term, I want to be able to live and work from anywhere in the world. I want to set my own hours and travel internationally many times each year. And I want affordable child care and health care.
I have all that and more, but it required an overhaul of every facet of my life. My family and I spend most of the year in Brazil, and it took work to actively create income streams that allow these financial freedoms.
In the long-term, I want to be able to live entirely off my passive income (in other words, to reach financial independence). I hope to get there within the next three years.
None of the above was possible when I was spending almost as much as I made each year. But once I started defining my goals and designing my ideal lifestyle, I readjusted my priorities. That meant cutting spending back to levels not previously seen since my 20s, but it didn’t feel like a sacrifice because I knew I was actively creating my perfect life.
Spending less doesn’t have to mean suffering. But it does require a more intentional mindset and approach to your budget and lifestyle.
2. Lock Your Budget to Pay Off All Unsecured Debts
It doesn’t make sense to invest and actively build wealth and passive income while you still have expensive debts hanging over your head. If you can earn a 10% average return from the stock market but you’re paying 24% interest on a credit card, the highest and best use of your money is paying off the credit card debt rather than investing.
That means your first financial priority must be paying off all unsecured debts.
Lock your current budget in place and put every spare dollar toward these debts. Follow the debt snowball strategy to knock out one unsecured debt at a time.
And don’t bump up your spending budget until you’ve paid them all off, regardless of pay raises. If anything, revert to the slimmer budget from before your last raise.
You start thinking differently about money and your goals after you pay off your debts. Rather than thinking defensively, fixating on just climbing out of the hole, you start thinking offensively. Your mind opens to possibilities like designing your ideal life, such as financial independence and retiring early.
That helps inspire you to avoid lifestyle inflation even after becoming debt-free.
3. Beware Structural Expenses
Housing and transportation consistently make up around half of the average American’s household spending, per the Bureau of Labor Statistics. And they’re not easy to trim once you buy a home or car.
It’s far easier to spend less on food and beverages and discretionary costs like entertainment and apparel.
As you look to avoid lifestyle inflation, focus first and foremost on holding the line on housing and car payments. Don’t move into that larger apartment or buy that new house. Don’t buy a brand-new car to show off how successful you are.
By keeping your structural expenses low, you can manage your discretionary budgeting through other means, such as automating your savings rate.
4. Automate Your Savings and Investments
You can’t spend what you don’t have in your checking account without taking on credit card debt. So don’t let money earmarked for savings ever touch your checking account.
First, decide on your target savings rate: the percentage of your income you want to save. Then talk to your employer’s human resources department about splitting your direct deposit to send some directly into a high-yield savings account. If they can’t do that, set up automated recurring bank account transfers to your savings to take place the day after each payday.
From there, you can either set it aside for your emergency fund, put it toward early debt repayment, or invest it through your investment account. You can further automate your investments with a free robo-advisor such as SoFi Invest or M1 Finance.
You can then adjust the savings amount when you get a raise to avoid spending it.
5. Lock Away Your Credit Cards
If you run into trouble paying your credit cards off in full each month, stop using them. Lock them away in a drawer somewhere or even physically cut them up.
That forces you to change your spending habits and only use your debit card and cash, which only lets you spend the money allotted in your checking account each month.
But this strategy only prevents lifestyle inflation if you adjust your automated savings each time your income increases.
6. Plan Your Goals and Budget With Your Spouse
If you’re married, your spouse must be on board with your spending and budget plans. Otherwise, it doesn’t matter how committed you are to avoiding lifestyle inflation and reaching your financial goals faster. They could just keep spending every extra dollar as you each earn more.
Talk through your long-term goals and ideal lifestyle together. Don’t stop until you agree on a vision for how you want your lives to look.
Then talk through how you plan to achieve it and how quickly. Put all budget categories on the chopping block. Nothing is sacred. And then discuss how future raises fit into your budget and long-term goals.
Ideally, don’t lift your spending until you’ve achieved at least some of your long-term goals. But whatever your agreement, ensure you both commit and follow through.
7. Reinvest Your Passive Income
Many investments generate passive income, which adds your active income and boosts your household revenue. But that creates a temptation to spend it.
Avoid that temptation.
Instead, reinvest your passive income back into more investments. With dividend-paying stocks, you can do this automatically through dividend reinvestment plans. Many real estate crowdfunding platforms such as Fundrise and Streitwise also let you reinvest dividends automatically.
Other investments require a little more effort on your part. For example, if you own rental properties, you need to set aside your rental cash flow in a savings account to put toward the down payment on your next property.
By reinvesting your returns, you take advantage of the power of compounding, a power that can grow your wealth exponentially if you give it even a few years to build on itself.
8. Socialize With Like-Minded People
The impulse to keep up with the Joneses and feel jealous about money is simply human nature. Because you want to prove you can afford the same things as your friends, you spend more than you want to, especially when you get a bump in salary.
That’s precisely why it pays to spend time with friends who have similar lifestyles and budgets as you.
Consider an evening out with friends. Your spendthrift friends typically go to an expensive restaurant, order pricy drinks, then hit up an upscale cocktail bar or club after dinner. Your friends who live more modestly prefer a homemade dinner and drinks around a beach bonfire or at someone’s house. That could mean a hundred or more dollars in savings for a single night of socializing.
The same goes for cars, houses, and other possessions. Expect to feel pressure to keep pace with your friends’ lifestyle habits, good or bad. Depending on which friends you hang out with, that could mean overspending on housing and transportation or reaffirming your commitment to a more frugal, high-savings lifestyle.
Cultivate friendships with like-minded people who share your financial goals. Hang out with people who don’t mind driving an older-model car or living in a less posh zip code to achieve their ideal lives sooner.
9. Aim for “Stealth Wealth”
If there ever were a financial epidemic in the United States, it’s the obsession with material goods as a means of proving our wealth and success. We want our neighbors and friends to see our success, so we use pricey possessions to flaunt it.
But we also live in a country where luxury goods aren’t limited to the wealthy. Almost anyone can qualify for the necessary credit to purchase expensive goods like cars, homes, and boats without having the money to pay for them. In the end, you often find yourself competing with someone in a completely different tax bracket.
Stop measuring your success in life with material goods — yours and your neighbors’. The true measures of success are health, love, friends, family, and experiences. You don’t need to prove anything to anyone.
The paradox of wealth is that the more you spend on the trappings of wealth, the less wealth you actually build. Fancy homes, cars, and clothes might make you look and feel wealthy, but they drain precious dollars from your real wealth: your investments. It’s why financial experts encourage “stealth wealth” rather than spending as much as you can technically afford.
Ironically, by building true wealth faster and focusing more on experiences, those still living paycheck to paycheck will envy you when they see how quickly you can achieve the quality of life you want. You’ll be doing things like retiring early, traveling, or sending your kids to college debt-free while they’re still paying off debt into their later years, a major regret of many older Americans.
10. If You Must Spend More, Set a Percentage
You may be wondering what the point of working so hard to earn more money is if you can’t spend it. The answers are plentiful. Examples include:
- To build wealth faster
- To help your kids with college costs
- To cover the cost of training for your ideal career rather than your current high-stress career
- To retire a few years from now and travel the world
But not everyone finds those reasons as compelling as I do. Most people need at least a little bit of immediate gratification.
If you can’t help but lift your spending when you get a raise, set aside a percentage of it to spend and enjoy now. But not all of that raise is yours to keep. Uncle Sam takes more of it than you necessarily realize. And unless you live in a state without income taxes, your state and even city might skim some money off the top as well.
So calculate that percentage set aside for spending as a portion of your extra take-home pay after all income taxes have been taken out. A $1,000 monthly raise might only leave you with $600 net extra income, so spending a third of it means $200, not $333.
Luckily, you have plenty of options for tax-advantaged accounts, such as individual retirement accounts, 401(k)s, health savings accounts, and education savings accounts, if you want to invest your extra money where Uncle Sam can’t reach it.
Most people rush to find ways to spend their raise as soon as they get one. Avoid that trap if you want to escape the rat race, constantly running on the hedonic treadmill.
Real wealth and your ability to change your life lie in your investments, not in an enormous home, fancy car, designer clothes, or the latest gadgets. But in investments that generate passive income for you.
Income that comes in while you’re sleeping, coaching your kids’ little league team, or vacationing has the power to change your life by freeing you from your high-stress job.
Don’t aim to be like everyone else. Design your own unique perfect life and turn it into a reality as quickly as possible.