Economy Issue 04 -2022 MAGAZINE
GBO_ lifestyle inflation

How to avoid ‘lifestyle inflation’?

Lifestyle inflation is an increase in spending when an individual's income goes up

Russia’s invasion of Ukraine in 2022 has given another blow to the global economy, which has already been reeling due to the COVID aftershocks. If the economic warfare between Russia and the United States-led Western bloc has been negatively affecting the energy sector, other factors like repeated COVID lockdowns in China and the monetary policy tightening race between central have been worsening things further.

So we have two things to worry about, inflation and a possible recession, for the next few months or to be realistic, for the next couple of years. The United Kingdom has been the worst sufferer of this whole crisis. Not only has its internal GDP slowdown cost the country a fall in the ranking of economic superpowers, but the political instability is also making the matter even worse. The country is on the brink of entering a recession.

With Russia cutting down its energy supplies to Europe and the G7-led Western bloc has now gone for the price cap mechanism to hurt Moscow’s trade of oil and natural gas. The British population is in a dire state as of now, be it paying energy bills and rent or shopping for daily necessities. Reports even tell that some regions of the country are going through food crises as well, with double-digit inflation figures hitting global headlines.

Moving on from the UK, let’s talk about the United States. Although its inflation didn’t touch the double figures, still it has been well over the 5% mark, thus forcing the Federal Reserve to go for monetary policy tightening, which, in turn, has made the dollar stronger (and simultaneously making imports an expensive affair for emerging and small economies).

Even though the domestic job market has been resisting the super-high inflation in a sound manner, a new phenomenon has emerged in terms of job cuts, as tech firms, which onboarded a huge number of professionals during 2020 and 2021, as communication technology witnessed its boom due to the remote work culture and social distancing amid COVID outbreak, is now witnessing a slowdown.

As per a recent report from Bankrate, full coverage auto insurance has hit a high of USD 2,014 a year due to inflation in the United States, along with labour shortages and supply chain challenges. It is now accounting for 2.9% of the average US household income.

Double-digit inflation in the UK is now forcing expat investors to rethink their retirement plans. The savings target has shifted the minimum cost of day-to-day living upwards by almost 20%, as per reports.

The Pensions and Lifetime Savings Association (PLSA) has calculated the least money a single retiree can get by is £12,800 a year, up from £10,900. At the same time, a couple needs a yearly income of £19,900, up from £16,700. For a moderate lifestyle, the numbers rise 12% to £23,300 for a single saver and 11% to £34,000 for a couple.

In short, there is no immediate escape from this economic turmoil. Inflation has gone up to that level, where even the salary revisions are failing to match up with the increasing costs. While many news reports are talking about the effects of inflation and recession on the global economy, in this article we talk about another lesser-known phenomenon called ‘Lifestyle Inflation’, something which becomes important in an environment where both job security and financial well-being have been put under stern test.

So what is ‘Lifestyle Inflation’?

Lifestyle inflation is an increase in spending when an individual’s income goes up. It tends to become greater every time as a salaried individual, despite getting a pay raise, finding it difficult to get out of debt (loans, credit card bills and EMIs), thus compromising on bigger goals like retirement savings. Under lifestyle inflation, people get stuck in a cycle of paying bills and then just managing to save enough money to survive a month.

Between July 27 and August 29 2022, financial group BMO surveyed some 3400 American adults, as part of its research called ‘Real Financial Progress Index’. The result showed that some 84% of surveyed individuals anticipate an incoming recession. Some 76% of the respondents even stated that they were making lifestyle changes to deal with the economic slowdown.

While some 34% talked about financial adjustments like delaying house or car purchases, 29% were concerned about their debt payments. The remaining 28% spoke about cutting back on their holiday spending. The study also saw 74% of the surveyed Americans expressing concerns about inflation being increased.

“People are feeling less confident than they were a year ago or even a quarter ago,” said Tina DeGustino, director of consumer strategy at BMO, while interacting with CNBC.

A recession, by a layman’s understanding, happens when two back-to-back financial quarters register negative economic growth, along with massive job losses.

The US economy, for example, contracted in both the first and second quarters of 2022 by 1.6% and 0.6%, respectively, according to the Bureau of Economic Analysis.

Despite the unemployment rate maintaining a low of 3.5%, the recent spurt of layoff reports adds a new headache for households and policymakers alike.

Another worry has been the persistently high inflation, which reached its record high of 8.2%. The Federal Reserve to has been on an interest rate hike spree since the beginning of 2022, with the goal of making the cost of borrowing money more expensive, thus reducing spending, which will slow consumer demand and ease inflationary pressure. However, falling consumer demand also means job losses.

While interacting with CNBC, certified financial planner David Mendels said, “If we do go into a recession, it doesn’t mean it will be bad or last long. And it doesn’t mean you’re going to lose your job, or if you do, it doesn’t mean you won’t get another.”

So, in short, if you are a new job entrant and sharing a three-bedroom apartment with two other individuals, stay there, cause at a time of low-income security, going for studio apartments would almost qualify as an act of lunacy. Also, try to avoid taking unnecessary loans, apart from controlling your credit card expenditures. In short, try to cut down lavish expenses and just save that money, to sail through these difficult times. Also, invest your money in savings accounts. The monetary return will help you to adjust to inflation.

So how can one avoid getting trapped in a ‘Lifestyle Inflation’?

“Six months to a year’s worth of income is what you should have in savings anyway. Bad things happen even when there’s not a recession. If you have that safety net, you can face the future more confidently,” David Mendels remarked.

He also pointed towards a viable backup option like opening a home equity line of credit, which will come in handy, if the person loses his/her job.

“You’d come out of joblessness with debt, but you’d be able to eat and not fall behind on other bills,” David Mendels concluded.

“Keep in mind that while your emergency funds generally should be in a cash account, rising interest rates mean you may be able to find a better return on your money than you’re currently getting, depending on where you keep it,” said Kathryn Hauer, a CFP with Wilson David Investment Advisors in Aiken, South Carolina.

“Open a high-yield savings account to hold your money. The bottom line is that if you’re feeling vulnerable to what a recession may mean for your financial security, it’s worth adjusting your budget so that you can build a cushion to weather a job loss,” she added.

In short, one needs a complete change in financial behaviour, to stay away from lifestyle inflation.

The very basic first step is keeping a tab on your spending. Maintain a diary, budget spreadsheet or even take the help of budgeting apps, but consider this as a necessary step to maintain your financial well-being. You need to follow a tightrope walking in the coming days, so having records of financial inflows and outflows on a weekly/monthly basis is very important.

Then make a budget for your monthly expenses. Shortlist the payment priorities and prepare a spending plan as per that. This will help you to control your expenses and save for essentials like required large purchases and even medical treatments.

Equally important is the understanding of essential and non-essential spending. A good amount of your salary (even after being inflation-compatible) goes for purposes like taxes, health insurance, food, clothing and accommodation. Vacation, buying cars and houses, and entertainment spending come under the category of ‘non-essential’ and plans on these things can be adjusted as per the economic scenario.

Disposable income is how you pay for vacation and those other non-essential purchases. For example, given the ongoing economic slowdown, you can put your plans of buying a house or car on the backburner for a few months; in case they are not among your absolute priorities presently (again it is a subjective point of view and can change person to person).

Another problem which is often encountered during budget planning is controlling the tendency of indulging in unplanned and recurring expenses. While the article is advocating hacks for avoiding lifestyle inflation, we all can afford a little bit of leeway right?

For unplanned purchases (especially non-essential ones), set a monthly spending limit. Talking about recurring expenses, also adds bit by bit to the cycle of lifestyle inflation. However, when it comes to buying gasoline and groceries, we can’t compromise there, despite higher prices. To compensate for that, we can switch to cheaper/discounted alternatives. For example, we can switch to a cheap mobile data plan for the time being. Also, keep your eyes and ears open for those discounted sales offers at supermarkets/grocery stores. And those who do frequent online shopping please try to control expenses there, unless and until it’s a product for household necessity purposes.

Also, many tend to forget about unsecured debts (loans that are not backed by collateral), such as credit card debt, student loans, and personal loans. These are ‘wealth killers’. Why is it so? Cause it doesn’t make sense to invest and actively build wealth and passive income on one hand, and then have a credit card and loan debts hanging over your head.

The individual may be earning a 10% average return from the stock market but he/she is paying 24% interest on a credit card. It doesn’t make sense because the individual, instead of investing more into tax-saving investments, is paying off the credit card/other unsecured debts. If you are one such individual, then draw up your budget plan in a manner, where you can pay your unsecured debts first. Get these commitments knocked out of your priority list. Then think about your long-term goals, including retirement, and start your savings as per that.

Talking about credit cards, if paying debts every month is becoming a difficult affair, then don’t use the card. Use your debit card and cash more, as it will allow you to spend the money which you have in your savings accounts. Each time your salary increases, you can adjust your savings account balances.

Talking about savings accounts, one should open an account and start putting money there from now on. It would be even better if you start this activity in your 20s itself. Even if you put your long-term goals on the backburner due to the ongoing economic slowdown, having steady savings will help you to complete those priorities once the situation improves. Another solution is scheduling recurring transactions into a sinking fund (a fund containing money set aside or saved to pay off a debt or bond). Also setting up separate funds as per the financial goals will be an added advantage. Be mindful of the occasional large purchases, as these can unsettle your spending plans. Instead of making these purchases with credit cards and getting into debt loops, it would be better to do the payments in hard cash.

Also, try to buy used/refurbished consumer goods instead of new ones. Facebook Marketplace, Craigslist and OfferUp will let you find the best local deals. Also, if you have unnecessary items at home and you need to pay off a loan amount as well, you can sell those old products on the above-mentioned online marketplaces. You can free some spaces at your home, along with shaking off some of your monetary worries.

If you get pay raises, instead of going after lavish items like cars and smartphones, put that amount into your 401(k) or IRA (Individual Retirement Account). You can even use that money to open other tax-saving investments, which will help you to start the process of your wealth building and boosting your post-retirement savings.

As per experts, you should be saving at least 10% of your income for retirement. Both 401(k) and IRA contributions carry tax benefits as well. Also, take advantage of tax-saving accounts when possible. While your employer’s 401(k) can be the go-to option as it allows you to make direct paycheck withdrawals, a 529 college savings plan is another good addition as these contributions can be withdrawn tax-free for undergraduate, graduate and professional educational expenses. Given the potential of student loan debt snowballing into another crisis in this recession environment, a 529 savings plan can be a game-changer here. Also, Health Savings Accounts (HSA) contributions reduce one’s taxable income. The withdrawals are tax-free in most cases. One can qualify for this scheme with a High Deductible Health Plan (HDHP).

Last but not the least, get philosophical about your financial health. Just because your friends buy expensive stuff, that doesn’t mean that you need to get involved in that materialistic rat race. Instead, use your salary hikes to pump your savings. Instead of entering an expensive restaurant or a high-profile pub, use house parties as a cheap alternative to spend good times with your friends. A dinner party at home will save you at least a hundred dollars, without sacrificing your urge for socializing. Also, interact with people who share the same financial concerns and try to discuss lifestyle inflation with them. The more you open up about the issue, the more it will help your mates to get enlightened about the topic. Also during these discussions, your mates may give you suggestions about savings schemes you haven’t heard about that much and in the long run, those tips will further boost your financial health.

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