Lifestyle creep: What it is and how it works

Many Aussies will have more cash in their bank accounts each payday as stage 3 tax cuts have now kicked in. And in more promising news, 86% of employers are intending to offer pay rises according to the Hays Salary Guide FY24/25. This might all sound great, especially after the past couple of years of rate hikes, higher rents and rising cost of living, but it’s important to make sure you make the most of any extra cash that comes your way. Too often people fall victim to lifestyle creep and it can stop them from reaching their financial goals.

What is lifestyle creep?

Lifestyle creep – sometimes referred to as lifestyle inflation – is when you increase the amount you’re spending on non-essential items as your income increases. Typically, the extra money will come from a pay rise but it may also come from decreasing costs. For example, you might have paid off a loan and the money you were putting towards your repayments is now ‘spare’ cash.

The psychology behind lifestyle creep

Lifestyle creep can be so gradual that you don’t even realise what’s happening. It might have started with buying yourself the latest gadget when you scored a pay rise and before you know it you’ve upgraded your car.

As lifestyle creep takes hold your standard of living changes and items you once thought of as luxuries may now feel like a necessity. And it’s not just big expenses like a new car or boat. It could be smaller things like buying more expensive bottles of wine, eating out more often, going from one streaming service to three. All these little extra expenses can start to add up.

If you find yourself living from pay to pay or your savings have not increased even though your disposable income has, you might just be in the grips of lifestyle creep.

The potential cost of lifestyle creep

The biggest problem with lifestyle creep is that it could interfere with your money goals and prevent you from achieving financial freedom. If you’re spending all your extra income on non-essential items it means you have less money to put towards your emergency fund, retirement savings, investments or even your mortgage. And over the long term this has the potential to cost you thousands.

Let’s say, for example, you took out a $600,000 home loan at 6.88% over 30 years and your monthly repayments are $3,944. One year later, you get a pay rise of $200 a month. Add that extra money into your mortgage each month and Canstar’s Extra Home Loan Repayments Calculator shows you’d save about $123,000 in interest and shave three years and 10 months off the term of your loan.

Or let’s say you invest that $200 a month and earn 7% a year on average after fees. After 10 years you’d have $34,617 stashed away.

Who is most at risk from lifestyle creep?

Lifestyle creep can affect anyone no matter how much they earn but there are two groups that are likely to suffer the most: those close to retiring and younger savers.

Lifestyle creep and those nearing retirement

If you’re five to 10 years away from retirement, chances are you are susceptible to lifestyle creep. You’re probably in your peak earning years, your debt is likely to be on the lower end and with any luck your children are more or less financially independent. You’re in a prime position to boost your spending. But go too far and it could be to the detriment of your retirement nest egg. You may not have enough money to maintain your lifestyle when you retire.

Lifestyle creep and younger savers

Scoring your first well-paying job could put you on the path of lifestyle creep. It can be tempting to spend up big when you start earning a decent income. The risk, however, is that you become accustomed to your new spending habits and it interferes with your financial future. Saving for a house deposit might be derailed or you could neglect investment opportunities. Something to keep in mind is that the earlier you start investing, the more time compound interest has to work its magic.

How to avoid lifestyle creep

There are several strategies that can help you avoid becoming a victim of lifestyle creep. Here are six tips:

1. Create a budget

It’s a good idea to always have a budget in place so that you have a plan for how to spend your money rather than buying whatever you need or want and hoping that you have cash left over. Add up all your expenses and subtract them from your income to see how much you should have available to save each month.

2. Allow for splurges

Treating yourself every now and again can help stop you from going overboard when you find yourself with a little extra money in your wallet. You can even build a ‘splurge’ fund into your budget and only use that money on indulgences.

3. Track your spending

One of the best ways to avoid lifestyle creep is to keep a close eye on your spending. Certain apps make it easy to track your expenses and even automatically put them into categories for you so that you can see exactly where your money is going.

4. Set financial goals

Having clear goals about what you want to achieve can help you stay on track. You’re less likely to spend money on non-essential items if you’re focused on reaching a particular goal.

5. Automate your savings

Stashing money away towards your savings or investments should be a priority not an afterthought. That’s why it’s important to pay yourself first. If you have worked out that you can save $100 from each pay, then make sure that it’s automatically transferred to a separate account.

6. Have a plan in place for pay rises

Think about what you’ll do next time you get a pay rise. Not having a plan makes it much easier for the extra money to get eaten up by everyday spending. You might choose to allocate a certain percentage towards saving or investing – 75% seems to be a common suggestion – and then add the remainder to your household budget wherever you see fit.